What is Creative Deal Structuring?Posted on April 3, 2012 by
One of the hot topics in real estate investing these days is something called creative deal structuring. This leads to a question that we’re often asked: What exactly is creative deal structuring?
To answer this question, we need to begin by describing what it’s not. One way you can buy a property is to pay cash for it. You won’t find any creativity in that deal structure. You can also find a property you like, apply for a mortgage, and then a month or so later, go to an attorney’s office to sign a big stack of hard-to-understand documents. Not much creativity there either.
Creative deal structuring begins when you find someone with a real estate problem that “normal” solutions can’t resolve. For example: A homeowner owns a nice home that in 2006 was worth $130,000 but today is only worth $70,000. She owes $80,000 on her mortgage – making her upside down by $10,000. Now throw some motivation into the mix – the lady needs to sell immediately so she can move to Tennessee and begin her new life.
Let’s see, a cash buyer wouldn’t be interested in this deal. And you’d be hard-pressed to find a realtor who would list this house – unless it’s a short sale listing. So how would you structure this hopeless situation?
Here’s one creative way: The owner’s monthly mortgage payment with taxes and insurance is $500. You agree to lease the property for $500 a month. You have the right to sub-lease the property to another tenant. Similar properties in the area rent for $900 per month.
OK, let’s look at the benefits of this structure – after all, no homeowner or investor would agree to this deal unless both end up in a better position. The homeowner gets the mortgage payments off her back, can pick up the tax benefits that come with owning rental property, finds someone who will manage her property, and she’s able to move to Tennessee. The investor, on the other hand, picks up a great rental that spins off $400 in monthly cash flow with little risk or up-front money.
You may be thinking: $400 a month? So what? Chump change!
But consider the bigger picture: What if you had ten of these properties in your investment stable? They’d bring in $4,000 a month in mailbox money. And if you had 20, it would be $8,000 a month. OK, would-be investor, roll this question around for a bit: If you were able to bring in an extra $8,000 a month, would you keep working where you work today?
Now for three big questions: Did the owner end up in a better position than where she started? Did you end up in a better position? Was this a win-win deal for both of you?
Want to make this deal better and even more creative? You agree to the deal as long as the owner will give you an option to buy the property at anytime in the next ten years for what it’s worth today – $70,000. You agree to split the upside 50-50 with the owner.
Do you think real estate values will increase over the next decade? Let’s say this property climbs to its 2006 value of $130,000. You exercise your option, buy the property for $70,000, and sell it for $130,000. You and the owner split the $60,000 profit 50-50.
Does the option improve the deal? Do you think it’s important to learn more about creative deal structuring?