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Deeds of trust as investmentDeeds as Sound Investments
by David L. Guglielmi
February 20, 2009
I love owning paper!
Paper, for those not in the real estate business, are debt instruments called "notes" which are secured by real estate. Examples of "paper" include mortgages, trust deeds, real estate contracts, and other debt devices used when real estate is sold, transferred, or otherwise encumbered without a full payment of cash to the seller.
Why do I love paper? Let me count the ways!
A predictable monthly cash flow
A cash flow completely secured by valuable real estate
The ability to buy paper at discounts to its current value, often between 12% to 24%
The potential to profit in foreclosure if a note payor stops making payments
Instant equity if a note is purchased at a discount AND MUCH MORE.
In other words, all the benefits of real estate without any of the management responsibilities, capital expenditures, repair and maintenance concerns, or liability issues of owning rental properties.
I am an active paper buyer of established notes. People know I'm in the market and call me when someone has a trust deed paying a sum each month (say $500) but they need all cash now for some reason (like $10,000 to pay the IRS or buy a new home). You can make great money and build a predictable and steady income buying existing paper.
But my favorite way of obtaining paper is to create it using land as collateral.
Here's how to do it.
Say you purchase a parcel of land that can be subdivided into building lots. Each lot cost you wholesale $25,000 and would sell for a 20% all cash markup or $30,000.
If I took cash for each lot, my profit would be $5,000. Not bad, but here is an alternative.
I'd offer them for sale this way:
Price: $32,000
Seller Financing: $2,000 down, 120 months, 8% interest, payments of $363.98/month.
What happens here? Why finance the sale this way?
What's the benefit to me as seller?
The land will sell faster. Seller financing on land makes it easier to find buyers.
My profit is now $7,000 instead of just $5,000 on a cash sale. I receive $2,000 plus the original retail markup of $5,000. That is 40% more money instantly!
But the best part is my yield on the note!
Any financial calculator will tell you that my yield on this note is NOT the coupon rate of 8% (what the buyer is paying to use my money) but actually 14.49%! That is the present value of this note to me is not $30,000 but $23,000 which is my cost ($25K) minus the down payment received ($2K).
In other words, I have created a note which earns me almost 15% completely secured by real estate!
But things can get better still.
What if I offer this buyer of my land this deal?
Instead of paying $363.98 per month for 120 months at 8% how about this offer instead?
If the buyer agrees to double their monthly payment to $727.96, I will cut their interest rate in half to 4% and this loan will pay off in not 120 months but just 45 months. This means their loan will be paid off more than six years faster and save them thousands of dollars in interest.
Would some buyers jump at this deal?
YOU BET! And with good reason! It is a great deal for them.
But it is an awesome deal for me! Instead of earning 14.49% on the original note, I'm now earning 19.78%! And getting completely paid off six years sooner!
Imagine a bond completely secured by real estate that pays 20% a year. That's what I've created with land.
If you understand "Time Value of Money" mathematics you can understand the potential here. Instead of buying existing notes,you can create them instead using land you've purchased and can wholesale for long-term financing profits.
The bottom line:
You can buy land at wholesale prices, sell it at above retail prices by providing financing and earn 12% to 25% or more on the notes you create when you do it!
The opportunities with land are endless! |
