How to Profit from Investing with Raw Land with Owner Financing

Think you're ready to begin investing in raw land? Here's a tip that can increase your profit fivefold. It's called leverage, and in the case of owner financing, I call it "soft" leverage.

Leverage is the advantage you get from financing real estate. It increases the profit potential by "leveraging" the cash you have to put down on a property. Here's the most basic example of how it works.

Let's say you have $100,000 to invest. You purchase a $100,000 property and pay cash. A year later, you sell the property for $120,000, and earn a $20,000 profit. You've just made 20% profit on your initial investment of $100,000. Not bad, considering current savings account interest rates.

As an alternative, you put up $20,000 as a downpayment (keeping $80,000 in reserve), and borrow $80,000 from a bank. Again, you sell the property after a year for $120,000, and earn a $20,000 profit. This time, there's a big difference in your rate of return. You invested $20,000 and received another $20,000 in return. That's a whopping 100% return on your investment.

As I said, that's a basic example of how leverage works. But let's move on to the real secret to leveraging your initial $100,000. We could call this "compound" leverage.

Once again you begin with the same $100,000. This time, you locate five different properties, each priced at $100,000. You put $20,000 down and borrow $80,000 on each. At the end of the first year, you sell all five properties for $120,000 each, earning a profit of $20,000 on every one of them. That's a total profit of $100,000 or five times the profit dollars you earned from buying just one property.

When you paid cash, or purchased just one property, your $100,000 controlled only one property worth $100,000. By leveraging your entire investment, you controlled a half-million dollars in property, thus magnifying your potential profit in total dollars.

Now let's "sweeten the pot" even more by bringing seller financing into the mix. This method could be called "soft" leverage. I call it "soft" because it simplifies the financing, and eliminates most of the usual costs of borrowing from a bank. Also, in today's tight credit market, it eliminates the potential for being turned down by the bank for a real estate loan.

When you borrow from a bank, you normally face a smorgasbord of fees and costs. First, there's the loan origination fee that often runs about 1%-2% of the amount borrowed. On a $100,000 loan that amounts to an additional $1,000-$2,000 in upfront expense. Then there's the cost of a credit report, appraisal fee, and possibly inspection fees. You also run the risk of being turned down by the bank or facing a low appraisal (which may require a larger downpayment).

When you include seller financing in your purchase model, you eliminate everything mentioned in the last paragraph. Not only do you eliminate the dollar cost of fees, you also reduce the stress of waiting for approval. In most cases, when your purchase offer includes seller financing, the seller either accepts, rejects, or makes acounter-offer. If they accept your offer, you're approved - period - with no fees or hassle.

Asking the seller to finance the transaction can also bring additional benefits. In many cases, the seller will accept about a 1%-2% lower interest rate than that being charged by a bank. To the seller, a 4% or 5% rate is much better than the 1% they receive on their savings account at the bank.

Even better, the seller may accept an offer structured with better terms than a bank would offer. It's another reason I call this "soft" leverage. It's easier on the wallet. Because sellers tend to shy away from having to wait 10-15 years to receive all their money from the sale, they tend to quickly accept a different approach.

Make your offer with these terms, and you may be pleasantly surprised with the seller's answer. Offer to pay 10%-20% down, with the balance amortized over 10-15 years - but with a 3 year balloon payment. This means the monthly payments would be relatively low (based on a 10-15 year amortization), and the seller would receive the entire remaining balance at the end of a short three-year period.

Because the seller gives you a deed, you own and control the property for 3 years having invested only 10%-20% from your available funds. The objective, then, is to resell the property before the three years passes.

With seller financing, there is one additional way to structure the terms of payment to your advantage. Offer to pay "interest only" for three years with a balloon at the end. You could even offer "interest only for three years, payable quarterly" (or semi-annually or even annually).

When used together, seller financing and leverage provide the opportunity to grow your nest egg at a more rapid pace. During a "buyer's market" as we have in place today, it also provides a benefit to sellers - the sale of their property at a time when most properties are languishing unsold in the slow market. Ready to invest? What are you waiting for?


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