For novice investors, a No Money Down strategy will look very different than it will for an experienced investor.  The risks of a true No Money Down strategy are too high for investors just getting into real estate investing.  While many novice investors started with this strategy in 2003 – 2006, 2009/2010 will not be a great time to secure these mortgages.  Additionally, the high costs and high risks of this financing strategy make it a poor fit for the novice investor.

So what is a novice investor to do when they are short on capital?  Take the traditional fundraising approach: Family, Friends, Investment Clubs and well wishers.  Fundraising in this manner not only gets a novice investor much needed capital, but it forces him/her to critically analyze their investment opportunity because they have to present it in a compelling manner to their future investors.

There are critical rules to working with friends, family, investment clubs, etc.  First, an investor should prepare clear terms and spell out exactly what will be done with any funding received.  For example, if an investment property will be purchased for $100,000 and the money received will go towards the down payment that should be clearly stated. 

Next, an investor should create a simple return structure.  It’s easy for non-real estate people to understand a monthly cash flow and it’s easy for an investor to manage.  Returning to the $100,000 example, if friends or family members commit $20,000 for the down payment, an investor should promise a fair return.  Assuming a 10% return on $20,000 ($2,000/year), an investor should commit to paying $167/month and returning the full principal upon the sell of the property.

These agreements should always be in writing.  This is a best practice for any investor and should be no different with friends, family, etc.  The more structure and professionalism an investor brings to the deal, the more credibility he/she will have when pitching their investment.  Be detailed about the role of the general manager and the role of the silent investment partner.  It might be worth having a lawyer draw up a very basic boilerplate contract to use for future deals.

Investors should also try to under-promise and over-deliver.  Never promise unrealistic returns or understate the risk of an investment to secure funding.  This only serves to ruin your credibility and cut off future funding sources when the road gets rough.  Real estate investments carry inherent risk that is only compounded by limited experience in real estate investing.  Being honest and regularly providing information to financial backers helps the novice investor stay abreast of the market and their investment.

Friends, family, investment clubs, etc. offer great opportunities to connect with other real estate investors and secure additional investment funds.  This No Money Down strategy provides capital and important relationships to help grow a successful real estate investment business.

“No Money Down…”  A phrase widely used in infomercials and by many proponents of real estate investing.  Does it exist; certainly.  Is it a good idea; sometimes.  Will it work for you; almost certainly not. 

After 2007, many zero down financing programs dried up, making the possibility of purchasing an investment property with no money down challenging.  Traditionally, no money down financing was reserved for investors who planned significant renovations to their property.  For example, if an investor wanted to buy a $50,000 home, and then perform $20,000 of renovations, it would be possible to get a loan for $55,000 or more.  The interest rate on these loans was usually significantly higher than a traditional investment loan, but it provided many buyers the advantage of securing property with no upfront equity.

Hard money lenders also filled the cash void for many investors before 2007.  If an investor identified a good investment opportunity, they could secure a traditional investment loan (80% Loan to Value) and then get a hard money lender to supply the 20% down payment.  Hard money lender traditionally charge rates above 10%, but again, they provide a way for an investor to secure an investment property for little or no cash equity.

While this strategy is high risk, it has significant advantages.  First, none of these loans are recourse.  This means that the only recourse the banks and the hard money lender have is the underlying property.  This will certainly do a number on an investor’s credit rating, but their home, other investment properties and personal possessions will remain secure.  As a quick aside, every investor should read every page of every document they sign.  Never sign up for recourse debt, ever.  Second, this strategy allows an investor to expand quickly.  Depending on the investment strategy, this can be a great means of securing multiple properties fast.

Numerous risks exist with this financing strategy as well.  Investors traditionally have to hit a homerun with a property to make this financing worthwhile.  At a 12-15% interest rate and a short term maturity with stiff penalties, any hiccups in the project could totally derail the investment.  In a rising market, this risk might be very manageable, but in a falling or even a steady market, this risk can overwhelm even the most experienced investor very quickly.

Like all financing, a No Money Down financing strategy is a tool.  This tool is very dangerous, even in the most capable hands.  Before an investor jumps into the No Money Down market with both feet, he/she should be well aware of the risks and expect to hit a homerun on their project.

Novice investors rarely understand the value of a great accountant until after they need one.  Real Estate accountants specialize in tax planning to help investors better understand the tax consequences of their investments.  Numerous laws govern taxes around profits and losses in real estate and a good accountant can help an investor navigate these laws to maximize their return on investment.

Before considering any real estate investment, an investor should speak with their accountant.  Many accountants provide free consultations and typically want to build a relationship in expectation of future services.  Like all real estate professionals, accountants should be vetted with a focus on their real estate experience.  Most accounts will have a cursory knowledge of the real estate tax code; however, an accountant that specializes in real estate taxes provides a much broader knowledge base and stays up to date on all of the latest tax changes.  While investors will certainly pay more for these professionals, the long run value will far outweigh the short term cost.

Investors should familiarize themselves with the following real estate tax terminology: Depreciation, Depreciation Recapture, 1031 exchange, and capital gains and losses.  Accountants also provide guidance around corporate structure.  Many investors don’t understand the value and simplicity of a Limited Liability Company or other forms of partnerships.  Accountants can recommend structures that supply protection against personal liability, while minimizing incremental tax burdens. 

Investors should utilize accountants year-round.  Paying too much in taxes is the same as giving money away.  Additionally, holding a property an extra month or year might not make a difference from a market price perspective, but that simple decision might represents thousands of dollars in tax savings. 

Finally, real estate accountants know real estate investors.  In real estate, access and relationships add value.  Accountants know investors that need to sell or buy properties right away for tax purposes, as well as investors looking for partners.  Their needs should be your gain.

Mortgage brokers provide financial solutions for investment properties.  They provide investors unparalleled access to a number a banking institutions and products, saving them time and money.  Like all real estate professionals, the great mortgage brokers create additional value for investors, while poor mortgage brokers simply take a commission and supply very few useful services.

Every mortgage broker can access the cheapest lending solution for your investment property.  Obtaining the lowest interest rate covers the origination fee mortgage brokers charge, but excellent mortgage brokers have the ability to do so much more.

Great mortgage brokers understand the interest rate environment extremely well.  While it may be impossible to predict future interest rates, having the knowledge of any regulations or economic impacts on rates will help investors make better financing decisions.  When considering whether to secure a fixed or adjustable rate mortgage, helpful advice from a good mortgage professional can assist you in choosing the best financial option. 

Excellent mortgage brokers also provide broader financial solutions.  Many mortgage brokers have familiarized themselves with hard money lenders, other real estate investors, mortgage lenders and other alternative sources of financing.  As a side note, many of these financial solutions should not be chosen by novice investors; however, as investors become more sophisticated it will be extremely useful to have a mortgage broker with access to additional financing sources.

Lastly, good mortgage brokers have great relationships.  Real Estate investors make up a very small world of professionals focused on a single asset type.  Mortgage brokers, who work with investors regularly, can supply potential investment partners and investment ideas as you develop your investment business.  Additionally, mortgage brokers know very detailed financial information about their clients, so their partner recommendations come pre-vetted. 

Great mortgage brokers provide low cost financing, fair pricing and connections to other investors around the real estate investment landscape.  The costs of a good mortgage broker and a poor mortgage broker vary slightly, but the value provided differs greatly.  Maximize your investment in a mortgage broker by choosing an excellent mortgage professional. 

Mortgage brokers provide an invaluable service when the time comes to obtain a financing solution on an investment property.  Great mortgage brokers provide more than loans with competitive interest rates, many provide creative financial solutions that can help maximize the value of your investment.

Like all real estate professionals, all mortgage brokers are not created equal.  Any basic mortgage broker can locate the lowest interest rate loan you qualify for.  It never hurts to call around to ensure your professional is getting you the best rate, but 90% of the time the rates will be the same.  The value of the mortgage broker can be seen in their creative financial solutions and interest rate advice.

It is important to understand how mortgage brokers are compensated, so that you understand the motivations behind their suggestions.  Good mortgage brokers have your best interest in mind regardless of their compensation, but an informed investor should always be cautious.

First, mortgage brokers are paid an origination fee based on the size of the loan they secure.  This fee can range from 0.5% - 1.0% of the loan amount.  In addition to an origination fee, brokers charge a host of processing fees, which should be scrutinized carefully.  Ask a lot of questions and don’t forget to negotiate.  These fees can add up to another 0.5% - 1.0%.

Second, mortgage brokers receive a rate lock fee.  Fee quotes normally last for 30 days; however, consumers have the option to lock in the quoted rate for some fee for a longer period of time.  Normally, this fee is not worth the trouble.  While rates will certainly move up and down as you decide on the appropriate lender and loan, this “insurance” is usually not worth the trouble or the money.

Third, mortgage brokers receive a fee from the lending institution that originates your loan.  This fee is sort of like a “finder’s fee.”  This is the big watch out because most banks tie the highest compensation to the loans they really want to push on consumers.  While a 30-year fix rate standard loan might be your best option, if a mortgage broker is being paid an extra 1% to put you into a 30-year Adjustable Payment/Adjust Rate Mortgage, you can bet most brokers will be pushing the later even though it is not in your best interest.

Additionally, watch out for fees you don’t understand.  Yield Spread Premiums for example represent the amount a broker charges over the offered interest rate.  Essentially, if you pay this fee, it means your broker did not get you the best rate.  Know your credit score because the more challenged your credit score the more fees brokers will assess.  Ask questions and negotiate, negotiate and then negotiate some more.  

In the land of the illiquid investment, cash is king. After 2008 lending institutions severely tighten their underwriting standards, requiring 20%+ down payments for investment properties. 20% down makes even the smallest investment a capital intensive endeavor. Buying a $100,000 property now takes $20,000 in cash. Not a small sum for many first time investors. What makes real estate even more challenging is the fact that the $20,000 investment will be tied up for the next two years (minimum) and cannot be used for any other down payments.

For many novice investors, this proves to be a significant barrier to entry and puts a hefty premium on success. However, even by putting 20% into an investment, real estate still remains one of the highest leveraged investments many individuals will make. This leverage provides the power behind investment returns in real estate. Let’s demonstrate this with an example.

Assume an investor puts $20,000 down on a property worth $100,000. Next, let’s assume the property appreciates 5% in the first year and the investor sells the property. For ease of explanation, let’s assume no selling costs. Upon selling the property, which is now worth $105,000 after the 5% appreciation, the investor pays off the $80,000 and receives $25,000. In one year, the investor turned $20,000 into $25,000, a 25% return, based on an appreciation rate of only 5%.

This is the lure of leverage. A great way to work with friends and family, who want to invest in real estate, is to promise a fixed return plus some return of principal. Consider a stable property selling for $100,000 with a market rent of $700. Rather than putting $20,000 down to secure the property, an investor might consider raising $10,000 from friends and family by promising them a yearly return of 10%, much better than a return they might get in a saving account. Again, let’s assume in the first year the investment appreciates 5% and the investor sells the property. Now the investor pays of the mortgage of $80,000, plus the friends and family loan of $10,000 and keeps the remaining $15,000. After subtracting the $1,000 additional interest payment, the investor is left with $14,000 or a return of 40%.

Importantly, leverage works both ways. While it magnifies gains, it also magnifies losses. Using the same examples above, if the property lost 5% of its value the returns would be highly negative. Leverage provides an excellent tool to stretch investable income and to boost returns, but it also adds to the risk of the investment and costs money in the form of high interest rates. All investors should take care to understand the cost of any financing they employ in their real estate investments. 

 An underestimated, but extremely important, source of real estate profits, financing can drastically changes the success of an investment. While an investment should not be made solely on the fact that a borrower can obtain favorable financing, financing options should play a very important role in analyzing an investment opportunity.

Consider the interest rate an investor will pay on a mortgage. Lets take a $125,000 investment property as an example. An investor puts 20% down and obtains a standard 30-year amortizing mortgage for $100,000. At an interest rate of 5% the investor pays approximately $535/month, at 6% its $600 and at 7% its $665. At 5%, the investor pays $130/month or $1,560/year less than he/she would have paid at 7%.

Taking this a step further, lets say an investor has to choose between buying today or waiting six months in hopes that the home will sell for less. If the home decreases in value by 5% after six months, but the interest rate increases by 1%, was it worth the wait for the investor? Lets take a look. Now the investor pays $118,750 for the house or 5% less than $125,000, but has to pay an interest rate of 6% instead of 5%.

Interestingly, the investor saves $1,250 on the initial down payment. Now, instead of putting $25,000 down or 20% of $125,000, the investor only puts down $23,750 or 20% of $118,750. The monthly payments show a different story. The $125,000 pays $535/month, while the $118,750 investor pays $570/month or a difference of $420/year. In less than three years, the $125,000 investor will be better off. Again, we assume that this is the same property, so there will be no difference in future appreciation. In this example, the owner of the $125,000 house would see their value depreciate 5% in the first six months and would then experience the exact same upside or downside as the owner in the second scenario who buys in at $118,750.

This analysis shows the importance of locking in low, fixed-rate financing for long term investments. Periods of historically low mortgage rates represent excellent buying opportunities in down markets. Low fixed rate financing allows long term investors to weather moderate deprecation, while locking in a low interest expense when the market turns around.

Novice investors often worry too much about buying before the bottom. When considering investing, it is better to consider the entire investment landscape. Historically low interest rates and deep discounts in real estate values provide excellent investment opportunities.