The Fundamentals Versus "Nothing Down" Strategy
Nothing Down deals may sound good, but they can cost you. The fact
is you should never ignore the fundamentals.
There are certain fundamental “rules” that apply to every real estate
deal. If you break those rules, your chances of
having a bad or non-performing deal on your hands can increase
There is nothing inherently wrong with getting a property without
paying anything down, but the key is deal structure.
Many nothing down techniques involve creating second mortgage notes
on a property to cover the cost of the down-payment that you are
trying to avoid paying up front.
Second mortgages make it easier to get in, but can make it very
hard to get out. They tend to have higher than market interest
rates. If you get into a jam and need to sell fast, you will likely lose money.
Leverage is a beautiful thing until someone quits paying their rent.
Robert Allen is one of the best known real estate “gurus” in the
United States. In the 1980’s, His book, “Creating Wealth” was a real estate best
seller. It had a heavy emphasis on creating 100% financing by giving
sellers full price for a property, if they would take a second mortgage
for the downpayment. It was all about using second mortgage notes to
But, just a few years later, Mr. Allen was filing for bankruptcy.
It’s not that you can’t buy property with no money down, but some
investors get so hung up on buying with special terms, they don’t
even realize that those terms could create some potential hazards.
And strategies that work well in one real estate market, can go belly
up when the market conditions change.
It is possible to structure a deal that appears to be great on the
surface, only to find that the income can’t cover the expenses. Or,
your payoff is more than the property is worth.
The real estate investing “hype”, would have you believe that any
deal with creative terms is worth doing. That is hardly the case. I
have seen “subject-to” and other sorts of creative financing deals that
were not profitable because the real costs were ignored in the excitement of
doing a creative deal.
When you buy the front end of a deal, you are also buying the back
end too. Sometimes, no matter how careful you think you are, fate
will intervene with circumstances that make for a difficult time.
Creative deals can turn into big trouble, as Mr. Allen found out.
His strategy worked fine in the 1980’s when interest rates were sky high,
and new loans were hard to qualify for. Many sellers at that time were
holding mortgages that had been created in the 1960’s or 1970’s. Those existing
mortgages were often well below the double digit rates of the mid 1980’s.
But by the early 1990’s, interest rates were sinking back into single digits.
This meant that those second mortgages were now very expensive, relative to new
mortgages with lower rates. The result?
There were no longer any buyers interested in those deals that once were the
investors “bread and butter” when interest rates were sky high.
A fundamental issue such as interest rates rising or falling, will affect buyer
demand. When interest rates are high, fewer can qualify, so financing with
second mortgages at 12% beats getting a new loan at 15%. But, when rates drop,
you can find yourself stuck with creative terms that are no longer desirable.
Thus, the buyers went elsewhere. This caught many investors of the day
paying mortgages that they could not get buyers or tenants for. The result is no
cash flow or a very negative cash flow….then foreclosure can’t be too far behind.
The key to success in any market is knowing how the changes will affect buyers and
sellers, and making adjustments to your strategy accordingly**