For Newbies

Closing Different Types of Real Estate Deals as an Investor

Closing Different Types of Real Estate Deals as an Investor

If you’re following the AdWords Nerds blog, you know that we’ve covered a lot of topics about real estate investing. What we haven’t covered yet, though, is closing different types of real estate deals, which we’ll remedy in today’s article. 

At first glance, this might seem like a topic for newcomers, but what follows is meant for seasoned real estate investors, too. How’s that possible? Well, real estate markets were tough on investors in 2021 and one of the best ways to survive a seller market is to make sure that you optimize the way you close deals, streamline in-house processes, and cut all unnecessary costs.

In the following paragraphs, we’ll break down different types of real estate deals. The idea is that by revisiting real estate investing basics, you might change your perspective on some of these types of deals (maybe start closing new types of deals) – an approach that has merit given the market circumstances.

The Multiple Close Model

Being able to close multiple types of real estate deals is important for real estate investors, even when meeting business goals is easy. We’ve discussed this elsewhere:

So they [investors] have the ability to flip when there’s a lot of profit to be made, they have the ability to wholesale when maybe there’s profit to be made but they don’t necessarily want to do the work, and they have the ability to work with leads that want retail price on their home.

We termed it the multiple close model and it allows you to make the leads that land in your sales funnel more valuable for your business, since you can close them using more than one investing strategy. Aside from stopping leads from falling through the cracks, it also helps you to find new revenue streams and to diversify your investment portfolio – making your business more resilient to change overall.

The multiple close model is great, but can you close real estate deals using different investment strategies? This is the biggest issue for real estate investors out there because in order to do a flip, do a wholesale deal, or sell at retail price, you need to set up your business in a certain way. You need to consider things like:

  • tools and processes for estimating deals;
  • experience as a real estate investor;
  • handling legalese and paperwork;
  • dealing with specific business operations, etc.

It’s a complex issue and we can’t help you with that. What we can do is run through the pros and cons of closing each type of deal – maybe you’ll realize that your real estate investing business can easily start implementing alternative exit strategies.

On that note, let’s dive into the list.

Types of Real Estate Investing Deals

We will share basic info on each type of real estate deal, and compare the pros and cons of closing them.

Wholesaling

In real estate, to close a wholesale deal means that you act as a middle man between a house seller and a buyer. The catch is to find a motivated house seller willing to sell their property below it’s market price, to put it under contract, so that you can sell it to the prospective buyer at a higher price and keep the difference as profit. You sell the property as is (without doing any remodeling work to increase it’s value) and sometimes you close with the seller and the buyer in the same day – this is a perfect scenario. The profit from wholesale deals works like finder fees do (and can be expressed as a percent of the deal), because you find an investment opportunity for a cash buyer, and they can rehab the property or do whatever they please with it.

Pros of Wholesale Deals

  • You don’t need a lot of capital to close a wholesale deal – you only need enough to give earnest money to the homeowner and lock the house under contract until you find a cash buyer. To do a house flip in a competitive market, you need hundreds of thousands, but you can close a wholesale deal with $10K.
  • You can close a wholesale deal even if you have bad credit since it’s easier to raise the required money for this type of deal.
  • Wholesale deals are great for making the first steps in real estate investing – you can learn a lot about the industry by simply finding deals for other investors.

Cons of Wholesale Deals

  • You can lose the upfront payment – it depends on the terms of the contract, but it can happen. If you don’t find a cash buyer within a preset time frame, the seller might keep the upfront payment.
  • You need an extensive network to close a wholesale deal – networking is crucial for building a list of cash buyers who are able to buy a property on short notice, and this is not an easy task, especially when you start out.
  • The profit is not fixed – if everything goes well, you will make thousands of dollars on the deal, but some cash buyers might proceed to complete the transaction only if your spread is tight.

Reverse Wholesaling

Some investors do wholesale deals in a reverse order to reduce the risks associated with holding a property under contract. So, you first lock in a cash buyer for the property and then you go and negotiate a good deal with the property owner. It’s a sub-type of wholesale deals, and Corey Geary, one of the guests on our REI Marketing Nerds podcast, employed this strategy to do more deals during the pandemic.

House Flips

House flipping has become synonymous with real estate investing thanks to popular TV shows. We all know how flips work: you get a distressed property, you rehab it, and you sell it for profit. It’s what real estate entrepreneurs do (it’s not really investing), because you take a resource (ugly house), you increase its value (by fixing it), and the profit comes when you find a buyer (for the finished product) – it all resembles an industrial process.

Pros of House Flipping

  • You can get high returns within months – if you get the house below market price and rehab it within a fixed budget under a time constraint, when you sell it you can collect returns as high as almost 100% of its original price (depending on the market).
  • You learn about every aspect of the industry – you work with contractors, attorneys, real estate agents, all sorts of professionals, and you come into direct contact with sellers and buyers in the market. It’s an unparalleled learning experience that you can use in future deals.

Cons of House Flipping

  • The fixer-upper process depends on hiring the services of others – this is particularly true of your team of contractors. In construction projects, deadlines are often exceeded, while the quality of the work that is done can vary, so you have to be on top of all this and manage the process.
  • You risk holding the property for too long – every time you move a deadline, the property management costs go up and this creates a dent in your returns.
  • The rehab project can be taxing, on every level – you might be overwhelmed by the amount of remodeling work that needs to be done for you to turn a profit, the costs of the construction work may significantly exceed the budget that was set based on your initial estimates, you may need to obtain building permits you never knew existed, etc.
  • Taxes can diminish your returns – change in property taxes while you fix the property and capital gains tax cut into profits.

The Live-In Flip

There is a sub-type of house flips that can help you address the dents from capital gains tax. It’s called a live-in flip, and, in a nutshell, you get tax breaks if you rehab a house in which you live. To qualify for Section 121 exclusion, you need to live in the house full time (to use it as a primary residence) and to stay there for at least two years before you sell it.

Live-in flips come with a trade-off: you save on taxes, but you are tied to the property. And even if you aren’t really there while the construction work is being done, you have to sort the logistics of moving in and moving out. If you need to move before these two years elapse, you will get only a partial tax break (depending on the reason: health issue, change of jobs, military deployment).

Buy and Hold

The idea behind the “buy and hold” real estate investing strategy is to profit from an increase in value over time – because in past decades sale prices of property have gone steadily up. As a property owner, you need to sell the house to cash in on the profit (relative to the price at which you bought it). Real estate investors look for ways to secure a positive cash flow in the meantime – because if you aren’t collecting some form of return, even if value appreciation goes up and is in your favor, bills for property management pile up, and you don’t see any profit until you sell the house.

So, these buy and hold properties usually end up as rental property investments. There are many ways to secure cash flow from a rental property, though.

BRRRR Deals

BRRRR is more of a method or an investing strategy than it is a type of deal. It stands for Buy-Remodel-Rent-Refinance-Repeat. In terms of real estate deals, BRRRR is a house flip deal, but instead of selling the property at the end of the rehab project, you keep it and rent it out.

Pros of BRRRR Method

  • The ROI is high – when you refinance the loan, the second loan is based on the after repair value (ARV) of the property, which means that you build equity that surpasses the amount you invested initially. You only need to keep the property long enough for this to materialize.
  • You can collect higher rent – since you are renting a property that was recently remodeled, you can increase rent relative to other buildings in the area. Also, rehabbed properties have lower vacancy rates, they are rented faster, and they attract good tenants.
  • The process is scalable – this is where the Repeat part kicks in. You can expand your real estate portfolio by simply repeating the same steps on a different property.

Cons Of BRRRR Method

  • The costs can go over budget – as with any other flip, you need to be great at estimating rehab costs. Also, if your occupancy rate is low, the costs go up.
  • The terms for the first loan can be tough – especially if you take a hard money loan. Interest rates are usually high, which can cause negative cash flow at the beginning and this will put you under pressure as you complete each step of the BRRRR method.
  • You can overestimate the ARV – if the value appreciation after rehabbing is off because you focused on repairs that don’t matter, you’ve got a botched BRRRR.

Rental Investment Properties

Getting a property to rent it out to tenants is a wealth-building strategy, but when you close the deal it’s important to consider whether the property under contract can be rented. There are dozens of ways to rent a property, and we will review those that are most popular with real estate investors.

Pros of Rental Property Investing

  • Rents go up over time – this is partly to keep up with inflation, but it will provide you with positive cash flow as long as you reduce vacancy rates.
  • You can enjoy tax depreciation – if you do the paperwork, you are eligible for tax write offs, although you need to study rental property depreciation to do it right.
  • You get a passive monthly cash flow – it’s money you can use to pay the mortgage, to get better loan amortization, to invest in other properties – rental income can be used in many ways.

Cons of Rental Property Investing

  • Landlord duties are a real drag – you have to deal with tenants (to screen their criminal and credit history, to make sure their payments are current, to cater to their needs) or to pay someone else to do this for you.
  • Property management is not an easy task – the property sustains wear and tear, you need to hire a cleaning service, handyman, and contractors, or do all of this work yourself.
  • You need a lot of capital – either you get into debt or you cough up a lot of cash. And this is not a liquid investment, if you need the money it’s hard to pull it out of the property on short notice.

Let’s turn to specific hacks for investing in rental property.

1031 Exchange

To those who aren’t into real estate or accounting, “1031 exchange” sounds like something that doesn’t really make sense, but actually, it’s a tax deferring strategy allowed under IRS Code Section 1031. In a nutshell, you exchange one rental property with another property of equal or greater value and you can deffer capital gains tax. It’s a way to build your investment portfolio without having obligation to pay tax on sales (although sometimes partial taxes still apply).

If you learn the rules of 1031 exchanges, you will have a tax shelter method under your belt, which is a great way to cut costs of doing real estate deals.

Turnkey Rental Properties

This is a property that already has tenants (or is ready to be rented to tenants). Turnkey rentals are usually managed through platforms that remove the hassle of property management, screening tenants, and analysis of real estate market data. While these peer to peer platforms for turnkey rentals make investing easy, they also charge fees, which will create dents in your returns.

Rental Debt Snowball

It’s a method to mitigate risks when you run multiple rental properties. Rental debt snowball means that you put together the cash flow from all of your rentals (and other capital as well) into repaying the mortgage on one of those properties. For example, if you have four rental properties, you collect all the cash flow to pay off the mortgage on one of them – you get rid of the debt four times faster and you end up owning one of these properties free and clear. The rental debt snowball method can be a source of stability and help you to increase your investment portfolio.

There is another strategy that is similar to rental debt snowball – it’s called the all-cash rental plan, and it entails saving up cash to buy property without going into debt.

House Hacking

House hack is one of the oldest real estate investing strategies: you buy a duplex, you move into one unit, and you rent the second unit to tenants. It’s a hack because the tenants are paying your mortgage. Also you can get a better loan terms because small multifamily units are considered residential loans, as opposed to investment loans (similar to tax breaks for live-in flips).

Since you live in the same place as your tenants, it’s much easier to complete all landlord duties as well, because they are your neighbors.

Short Term Rentals

You can also rent to people who need a short term stay, as opposed to finding a tenant that will stay for months on end. Usually these are vacation rental units for corporate travelers and tourists, like the properties on AirBnB.

Pros of Short Term Rentals

  • You don’t have to own the property to profit from short term rental – you can rent a property from the owner for the whole season and sublet it to subtenants.
  • You can charge subtenants more – because you charge them on a per night basis, not on a monthly basis.
  • There are far less tenant evictions – tenants are gone within days and you can collect payment in advance. You leave the evictions to investors in long term rentals, one headache less for you.

Cons of Short Term Rentals

  • Occupancy rates are lower – this is an unwritten rule, it’s way easier to find someone who wants to stay for months on end as opposed to someone who needs to stay the night.
  • Short term renting has a stigma attached to it – some property owners won’t allow you to sublet the unit because short term stays are associated with prostitution, adultery and potentially sex trafficking victims.
  • Often you need to furnish the unit – it’s a logistical issue, plus you need to decide whether to rent or buy furniture
  • Property upkeep is more taxing – you need to clean the place before you let new subtenants in, you need to settle utility bills, etc.

Investing in Debt

To be clear, we refer to buying someone else’s debt because as a lender you can collect interest payments, or, in rare instances, initiate foreclosure on a property and end up expanding your investment portfolio. Let’s check a couple of examples.

Mortgage Note Investing

The idea is to buy mortgage notes (real estate debt) at a discounted rate to the actual value of the house. It works similar to seller financing contracts – as long as the house owner pays their mortgage you collect interest, and if they fail to keep payments current you can either sell the mortgage note to someone else or to foreclose on the house.

Pros of Mortgage Note Investing

  • Mortgage notes provide cash flow – you collect interest payments as if you are the bank that issued house mortgage.
  • It’s a liquid investment – you can sell the note if, for whatever reason, you want out of the deal.
  • You collect returns without the hassles of traditional investor – you own the mortgage note, but you don’t own the house. So, no property management, no tenant screening, no landlord duties, no rehabbing, no vacancies – you are only collecting debt (including interest).

Cons of Mortgage Note Investing

  • It’s a legal minefield – mortgage notes are a complex issue, and you better be good at handling legalese if you want to profit from these notes. Debt can be stacked (tax lien, 1st position lien, 2nd position lien, equity backed loans) and if you aren’t careful you might lose money.
  • House owner may stop paying – in which case you initiate foreclosure. But the foreclosure process is prolonged and incurs costs and fees.
  • You are up against financial investors – they are after motivated house owners, or someone who is motivated to pay back their debt (as opposed to your usual quest for motivated house sellers leads who need to get rid of a property).

Tax Lien Investing

You are probably more familiar with this form of investing in debt: it concerns the entries on tax delinquent properties lists you use to get leads. When a homeowner doesn’t pay property taxes for several consecutive years, the county sells their debt (the tax lien) through a public auction. We’ve covered tax lien investing elsewhere, here we will review their pros and cons.

Pros of Tax Lien Investing

  • Returns from tax liens are high – sometimes the interest is 10% and above, which is more than the interest you can get from a bank for other financial investments (savings account).
  • You can get a property at a fraction of it’s cost – it’s a rare occurrence, but it does happen if the property owner doesn’t pay the taxes.

Cons of Tax Lien Investing

  • The property may have other types of debt attached to it’s title – similar to mortgage notes, the debt can be stacked when it comes to tax delinquent properties as well. You get the title and all the outstanding debt with it (HELOCs, other liens, underwater mortgage).
  • The property may require extensive rehabbing – this will immediately increase the costs of your investment, and you won’t be allowed to inspect the property until it’s yours.

Takeaway

The path of each investor is unique. There is no foolproof plan on making it as a real estate investor, especially in the current market. Some investors start with wholesale deals, and once they learn the ropes, they do house flips or they close on a unit that will become a rental property. Others are mom and pop investors who do a house hack, followed by a BRRRR strategy, etc.

You will have to navigate your way forward closing the type of deals that make sense for you at the moment. Everyone has a limiting factor, whether that’s access to capital, little to no previous experience, dependence on others (contractors, attorneys, mentors, cash buyers), or a market that’s not favorable to them.

We did our best to provide a comprehensive list of different types of real estate investing deals. The list is not exhaustive, though. There are many other strategies for investors, but what ended up included in our list can help change your perspective on closing a specific type of deal.

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