I get a lot of flack from wholesalers and rehabbers.
It’s usually from the ones who haven’t experienced a full market cycle and are still in the “real estate always goes up!” mentality.
And so I want to just make this very clear.
I’m not saying wholesaling and rehabbing is on its way out.
I’m not saying this whole pandemic situation is going to tank the economy.
I’m not saying I know anything about what’s going to actually happen in the future.
What I AM saying is that in order for you to be in this business LONG-TERM, through any market cycle and through any crisis…
There are 3 things you need to do as a real estate investor.
- Reduce your reliance on 3rd party lenders.
- Reduce your reliance on big equity.
- Reduce your reliance on market values.
I was an expert panelist on an industry webinar recently with some of the top minds in the real estate investor world, discussing how to prepare for an upcoming recession, if and when one occurs.
The topic of making your business “anti-fragile” came up. And what I’m saying here speaks directly to that.
Let’s discuss each of the three items above here in more detail…
1. Reduce your reliance on 3rd party lenders.
This includes private lenders, hard money lenders, and banks. They’re all the same. Because they all operate under the same fundamentals, whether they’re regulated or not.
The one exception is what I consider a TRUE private lender, which is an individual in your own private network of family and friends, who is NOT in the money lending business, but they lend you funds for your deals, maybe from their IRA or something else.
Other than those types of “true private lenders”, you need to reduce your reliance on 3rd party lenders as a whole.
Here’s the problem — when you operate in the fix and flip business, as all wholesalers and rehabbers do, your business relies on 3rd party financing.
This includes the hard money loans the rehabber might use to acquire and rehab his projects.
And it would also include the traditional mortgage financing provided by banks that the end-buyer owner-occupants need in order to purchase the newly-rehabbed home.
When the lending dries up, the rehabber (and by extension, the wholesaler) sees a significant decline in business.
Let’s look at a couple very real scenarios.
A friend of mine in the hard money lending business just messaged me the other day (late March 2020), and said that PeerStreet just halted all real estate.
This pulls $1.5 BILLION of liquidity out of the hard money lending market.
Now, you may have never borrowed funds from PeerStreet, or you may be a wholesaler who never borrows funds anyway, but consider this:
PeerStreet is just ONE example of large institutions pulling funds out of the real estate market right now.
There are other institutions who provide liquidity in what’s called the “secondary market” who are also pulling funds.
The “secondary market” refers to all the large financial institutions to which all the smaller “private lenders” and “hard money lenders” re-sell their loans to, so that the smaller companies can keep lending money to more customers.
So if the secondary market dries up, the primary market (i.e. the hard money and private money lenders that MOST rehabbers rely on to do deals) dries up as well, and many smaller firms will go out of business.
Even if they don’t go out of business, they will most certainly make their lending guidelines more strict.
For example, they may only loan 65% LTV instead of 75–80% LTV.
If they do that, then that means the rehabber has to come up with more cash out of HIS pocket in order to do the deal, right?
This is what’s going to put many rehabbers (and by extension, wholesalers) out of business.
When a rehabber can’t get funding for his deals, he’s not going to buy deals from wholesalers.
I would guess the ratio of wholesalers to rehabbers right now is likely 100:1.
So when just ONE rehabber goes out of business, A HUNDRED wholesalers go out of business.
Are you starting to see the issue here?
Ok, even if the hard and private money lenders stay in business, there’s still the issue of the traditional banks which lend to the owner-occupants.
If traditional mortgage lending dries up (like it did in 2008), or even if it simply implements stricter lending guidelines…
We will see a sharp decline in the number of owner-occupants who are even ABLE to purchase a new home.
In other words, the market for retail home sales diminishes, perhaps significantly.
If there’s no market to which the rehabber can sell his finished product, why would he keep buying houses to fix up?
The rehabbing slows down.
And by extension the wholesaling business slows down.
To put it simply — the fix-and flip business (which is comprised of both rehabbers and wholesalers) relies almost completely on 3rd party lending. If lending takes a hit, the fix-and-flip business takes a hit. Period.
So what’s the solution here? What do you need to do to reduce your reliance on 3rd party lending?
We’ll get to that in just a minute. Let’s keep going looking at the other two issues first…
2. Reduce your reliance on big equity.
If you need to get a giant discount on a house in order to make money on it, you are vulnerable.
If and when the housing market takes a dive, home values will go down.
This could be caused by any number of things, not the least of which is the financing industry and Wall
Street, as we’ve already discussed in point 1.
Last I checked, equity was at an all time high. (By the way, doesn’t that article make you feel like it’s probably 2005 all over again right now??)
This is a function of the total residential mortgage debt owed across the whole country, and the overall market value of the total residential housing market across the whole country.
But what happens when the market value of all those houses goes down?
You will see a reduction in the average amount of equity in a home.
Will there still be houses with plenty of equity for the rehabber to buy it right?
But they could eventually become the exception and not the rule.
If there isn’t enough equity for a rehabber and/or a wholesaler to get a big enough discount on the property to make the numbers work, the deal simply can’t be done.
This will cause a reduction in the number of house-flips overall.
Meaning many rehabbers’ businesses will slow down, if not stop completely.
And remember there are probably 100 wholesalers for ever one rehabber, so when one rehabber goes out of business, 100 wholesalers do too.
Even if I’m way off on my ratio there, let’s say it’s only 10 wholesalers for every rehabber, the point is the same — wholesalers and rehabbers are intertwined, so if you think just because you’re a wholesaler that none of this stuff affects you, think again.
3. Reduce your reliance on market value.
When a rehabber buys a house to fix and flip, he’s relying on his own prediction of what he will be able to sell his finished product for at some point in the future.
Of course we call this the ARV — after repaired value.
Depending on the size of the project, the rehabber needs to predict the after-repaired value of the house anywhere from 1–6 months into the future.
In a good economy with a rising housing market, this is relatively easy and safe to do.
In a bad economy with a declining market, this is extremely difficult and risky to do.
You’ve heard the old adage — it’s like trying to catch a falling knife with your bare hands.
When values are declining, the rehabber must be in-tune with this, and he must buy his projects at even deeper discounts (assuming that’s possible depending on how much equity is in the house).
The rehabber must also be willing to take on more risk as there is increased uncertainty in what his project will be worth in the future.
This causes him to buy fewer houses, causing his business to slow down if not shut off completely. Which in turn causes even more wholesalers to go out of business.
Are you starting to see the big picture here?
So what’s the solution? How can wholesalers and rehabbers reduce their reliance on all these things?
The solution is to incorporate creative financing strategies into your real estate investing business and become what I call a “Transactional Engineer”.
In my opinion, if you’re not using creative financing on a regular basis in your business, you’re ALREADY leaving a bunch of money on the table, not to mention leaving your business vulnerable to outside forces, which I’ve laid out in the three points above.
But how do creative financing strategies solve all those problems and reduce your reliance on 3rd party lending, big equity, and market value?
By removing the need for any 3rd party lenders at all.
By providing ways to make money on low-equity deals.
By unhooking the house from market value and chaining it to “seller financed value”.
1. How “Transactional Engineering” reduces reliance on 3rd party lenders.
In a typical creative financing transaction, there are no 3rd party lenders involved, except perhaps the seller’s existing underlying mortgage.
There is no need for the Transactional Engineer to use hard or private money lenders in order to acquire the property.
Nor does he need cash to rehab the property because if you do it right, the property will either already be in good shape and not need fixing up, or the owner-occupant buyer will agree to fix up the property themselves.
There also is no need, or at least a diminished need, for the end-buyer owner-occupant to get any sort of traditional mortgage.
Therefore, the state of the financing market as a whole does not diminish the Transactional Engineer’s business in any significant way.
2. How “Transactional Engineering” reduces reliance on getting big equity.
Transactional Engineering, creative financing, seller financing, lease-options, etc.
All of these concepts and strategies do not rely on getting a lot of equity when you buy.
That’s because as Transactional Engineers we can CREATE EQUITY out of thin air, so we simply don’t have to get as much equity on the front-end going into a deal.
How do we CREATE equity?
Well, when you can provide built-in financing with whatever “thing” you’re selling, you automatically and inherently increase its value to the buyer.
When I sell a house with seller financing, “easy qualifying, no banks needed,” I am providing something of extreme value to my buyer.
Something for which they are happy to pay me OVER market value.
Thus, I CREATED equity out of thin air.
So on my acquisition of the property, I no longer need to get a big discount in order to make a profit.
In fact, I can pay up to full market value for the house because I can sell it for OVER market value because I’m providing financing with the house.
3. How “Transactional Engineering” reduces reliance on market value.
We just touched on this a little bit in the point 2 above, however, I want to drive this particular point home for you.
When you sell a house with seller financing, you are no longer selling on the basis of price.
You are selling on the basis of the monthly payment.
Your buyer is less concerned with the price as he is with the monthly payment and the down payment.
So if you and your buyer agree to a payment of say, $1,000/mo…
Then you can work backwards using a financial calculator to figure out what the price needs to be in order to fit that monthly payment and the terms under which you create your buyer’s note to you.
For example, if you negotiated a $1k/mo payment, and you wrote up the note to have a 40 year amortization and a 9% interest rate, my trusty 10bii financial calculator tells me the price (or “present value”) is $129,640.
No matter what the market says the value of the house is, when you negotiate financing terms with your buyer, the market value is irrelevant.
Even if the market says that same house is only worth $100,000, whether there’s a downturn in the housing market or not, the price and value of the house between you and your seller-financed buyer is now $129,640.
Are you getting this?
So the big takeaway for you here is this:
If you want to be in this business LONG-term, you MUST incorporate these sorts of “Transactional Engineering” strategies.
I’m not saying don’t do wholesales and rehabs.
I do a few of those myself every now and then when the numbers make sense.
I’m saying, don’t pigeon-hole yourself into just doing one type of deal or another.
Don’t look at yourself as just a “wholesaler” or just a “rehabber”.
Look at yourself as a real estate ENTREPRENEUR.
As a “Transactional Engineer”, you become a financial wizard who can take any seller situation, any economy, and any deal, and find a way to make a win-win-win solution for which you get paid HANDSOMELY.
Now, aside from all the benefits of being a “Transactional Engineer” I just mentioned, there are a few more that come with it as extra “perks”…
1. You will be able to more easily run your business from your desk in a few hours a week.
2. You will be able to do deals “virtually”, it does not matter where the house is, and so you will be able to expand your business NATIONWIDE, which opens up a whole OCEAN of opportunity for you and takes you out of the local “hustle and grind” altogether.
3. You will be able to make more money in less time with less effort. You will get paid for what you KNOW, not what you DO.
There are a lot more secondary benefits than even the ones I’ve mentioned here, but I’ll let you imagine those on your own.
Just ask yourself, how would your life be different if you were making more money and decreased your working hours at the same time?
Isn’t that what we’re all after anyway?
More with less?
That’s the name of the game, in my opinion.