What to Know Before Structuring a Creative Finance Deal (Rookie Reply)

Ashley Kehr:
So you’re ready to start investing, but the next step can look very different depending on your situation. Maybe you’re 21 and trying to house hack in an expensive market. Maybe you’re about to inherit a large amount of cash, or maybe you’ve made an offer and suddenly need proof of funds.

Tony Robinson:
Today’s questions come straight from the BiggerPockets starting out for them, and they’re all about slowing down just enough to make the first move the right way.

Ashley Kehr:
This is the Real Estate Rookie Podcast. I’m Ashley

Tony Robinson:
Carroll. And I’m Tony J. Robinson. With that, let’s get into our first question for today. So question number one comes from Brandon and he says, “I’m currently in college and very interested in getting into real estate investing. I’m in a local networking group where I have a few real estate investing people, and that’s how I discovered BiggerPockets in podcasts, which I’ve used as my main resource. I’m very interested in house hacking as I feel that’d be my most realistic way to get started. Has anyone gone down this path? And could you share any thoughts, advice, et cetera? I’m in New Jersey. The market is extremely high, which is my biggest concern about getting into it, but I’ve built good credit, which I know is useful. Thanks everyone.” Now, first, before we jump in, let me just clarify for those that maybe don’t know, what do we mean when we say house hacking?
So basically house hacking is you buy a property and instead of living in all of that house yourself or all of that property yourself, you’re simply renting out in the additional living space. It could be you buying a big single family house where you’re renting out other bedrooms. It could be you buying a house with a walkout basement. It could be you buying a small multifamily. It could be a house with an ADU. There’s a lot of different forms that house hacking can take, but the essential idea is that your primary residence, you leverage that extraditional space to turn into a rental. So just clarifying what the strategy is. Ash, you’ve never house hacked before, right?

Ashley Kehr:
No, I haven’t. I mean, besides my college dorm, I guess. But I didn’t own it, I guess. So it’s just paid rent.

Tony Robinson:
I haven’t either, but we’ve interviewed a ton of guests, a ton of ton of guests on the podcast who got their start in house hacking. And I mean, you’re just asking for advice. I’ll give you my take from all the stories that we’ve had on the show is I think for someone in your position, it is the absolute lowest barrier entryway to get started. Like Ashley just said, she already had roommates when she was in college. And say you are to buy something, you’ve probably already got roommates right now. So you’re just transitioning from you and your roommates paying some landlord to now all of your roommates paying you. And I think that is the easiest transition. You literally take all the people you’re living with and say, “Hey guys, you want to come with me and we’ll get this nicer place and I’ll maybe charge you guys a little bit less?” And that’s how you can get started.
So the benefits of house hacking are that typically your cost sign into the deal are going to be a lot lower, 5% down, 3.5% down, sometimes 0% down if you can get the right loan. And it allows you to live in a place that’s maybe more expensive like New Jersey and still reduce your own living expenses by having someone else cover that cost. So all in all, I think it’s probably one of my favorite strategies for someone in that specific situation.

Ashley Kehr:
I think you really emphasized a key point as to reduce your living expenses because I think sometimes there’s this theory that in order to be successful at house hacking, you are paying $0 to live there and you’re getting all of your expenses covered. That doesn’t necessarily make it the successful deal. Even if you reduce what you would go and pay rent somewhere else, you’re able to save that little extra money. So you’re already making out. Even if you were to pay $2,000 towards your house hack mortgage, and that’s the exact same amount you would be paying for rent somewhere else. It seems like a wash, but it’s not because you’re getting equity in that property. You are getting mortgage pay down, you’re going to get depreciation on it when you turn into rental, and you’re going to actually have an asset that you own compared to if you were paying rent.
And if you’re buying in a high cost of living area and has seen a lot of growth, a lot of appreciation, that appreciation can be big money even if you are paying the same amount or similar that you would in rent because you’re having a tenant pay for at least part of your mortgage payment. So I think don’t get too caught up in having a successful deal of not having to pay anything to live. A great deal could just be that you are paying the same amount you would in rent somewhere, but you’re having a bigger place, you’re having some of your utilities paid or whatever it may be, sharing with the other person you’re house hacking with. But really just that appreciation, that equity you’re building from appreciation and mortgage pay down plays a lot into building wealth in the long run.

Tony Robinson:
Let’s just clarify next steps because just to give a bit of an action plan here. I think the very first thing that you need to go do is go talk to a lender to see what can I actually get pre-approved for. I remember long before we bought our first primary residence, I went and I talked to a lender and I’m in Southern California and she was like, “I can approve you for like $275,000.” And for me in California at the time, that truly couldn’t buy me anything in the city that we lived in. So I was like, “Okay, I’m still a few years away from actually being able to own something in the area that I live in.” So I think just going there first to get an idea of what can you currently get approved for. And you might be surprised, maybe you get approved for a little bit more, maybe you get approved for a little less.
But either way, you walk away with some clarity on what you need to do next. Because if you are approved for an amount that actually gets you into something in that part of New Jersey, well, now you can start using that to build out your buy box to, okay, well, what kind of property do I actually want to purchase? Then you go start talking with agents and you build your buy box and you submitted offers and you can go down that path. And if the lender’s like, “Hey, you’re 21. We can’t approve you for anything, but here’s what you need to do in order to get that approval.” At least now you have a roadmap on what to focus on next to get you there.

Ashley Kehr:
And I think that’s a great idea too, because you’ll be able to talk to the lender about having that renter in your unit as additional income because a lot of lenders won’t actually take 100% of the rent and actually allocate it as income. Sometimes only take a percentage of it. So that’s something to talk about with your lender because if you plan on, okay, I’m going to have somebody pay a thousand dollars, that’s a thousand dollars I don’t have to worry about for my debt to income, but sometimes they’ll only take a percentage of that and not the full amount for your primary residence. So make sure you ask the lender about that too and when you’re going to get pre-approved as to see what amount you actually need to charge in rent to make it work because you don’t want to get pre-approved for an amount and then realize that it’s not going to work out because the tenant isn’t going to be paying the amount of rent that you actually need because they only take a percentage of that.
Okay, so coming up, we have a rookie investor who is inheriting $700,000 and wants to know if it’s enough to go full-time in real estate investing. We’ll be right back after a word from our show sponsor.
All right, so we talked about getting into a house hack. Now let’s look at a different rookie situation. Someone’s having a large amount of cash come in and wondering what’s the best way to use it and how they can actually go full-time real estate. So this question is from Andre. “I want to build a real estate portfolio to replace my income from my jobs. As the title states, I’m very lucky and likely inheriting roughly $700,000 by the end of the year. I earn about $4,000 per month and not for my job. Since I was 13, I would watch Brandon Turner and Meet Kevin videos on the Burr strategy and house hacking. It might finally be the time to make it a reality. Is it possible in LA to make this my full-time thing already or is $700,000 not enough? Thank you. Okay. Well, first of all, Andre, I’m glad that you are planning to use this lump sum of cash that you are getting very wisely instead of going out and buying your very own Lambo.
And also awesome that you’ve been learning about real estate investing since you were 13. That’s great. So you’ve already got a lot of knowledge and I’m sure and done a ton of research on this. So I guess Tony, I’ll take this more from you, but as far as living costs and cost of property, I know LA is a high cost of living area, but ideally could $700,000 buy you one property? Would you recommend splitting it up into different down payments? I mean, in my market, $700,000 would get you several properties, decent rentals, but what about in LA market?

Tony Robinson:
I mean, you could get a property in LA for that amount. So I don’t know if investing all of that capital necessarily into the LA market would be the right play if we want to focus on cashflow. Now obviously there’s a lot of different strategies that we can focus on to get you there, but I think if we just look at the facts around the table, we’ve got $48,000 a year in income that we want to replace. We’ve got a 700K kind of pile of cash that we can go work with. There are several real estate strategies today that can get you at least a 10% cash on cash return. And even more that can get you higher than that. And even at 10% on 700K, that’s $70,000 a year, which is more than the $48,000 that we need to replace. We still got some room to up there.
So I think the very first thing that I would do here is first just try and identify what cashflow focused strategy do I feel aligns best with who I am, how I like to operate? And I would maybe narrow down the strategy first. Again, we’ve had the good fortune of interviewing a lot of people on this podcast who’ve done a lot of different things. You can rent by the room. We actually just interviewed Han Stone who did, not too far from LA, but he was doing assisted living facilities. And he was making almost what you make in a year. He was making that per month with his assisted living facilities. Could you do something like a sober living facility? Could you do short-term rentals? Could you co-host for other people where you’re managing? There’s a lot of different strategies. So is the pile of cash enough to replace $48,000 a year?
I think absolutely yes. But the bigger question is what strategy do you want to focus on to actually execute that? But is buying just like a traditional long-term rental or even a house hack in LA, is that going to be the best move? I don’t think so. There’s probably some other players we can go focus on that’ll get you there a little bit faster.

Ashley Kehr:
Okay. So I’m going to take a little different route on this. I got two different options for you. One option, you throw it all into a brokerage account in the stock market. If you got 6% just in one year, that would be $43,000 in interest. That basically covers your salary. So you could keep that $700,000 in the stock market and just pull out that $40,000 each year and you would continue to have 700,000. If it earns more, I think I actually looked at one of my retirement accounts and so far this year I’ve had a 20% return, even more. So that is also an option. I love real estate, but I also like index funds and brokerages. Okay. Next option is you do a mix of both of those. So the first thing is you’re going to take some of that money for a down payment to do a house hack.
I’m assuming probably don’t have a property now. There was no mention in it if he has a primary residence or not. If you do not have a primary residence, I would buy a property, use part of the money as a down payment and start house hacking. Then I would take the rest and I would put it into a brokerage account and let that money grow. Then I would get your house hack going and I would continuously do a new property every single year. So live in it for a year, move out, rent it out, go to the next property. I would take money out of your retirement account, or not your retirement, your brokerage account to fund the next property purchase. And this may not be the best way to actually go full-time real estate investing, but I think that if the longer you can work your W-2, it’s going to be easier to get pre-approved for loans.
Maybe you could cut down to part-time because now if you’re house hacking, you’re having a lot of your living expenses covered for you. So that’s what I would do. I think I would do a mix of both of those. I wouldn’t go and blow it all on real estate investing in the first year at least.

Tony Robinson:
That’s a great point, Ashley. I like that approach of just sticking it in somewhere to the market or wherever it may be and letting it grow. There are even just high yield savings accounts right now that are still paying 3% just for leaving it in a savings account. So that’s a good point. I guess there are a few options here.

Ashley Kehr:
Yeah. And I think just starting out too, you’re going to be a better investor if you take your time. And if you have this large cash, instead of taking all of this and investing, putting all your eggs in one basket, I like the part of breaking it up and house hacking every single year and doing that for the next five years, you can accumulate some really nice properties and a good sized portfolio.

Tony Robinson:
I think the other thing too is that I wonder, because a lot of people talk about wanting to leave their jobs and sometimes maybe it’s not necessarily that you want to stop working. Maybe it’s just a change of the work that you’re doing. And maybe that 700K gives you some flexibility to maybe you go work with a big flipper or a wholesaler in Southern California. I’m sure there are a lot of them who would love someone who can help project manage or do things like that. So could you even just transition into something that’s maybe more real estate related? And even if you’re making a little bit less to begin with, that’s where you can use the 6% that’s coming off of the 700K to help tie things over while you build that up. So lots of options here, but I like that we’re at least having this conversation about how to use the money the right way.

Ashley Kehr:
Yeah. And the last thing I would add is look at the market that you’re looking and buying in and see what appreciation has been over the course of 10 years, and then compare that to how the money would do in the stock market too. So I would look at both of those and kind of compare and make sure you take into your account your mortgage pay down that your tenant would be paying as part of that calculation too.

Tony Robinson:
All right. We’re going to take a quick break, but when we’re back, a rookie has an accepted creative offer and needs proof of funds by Monday. We’ll talk about what proof of funds really means and why rookies need to understand financing before they write the offer. All right guys, our last question today comes from Jehoo, and this is a good one for any rookie tempted by creative finance because what happens when you get a deal under contract before you know exactly how the money will show up? So here’s the question. Jahu says, “I’m looking for some guidance from experienced investors. I have an accepted creative offer on a triplex in Winston-Salem, North Carolina. I need proof of funds by Monday. I’m a newbie and I’ve never heard of proof of funds until now. So here’s the offer structure. The price is $445,000. The cash at closing is $385,000.
There’s a due diligence cost of 2,000. Seller financing for 60, 7% interest, 30-year amortization, a 24-month balloon. There’s a promissory note, and the seller will contribute up to 5K towards closing costs. Jehoo says,” I’m exploring private capital to fund the 385K needed at closing. For those who have structured deals like this, how do I provide proof of funds by Monday? What’s the best way to raise the capital on a tight timeline? Would hard money make sense here or would you avoid it? I’m open to advice, introductions, or potential partners. Thanks in advance. “Well, first let me say, for all the people that I’ve met who want to get started in real estate investing, their typical blocker is analysis paralysis. Is that they look at a million deals, but they never actually pull the trigger on anything because they’re like,” I have to figure everything out.
“So Jehoo, even though you may be in a little bit over your head right now, I still love the fact that you found what you thought was a good deal and you took action, you’re kind of figuring out along the way, because even if for whatever reason you can’t get proof of funds by Monday, I still think the learning experience of trying to make this whole thing work is exponentially more valuable than probably even the deal itself. So I just want to start with that. But I think, Ashley, let’s just kind of lay out the details of this offer. So the purchase price is 445,000. The seller is willing to finance 60,000. So the other 385 has to come from somewhere. The 60,000 that the seller is financing is being offered at a 30-year amortization, which means they’re spreading out those payments over 30 years at a 7% interest rate.
However, there’s a 24-month balloon. So 24 months after they closed, Jay, who’s got to pay back everything that’s owed on that 60K that was lent out.
So there’s a few things that come to mind for me I think to be able to really guide which way makes the most sense. But I think I’d want to know, Ash, what is the business plan with this deal? Is this a turnkey rental where tenants are already in there, they’re paying, there’s no upside renter at the top of the market? Or is this like a hoarder house where you’re going to have the ability to really go in there and fully renovate the place and either flip it or sell it or flip it or rent it? Because I think the exit strategy kind of defines what method you should take because if it is a big value add play, then yeah, I do think that maybe bringing in hard money could be the quickest fix because they’re going to be able to give you the cash that you need to renovate the place as well and then hopefully pay this guy off in 24 months.
But if it’s just like a turnkey deal, I don’t see a super easy path forward to be able to have proof of funds by Monday and kind of execute the business plan. But those are my initial thoughts. What are you thinking Ash?

Ashley Kehr:
Yeah. The best bet, if it is a turnkey thing and you can’t find a private or a hard money lender is going after a private money lender. So basically contacting anyone and everyone you’d know over the weekend. And basically if you find someone that would be interested in lending you that money for this deal, then basically they will show that they have enough funds and they are going to lend you the money. So oftentimes it’s a letter from their bank stating the amount. Sometimes it’s just a bank statement showing the amount of funds they have in their bank. But typically when sometimes a buyer, I’m sorry, sometimes when a seller accepts an offer, they want to make sure that they’re accepting the offer from somebody who has the money to actually close. Because this is an example, your situation right here that if you go out and you end up can’t find anyone to actually fund this deal, you’re going to have to back out of the deal.
And that’s something they want to make sure there isn’t any risk to that happening or to lower the risk of that happening by showing that you already have the money and can show where you are getting it from. So I would say reach out to as many people as you can this weekend. Post your deal in the BiggerPockets forums. Reach out to friends and family and not even say, would you be interested in this deal? But ask them if they know anyone that would be interested in this opportunity. And then if you had an idea of how you were going to structure that, so you need the 385,000 and it’s a 24 balloon note on the 7% interest that you’re doing for seller financing. So how would you structure this other set of financing? Would you also do it for 24 months? And then you’re making sure you’re going and getting a full mortgage to pay everybody back in those 24 months.
Kind of have an idea of the amortization and the terms and any balloon payment that would make this deal work for you. So however you ran the numbers, I would assume you ran borrowing 385,000 at X percent over a certain amount of time to make sure that the deal makes sense for you and put that into the opportunity for somebody to invest with you kind of what you’d be willing or able to pay them in interest and for how long too.

Tony Robinson:
I think the other thing that comes to mind too, Ash, is just like, do you need creative financing on this deal? I feel like to your point, that 24-month balloon, it’s going to complicate whatever other financing you get as well. And oftentimes a lot of even hard money lenders, they won’t want you to have any sort of second mortgage against the property. They’ll want you to have some skin in the game is what they call it where you’re bringing some form of capital to the table as well. I just wonder, if you go to maybe a credit union or local small regional bank in Winston-Salem and say, “Hey, I’ve got this deal that I think is a really good deal. Can you take a look at it?” And maybe the interest rate is a little bit higher, but if they’re giving you a nice 30-year fixed mortgage, you don’t have to worry about the balloon or all those other things.
So I think that might be one thing that I look at as well as like, “Hey, are there other maybe more traditional types of financing that will work better for your situation given that you don’t have necessarily the proof of funds to move forward with it?” Now, as a last resort, I don’t know how well connected, Jay, who you are in that market, but if you know any wholesalers, maybe you can go present it to them. And if you don’t necessarily have the cash to take it down yourself, can you connect with one of these wholesalers and say, “Hey, look, I’ve got this under contract. Give me a portion of the assignment fee if you can find someone else to go take this deal down.” So you don’t get the deal, but at least you get some sort of financial benefit from having done the work of putting the contract together and the wholesaler’s going to go push it out to their market to see, hey, which of their buyers can actually move by Monday to get the deal taken care of.

Ashley Kehr:
Well, thank you guys so much for joining us for today’s episode of Rookie Reply. I’m Ashley He’s Tony. And if you’re not already subscribed to our YouTube channel at RealEstateRookie, make sure to subscribe and comment on this video if you have questions that you want us to use in our next rookie reply. We’ll see you guys next time.