The Ingredients of a Super Deal: The Hillcrest Cottages

Creating Equity with Very Little Cash

For most start-out investors, cash is scarce. That was my situation when I started out: I had big ideas, but very little cash. I soon discov­ered that my big ideas would help me only if I rolled up my sleeves and went to work. When you don’t have much money to invest, you must sup­ply something else that will persuade sellers to accept your offers.

As you will learn, solving a distressed seller’s problem can have as much value as a cash down payment, once you understand how it works. I decided to specialize in rundown fixer properties, because they would be easier to acquire with my limited resources—and I found that rundown properties quite often had owners who were in financial trouble. This com­bination is easy to find, because they often go together.

My investment strategy is to create equity quickly with the lowest cash down payment—sometimes none at all, as was the case with the Hillcrest cottages. My plan is simple: I purchase ugly, rundown properties from highly motivated sellers and turn them into beautiful profit makers.

Hillcrest Cottages—A Million-Dollar Problem

The Hillcrest cottage property was a perfect example of creating instant equity using personal skills rather than cash. Hillcrest was an ugly run­down property consisting of 21 cottage-type dwellings that was situated on a hillside lot in my hometown. No other property I’ve ever owned, before or after, has been uglier than Hillcrest and none have ever had so many things wrong. Even the sellers of Hillcrest were all messed up
The owners of Hillcrest, Pete and Mike (not real names), shared unequal ownership interests in the property. Pete—who owned 65% and lived on the property—had the most to say, because he had the majority ownership. This was a problem for both owners, because Pete was a very poor landlord: he simply could not handle tenants and ran them off faster than he could find new ones. The results showed and the rental income was not enough to pay the mortgage payments and expenses. Hillcrest was in serious financial trouble when I made the offer to buy it. Two lenders had already started foreclosure proceedings, even though neither really wanted the property back.

Knowing the Real Reason for Selling Is a Big Advantage
One of the most urgent reasons for selling investment property is when the income drops below the mortgage payments and expenses. The owner is faced with covering expenses out of his or her own pocket or allowing the lender to foreclose the mortgage and take it back. In the Hillcrest sit­uation, Mike had a well-paying job, while Pete was living off the property. Mike was, naturally, unwilling to spend more of his hard-earned money to compensate for Pete’s poor management.
Being aware of the financial problems of a seller is very important when you’re trying to figure out his or her motivation level. I always do as much probing as I can before I write offers. Remember: the higher the motivation level, the less cash you’re likely to need to buy the property.
Let me make a point here. If you can figure out the seller’s urgency— like the property being in foreclosure, the seller in need of quick cash, job relocation, or pending divorce—and then time your offer to relieve the seller’s problem at the very last moment, you’ll get offers accepted that wouldn’t normally stand a chance. My Hillcrest offer was a good example of perfect timing.

Another threat facing the owners was the City Abatement Committee. Pete had repeatedly told city building officials that he would repair numer­ous building code violations on the property, some of which were haz­ardous conditions. The city had inspected the units earlier, when several nonpaying tenants filed complaints in an attempt to avoid paying rents. The Abatement Committee red-tagged the property and had even sched­uled it for demolition, if repairs were not completed by a specific date. Obviously, this created a very serious urgency for the owners.

Key Ingredients for a Super Deal

Let me pause for a moment so we can review why Hillcrest had the poten­tial to be a “super money-maker” deal for me.
The property was run down and unattractive, thereby eliminating most competition as prospective buyers.
There was an abundance of fix-up work, which I could do myself— or knew how to have done.
I learned early on that the owners were in serious financial trouble.
It was an excellent opportunity to create immediate equity from fix-up rehab.
It was a partnership property where unequal partners were not in agreement. In fact, they were fighting.
Rent collections were low because of deadbeat tenants and poor management.
The mortgage payments were delinquent and property was in fore­closure.
There were problems with a government agency: the City Abatement Committee was demanding fix-up.
There were “red-tag” building code violations that had to be fixed in a short time, which created great urgency.
10. The property owners had a high level of motivation, without many options.

Seldom do you find so many things wrong with both the property and the owners as was the case at Hillcrest. I had a feeling that almost any pur­chase offer I made, within reason, of course, would receive serious consid­eration by both owners.
Hillcrest Purchase: Zero Cash Down

Remember what I told you earlier—I had big ideas but very little cash. I also said I was ready to roll up my sleeves and go to work. That’s exactly what I meant. So I prepared the following offer to purchase Hillcrest.

I proposed, instead of a cash down payment, a property trade, using the equity in a three-bedroom house I owned. Naturally, the owners would have preferred cash; however, they didn’t have a lot of time to negotiate, due to the pending foreclosure, and my offer was the only one they had. When you think the sellers are extremely motivated, you can adjust your trade equity upward until you’re challenged. Don’t forget: there is never any harm in asking for the moon.

The property I was offering in trade was an older three-bedroom house on a large commercially zoned lot in a major growth area. I had owned the property for a little more than a year and had it rented for about the same amount as the mortgage payment. I had originally planned to eventually convert the house to a small commercial venture, like an insurance agency or a real estate office; however, I had never gotten past the idea stage. I had purchased the property for $80,000, with a $20,000 cash down payment. (Sometimes at my seminars people ask, “Where did you get the $20,000 cash?” It came from a $50,000 refinance loan on another property.)

After a short negotiating session, Pete and Mike decided Hillcrest was worth no less than $234,000. Until I came along, they had been asking $295,000. But now, they needed a very quick sale, so they agreed to my property trade proposal. I had not yet told them what my property was worth. Here’s how I determined my sale price.

The Hillcrest Cottages Transaction

I agreed to pay $234,000 for Hillcrest. I would assume three existing mort­gages totaling $143,000. It wasn’t hard to figure their equity was $91,000 ($234,000 minus $143,000 equals $91,000). Knowing the amount of their equity made it quite easy for me to come up with a fair market value for the property I was using to trade in lieu of a down payment. I simply added $91,000 to the existing mortgage balance of $58,000 and came up with a selling price of $149,000. See how easy appraisals can be.
Folks often ask me why the Hillcrest owners accepted my trade prop­erty at such a highly inflated price. They are quick to point out that buy­ing a property for $80,000 and then selling it just 14 months later for $149,000 seems like a rather hefty markup. However, the $69,000 markup, hefty or not, was not even slightly challenged by either Pete or Mike. In fact, they were more anxious than I was to sign the deal.

The valuable lesson I learned from Hillcrest was that distressed sellers are not nearly as concerned about how much money I make as they are about getting relief from their problems. Solving problems and providing relief to sellers pays very big profits in the fix-up business. That’s why I advise all beginners to become problem solvers first and deal makers sec­ond. As I mentioned in Chapter 1, I would eventually sell the Hillcrest cot­tage property, along with five small rental houses on Hamilton Avenue, as a package to one buyer. This sale alone would earn me over a million dol­lars in profits, because I was able to solve the seller’s problems.

Fixing Up Hillcrest Cottages

Fixing up Hillcrest was quite a chore, but, because of my large down pay­ment (the $91,000 house trade), I had enough equity to borrow all the fix-up money. A local real estate lender appraised the property and loaned me $51,000 to do the fix-up work. Since I did most of the fix-up myself, except for hiring an electrical contractor, I ended up with about $20,000 left over.

I worked for nearly two years getting Hillcrest fixed up and running smoothly. I filled in the ugly swimming pool and completely replaced most of the electrical wiring. I repaired sagging carports, built new floors, and replaced nearly half the plumbing fixtures. I also spent considerable time watering and restoring almost two acres of lawns, trees, and shrubs. Naturally, I painted the property inside and out. I built a white picket fence around the front lawn area.

Finally, the work was done and the property was beautiful. I had absolutely no trouble renting the cottages to good paying tenants. The fact is, I started keeping a waiting list. Needless to say, when I filled the place up, I had excellent monthly cash flow. Even with high interest payments on my fix-up loan, I was still making a nice profit every month.
Hillcrest was located along a major thoroughfare, where hundreds of cars passed by daily. People would slow down and stare at the property. I could see they were very impressed. Sometimes they would walk up to me and tell me what a wonderful job I had done. They couldn’t believe how such a filthy, rundown property inhabited by winos and deadbeats could change so quickly. Of course, the answer was a bit more obvious to me. I spent at least three or four days every week working on the property. Later on, after I sold Hillcrest, I estimated that if I had worked 40 hours a week for two years, my earnings would have been something in the neighbor­hood of $300 an hour. I can tell you, I’ve worked at many jobs during my lifetime that paid a whole lot less.

Selling the Fixed-Up Hillcrest Cottages
Almost two years after I acquired Hillcrest, I sold the property to a local physician who was looking for investment real estate. He was also seeking a way to shelter his regular income from taxes. In order to create the right-size tax deduction, the doctor needed to acquire depreciable property worth about $600,000. He wanted to use maximum leverage, like a very small cash down payment. We put our heads together and I agreed to sell Hillcrest cottages, along with five small rental houses, to the doctor, all on a single contract, with no money down.

That was just what the doctor ordered. He agreed to my selling price of $594,000. You’ll notice that my selling price closely resembles the amount of real estate the doctor told me he needed. I might point out, I’ve always prided myself on being able to accommodate a buyer’s circum­stances. This sale was one of several I designed to fit the special needs of my buyer. Obviously, it worked out very well for me, too.

Removing the Risk from a “No-Down” Sale

People often ask me, “Isn’t it a bit risky to sell a property for no cash down payment?” The answer is “Yes, of course, unless you can offset the risk by using some other means.” In this case, I asked for and received addition­al collateral.
I said, “Look, doctor, I normally insist on a minimum 10% cash down payment. However, I am willing to take a promissory note and deed of trust for $60,000 (approximately 10% of $594,000) on another property you own in lieu of a cash down payment. I’m not asking for any payments on the security and it won’t cost you a dime as long as you make the $6,000 monthly payments on the $594,000 Hillcrest contract.”

I also told him that after five years of payments (60 times $6,000, for a total of $360,000), I would release (reconvey) the $60,000 collateral note. This simple arrangement protected me and, at the same time, it allowed the buyer to use his existing equity to purchase more real estate without spending his cash.

Naturally, if he failed to make payments on the $594,000 contract, as promised, during the first five years, I would not only take back (foreclose) the Hillcrest property and five houses, but also the $60,000 worth of addi­tional collateral property. I call this my “two-for-one” contract. I’ll sell him one property, but, if he doesn’t pay me as agreed, I’ll take two properties back. After receiving payments for five years, I feel safe enough to release the additional security. By the end of 60 payments, a big percentage of the risk is gone. It’s kind of like the first five years of marriage. Chances are, if you make it that far, you’ll probably stick it out until the end.

Fixer-Uppers part 14

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