By Alan Cowgill
Whether you’re an experienced real estate investor or just getting started, negative cash flow can cripple your business. I know this from some hard personal experiences early in my career - and I also know that there are many ways to bounce back.
In early 2002, I hit the wall. I had a negative cash flow of $10,000 a month. Worse, I had just quit my J-O-B of 17-1/2 years so I could achieve my dream of becoming a full-time real estate investor.
I thought I had planned for everything. I’d attended great seminars and studied at the feet of the masters. What I hadn’t foreseen was a downturn in the rental market in my city - and it reached up and bit me. Since I hadn’t done the job of finding private lenders, I couldn’t fund my business.
Fortunately, I got some good advice at the time, and it got me back on the right path. I went to work filling vacancies, cashing out lease-option tenants, and selling shaky properties… and narrowly dodged the bullet.
But after learning my lesson the hard way, I’d like to save you from having to deal with similar cash-flow problems. Here are a few ways to get out of trouble… or at least generate some near-term cash:
1. Refinance.
If you’re paying a private lender a high interest rate and you think you may end up holding a property longer than planned, you need to make sure you don’t get “upside down” on the loan (meaning you owe more than the property is worth). The key to knowing which way to jump is to watch your profit margin. If you need to buy some time, either bring in a private lender at a lower rate or find a lending institution that offers a lower rate if you refinance.
You’ll need to do the math and see where the breakeven point is. Let’s say you’re paying a private lender 15 percent, but can get 6 percent from a local bank. The breakdown looks like this:
loan amount x 15 percent ÷ 12 = A interest per month
loan amount x 6 percent ÷12 = B interest per month
A interest minus B interest = amount saved per month if you refinance
closing cost ÷ amount saved per month = breakeven point (in months)
Let’s say your breakeven point comes out to six months. In that case,
if you’re going to hold the property longer than six months, it makes
sense to refinance.
2. Find at least three mortgage brokers and let them vie for your business.
3. If you have a bunch of equity in the property, you can:
Sell the property at full price. If you need cash, you can carry
back a second mortgage and then sell it. You can often find a buyer for
the second mortgage by running an ad in the local paper.
Wholesale the property to a real estate investor.
Cut your price and look for a cash buyer.
4. Look at your “model.”
Take a hard, unbiased look at the structure of your business. Is it making you money? Do you know your real numbers? If you discover that it’s not profitable, it’s time to make some changes.
For example, when I got into the real estate business, I was investing in low-end rental properties using a buy-and-hold strategy. That worked up to a point, but I wanted to generate more cash flow without having to wait years to pay off my loans.
So I decided to buy, fix, and sell the same kind of low-end houses with a lease-option exit strategy. Because I was fixing up the properties to sell, not to rent, that meant I was putting more money into them.
Unfortunately, this strategy didn’t work, because my would-be tenant-buyers still had a “renter’s” mentality. They would live in the property for a few months to a year and then quit paying. I’d evict, put $3,000 back into the property to get it up to speed, and then go through the same process all over again.
When I did the math, I realized that I wasn’t making the profit I had expected. To top it off, when I did get one of these low-end properties closed, I’d end up carrying back a second mortgage. That just added insult to injury.
Here’s a different business model that might be more successful for you:
Target a medium-priced (or higher) property.
Purchase the property for all cash using private money. Let the money accrue.
Fix up the property and sell it at retail.
If the property doesn’t sell in six months, refinance at 6 to 7 percent
interest. This frees up the private lender’s money so you can use it
again.
Put a lease-option tenant or land contract (sometimes called a contract
for deed) buyer in the property. This covers your monthly expenses.
Unlike my original strategy, this model has a lot of upside. You buy a
property for all cash and have zero holding costs. If you can sell it
at retail, you’ll get some quick cash. Otherwise, you go for soft
terms, free up the private lender’s money so you can use it again, and
get a cash-flow property by refinancing at a lower interest rate.
5. Work with tenant-buyers who have credit challenges.
If your tenant-buyer will need to open up a credit line to get
financed, hand him the form when you do the lease option or land
contract/contract for deed.
Put an escalation clause in the contract, both on the price of the property and on the monthly rent or mortgage.
Some of the above solutions might not sound very appealing, but they
can save your dreams of real estate wealth when you’re against a wall
and strapped for cash. The key to getting out of a money jam is to take
action… and then return to invest from a stronger position another day.
[Ed. Note: Alan Cowgill is the president of Integrity Home Buyers Inc., and is the nation’s leading speaker on private-money financing.
