For years I knew about things like options, leasing, contracts for sale, notes and mortgages, et cetera. I had heard of and even used techniques with fancy titles like: Sale-Lease-Backs, Purchase Option-Backs, and Paper Down and Paper Back.
Now I'm telling you to dissect real estate transactions this way. Own options (the appreciation) in a clean, conservative, private corporation in Nevada. Let's call it Warbucks Future-Growth, Inc. Own leases (the cash flow) in your home state. You have to pay tax in your home state because that's where the act of management is conducted. Call it Red Inc., Management. The title, "the fee," (the tax benefits) you should own in your personal name until you've sheltered all the personal income your real estate ownership can shelter; then go to corporate ownership. With that, let's move on.
Suffice it to say that those who become specialists in component-izing a real estate deal will control the future of this and many related businesses.
I have news...it's been happening for years. Builders and developers do it. Realtors do it. Guess what...even banks do it!
When a bank issues a mortgage with negative amortization (like FHA 245's) it is issued under the guise of a more "affordable payment plan." What has really happened is you have shared the appreciation with the lender. Ever heard your colleagues speak of something called a "shared appreciation mortgage?"
Have you spoken to people who buy and sell mortgages? Do you know what your friendly institution does once they have funded your request for mortgage money? It is sold on the secondary mortgage market to organizations like Fannie Mae and Ginnie Mae at a discount. At first, I thought that "paper" trading has just arrived!
Options and leases have been around as long as the "oldest" profession! It has been camouflaged as "high finance" and guarded by the "elite" of the investment world.
Let me see if I can share some of the this with you. Let me outline the I.D.E.A.L. investment.
I = INCOME…leases control cash flow; debt instruments (mortgages) provide cash flow; Both may be divided and shared; both represent income streams of future dollars which sell at a discount in the cash marketplace.
D = DEPRECIATION…is an IRS mandated deduction; it is true tax shelter. The legal or equitable owner has this benefit. This is the best source of financing without banks.
E = EQUITY BUILD-UP is a benefit usually in favor of the owner in the reduction of debt. However, if an option is written for the equity in a property, the equity build-up goes to the Optionee.
A = APPRECIATION may be shared by properly structuring the financing or with use of an option. Appreciation is not taxed until it is realized as a gain. It is a safe absentee type form of investment without much risk.
L = LEVERAGE is a powerful tool when used properly. It has no match. Houses, apartments and mortgages are leveraged, people are leveraged, knowledge, especially, is leveraged.
I hope to stimulate your mind so that you too may combine and rearrange these and other bits of knowledge in a way you never thought possible.
You will soon find yourself catapulted into the financial stratosphere of benefit distribution, the best is coming up.
Splitting Benefits Opens the Door to Financing Without Banks
How about acquiring an $80,000 Single Family House without going to a bank, using none of your money, having a positive cash flow and sharing in the appreciation?
Possible? Read on.
You located a SFH with a bonified verifiable MAI appraisal of $80,000. You (and/or assigns) now contract to buy this house for just 10% under fair market value or for a sale price of $72,000. Is that reasonable in your marketplace?
It has an assumable FHA first mortgage of $64,000 @ 8-1/2% with 25 years remaining and PITI of $625 per month. You agree to pay $8,000 cash and take title "SUBJECT TO" the first mortgage. The seller agrees and you are elated because you can buy a $80,000 house for $72,000 and the house will rent for $650. (Wow! Positive cash flow). Just one (small) problem...you don't have $8,000.
You can borrow it but the additional debt service will turn a comfortable $25 positive cash flow in to a hungry alligator. What to do? SPLIT THE BENEFITS, what else!
Magically you become transaction engineer and your first task is to locate someone with $8,000, a tax problem and a desire to invest.
Show them how investing $8,000 now yields an immediate tax deferred profit of $8,000 ($80,000 appraised - $72,000 price). Explain that owning an $80,000 house with a $70,000 depreciable basis will result in depreciation deductions.
Excitedly point out that the depreciation deductions means tax sheltered income. Be sure to note that this is guaranteed by the government and without risk.
Finally show them how smart you were to add "and/or assigns" on the contract after your name. And how this allows you to assign the contract to them if you so desire.
They will undoubtedly say "this sounds great, but I know nothing about renting houses." "I'll get burned." "What about vacancy?" "Unscrupulous tenants…!"
Being the astute transaction engineer that you are, your next task is to explain how you will lease the house from them, guaranteeing the rent, handling all vacancies, management and maintenance. Assure them that your innovative and proven single family house management techniques are the best in the business.
In other words, you are offering all the benefits of owning real estate without any of the headaches.
Explain that since he put up the cash, the deed will be in his name and that he is taking title "subject to" the first mortgage. I.e. "subject to" means he will have no personal liability for satisfaction of that first mortgage in the event of default.
Finally tell him that as your incentive to "really work hard" you want an option to purchase a one-half undivided interest in the property at any time during the lease term for one dollar over what he paid.
So, suppose if in five years that $80,000 house sells for $100,000, he gets the mortgage balance plus his $8,000 back and the two of you split the $28,000 ($100,000-$72,000) profit 50/50.
Nothing more fair than 50/50, huh? See if I can summarize what happened:
Step 1: Your domestic buy-sell corporation (Buy-Sell, Inc.) found and contracted to buy the house.
Step 2: Buy-Sell Inc. sells "assigns" the entire contract, including all rights and benefits to Warbucks Future-Growth, Inc.) for a nominal fee of $100.
Step 3: Warbucks Future-Growth, Inc. "assigns" the contract to the cash investor; earns another fee and retains the option (the "appreciation").
Step 4: The cash investor closes, takes title and consequently the tax benefits.
Step 5: Red Inc., Management leases the house for $625 (his PITI) and rents it for $650.
Therefore Red Inc., Management gets the benefit of the immediate $25 cash flow and all subsequent rental increases.
Step 6: In five years the house is sold. The cash investor gets his original investment back and the appreciation is split between Warbucks Future-Growth, Inc. and the cash investor. Thus, the capital gain is earned in Nevada, TAX FREE!
We have divided this house in such a way that gives everybody involved just what they need. Did you notice that his interest, the lease and/or option may be divided, traded or sold? Did you also notice how exciting this could be when you start adding zeros? And the most awesome thing is this: You could own all the stock in all the corporations
These ideas are so limitless and broad that it would be pretentious to even attempt to simplify it. What I have decided is to actually dissect a property for you in a way you have never seen and never thought possible.
Experience and actual problem solving are your true teachers. Frank Lloyd Wright said "The human race built most nobly when limitations were greatest." "Limitations," he said, "have "always been the best friends of architecture"...and corporations...and creative real estate. Corporation strategies (of the Laughlin variety) and "Como Style" Creative real estate technique were both born as a result of limitations.
My advice to you when analyzing real estate problems is to th ink about its parts and how they may be divided. That is, distribute what is needed to the corporation, the investor, the entity that needs it.
Let me give you some food for thought. Owning the "fee" to the bundle of rights known as real estate means by definition that you own everything about that real estate from the center of the earth to the edge of the universe in a pie shaped piece.
Starting at the center is the mineral rights, the ground itself, the improvements and the air rights. There are different minerals underground which may be sold or leased separately. The ground may be subdivided, sold, leased and mortgaged. The improvements may also be subdivided, sold, leased and mortgaged.
Imagine for a moment that your domestic corporation, Real Estate Domestic, Inc. (AKA RED, Inc.) contracts to buy a large commercial building valued at $1,000,000. This building is free and clear and filled with tenants. It has a gross income of $100,000/year. RED, Inc. executes an agreement to buy this building all cash; and then for consideration assigns (or transfers) the lion's share of its rights in that agreement to Warbucks Property Corporation (WPC).
How might the WP Corp./RED, Inc. Joint Venture raise this kind of money? Well, suppose they created a land lease that paid $25,000/year and contracted to sell that land lease to a pension plan at a capitalization rate of 8% (The WPC Pension Plan of Nevada would work, by the way.)
Based on the income, that $25,000/year land lease would be worth $312,500. Pension plans have no tax liability but by law need safe investments. This "safest" position and the cash on cash return would be the perfect investment vehicle for a pension plan.
Next, they contract to sell the improvements to an insurance company by virtue of an "operating" or "inner lease" that pays $25,000/year at a capitalization (return) rate of 10%. The inner lease, at this rate would be worth $250,000. The insurance company would own the improvements and therefore tax sheltered income.
If you recall, the total income was $100,000 less the $25,000 (the land lease) less $25,000 (the inner lease). That leaves $50,000 for selling to yet another corporation or investor.
In the event this building is filled with top grade tenants and that $100,000/year gross income is virtually guaranteed, is there any reason a lender wouldn't lend based on the strength of the leases and the income they represent?
Sell the $50,000 additional income to an corporation to yield 10% cash on cash and have the benefit of future rental increases. This position we will call the outer or managing lease. A 10% cap rate on $50,000 income is a value of $500,000.
Let's total the parts:
(1) land lease $312,5000 plus;
(2) inner lease $250,000 plus;
(3) outer lease $500,000 = ?
Hey wait a minute. The sum of all three is $1,062,500! But the purchase price is only $1,000,000.
Who gets that extra $62,500? Any corporation who is smart enough to hire a transaction engineer, I guess. It might even make sense to build a real estate corporation and train someone just for transaction engineering. This corporation would be born (formed) and live (be domiciled) in Nevada because with this strategy the lion's share of the profit would, by design be earned tax free there.
Not bad pay, huh? When a building is dissected properly and the parts sold to the right corporation it can be real profitable.
It may seem that this format is applicable only to large transactions. I assure you it is not. I will agree you probably would be unable to sell the improvements in a single family house deal to an insurance company. This void might be filled, for example with owner financing.
The land can be extracted for every deal. It's easy. You simply do it with a deed.
Leases and options are created daily. You would not do a total multiple break up in every deal. Just think about how to build these ideas into any deal where it makes sense.
© MMI By Ray Como. All Rights Reserved
Ray Como has created, produced, copyrighted and self-published 15 audio cassette programs and lots of other forms and tools for business, real estate, corporations, selling, marketing, finance, management and Entrepreneurship.
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