Discounted Land Contracts & Notes for your IRA
By: Mehran Aminzadeh October 2010
While there is fear created by media and general public on real estate investing, the savvy investors are buying real estate for long term hold. With real estate prices at historical low levels, the investors with the long term buy and hold strategy will create real wealth. With massive foreclosures and lack of funding from banks and lenders, active real estate investors and entrepreneurs use very affordable terms and seller finance to home buyers. They then discount the notes or (land contracts) to investors who are looking for solid investment vehicles with good cash flow and built-in equity. Discounted land contracts and notes can be a great vehicle for building wealth in your IRA or Roth IRA and many investors prefer the strategy of holding paper over rental property.
The number of active investors and entrepreneurs who buy foreclosed properties and sell with seller financing is on the rise. Home buyers are unable to get home loans from banks and are willing to put sweat equity to remodel the foreclosed properties if the payments are low and affordable. Entrepreneurs are commonly selling foreclosed properties with seller financing and After-Repair-Value (ARV) of $75K to $100K at only $35K to $60K with 15 to 30 year term at 9% interest to home buyers. Note that a few years ago some of these homes were sold for $200K to $300K. The mortgage payments are very affordable in the range of $300 to $600. The mortgage payments are typically about 60% of the market rents and is intentionally kept low in the current market to ensure the home buyer is successful. The entrepreneurs are paid just like a bank for the mortgage and provide homeownership to families who cannot get a loan. Entrepreneurs may then discount the land contracts (or notes) and sell / assign their position to passive investors who want to earn double digit rate of returns at 60% to 75% of the loan balance depending on the length of seasoning of the land contract.
Opportunity available to passive investors:
Investors who are not happy with 2% or less CD rates or stock market recognize that now is the best time to make investments in real estate for the long term. An investor who is occupied full time or part time in a profession other than real estate recognizes that they still can participate passively (or with minimum effort) in real estate and build wealth for the long term. Investors with retirement funds and private lenders recognize now more than ever before the cash flow in an investment is more important than appreciation. An alternative to investing in rental properties or apartment buildings is to buy a performing note or a land contract with low Loan-To-Value (LTV) ratios of 70% or less at a discount while the market is favorable. This market has created an incredible opportunity to invest in a cash flowing properties with about $25K to $35K with a tenant-buyer in place and the investor essentially becomes the bank.
Discounted land contracts vs. rental properties
While rental property and apartment buildings remain popular long term investment vehicles, investors who have experienced rental properties for a few years realize the net Cash-On-Cash-Return (COCR) on their investment is typically less than 10% at best and often 5% to 7% due to repair costs and tax and insurance expenses or rent fluctuations and vacancies. Even when experienced property managers are utilized the rental property can be overwhelming for busy investors whose primary job is not real estate. The investors who prefer rental properties often limit how much net COCR they can gain in anticipation of cyclical appreciation. The benefits that discounted seller financed land contracts have are:
- Home buyer pays for mortgagee, taxes, insurance and repairs
- The seller gets a fixed monthly cash flow with no surprises
- Investor buys the land contract at a discount (60% to 75% of the loan balance depending on the seasoning). This gives build-in equity without speculation or relying on the timing of the real estate recovery.
- In the current market you can find discounted land contract with 16% to 20% rate of return. The compounding effect of this return easily outperforms the appreciation of a rental property.
- When the tenant-buyer refinances or sells they pay off the investor the loan balance.
- If tenant-buyer defaults investor evicts (no lengthy foreclosure is required) and can sell, rent, or place a new tenant-buyer in the property with better terms.
Some real estate investors prefer holding notes or land contracts to rental properties since it provides predictable return without speculation on appreciation. These investors prefer to free themselves from repairs and expenses of a property and earn a great return on their investment by giving the home ownership and responsibility to a home buyer and both sides enjoy what they want. The note investors free their time and invest passively in several notes or land contracts and diversify by investing in multiple markets. They would be very limited in the number of rental properties or number of property managers they can manage and will be limited in the net cash flow of rental properties. The note investors can optionally utilize asset management companies to manage collection from tenant-buyers, eviction, or re-sale to new tenant-buyer if necessary to make this a truly passive investment.