Nothing Down or Zero Down Property Investing – Profits or Pitfalls?
To gain possession of a real estate investment property without spending any money upfront sounds too good to be true, but is it? Published by Mr. Carman for the API Magazine of Australia in June ’07.
“Buy a property without putting in any of your own money!” “Own your home even if you have impaired credit!” Both options sound appealing, don’t they? Over the years there have been a swag of books, seminars and the like showing how to acquire property real estate without putting in any cash. These ‘Nothing Down’ methods were popularised by the American author and seminar leader Robert G Allen during the 1980s in his book Nothing Down, although the techniques themselves have been around for many years. There have been a slew of other authors since – for example Joe Crump in the United States, promoting ‘zero down’ ‘no money down’ ‘purchase property with little or no money down even if you have bad credit’ and ‘creative real estate investing’ techniques (although the latter encompasses more than just Nothing Down methods). Nothing Down methods in real estate investing still have some profile and are worth looking into.
The appeal of Nothing Down or Zero Down techniques is obvious: if you have a choice between acquiring a property without committing any of your own capital, versus having to put your own money in the deal in the form of a deposit, wouldn’t you obviously opt for the first option? After all, why part with your own cash if you don’t have to?
This sentiment is reinforced by the calculation familiar to and beloved to investors in real estate: the cash-on-cash return. The formula simply compares how much cash an investor in real estate gets out of an investment in property with the cash that’s put in. Suppose you put $75,000 deposit down for a $250,000 property and it returns $15,000in rental income in the first year, less $12,250 in interest repayments – a net income of $2750. Your cash-on-cash return for that investment real estate property is 3.7 per cent (2750 divided by 75,000).
But if your deposit is zero, then you’re diving the $2750 net income by zero, meaning that your cash on cash return is technically infinite. (Remember from high school maths that nay number divided by zero is technically undefined). Surely an investment with an infinite return is an investor’s dream? And any real estate investment where you don’t have to lay down a deposit is going to be a winner,right? Well, it’s not as simple as that, for reasons we’ll soon see. But first let’s take a closer look at what Nothing Down or Zero Down real estate investing techniques are and how they work.
While Nothing Down techniques entail acquiring a property without the investor putting in any of their own cash at the front end of the deal, the term does cover a grab-bag of techniques and methods. ‘Nothing Down’ or ‘Zero Down’ is a general term which covers any method of acquiring a property real estate investment without parting with your own cash for the deposit.
Nothing Down methods don’t mean that the seller doesn’t obtain cash. Rather, the buyer/investor doesn’t put their cash into the real estate deal. These methods were particularly aimed at people who wanted to own their own home but who, for some reason or another (such as poor credit history), weren’t able to raise the funds for a conventional bank loan. The Nothing Down technique which is most familiar to Australian property investors is where the equity in one real estate investment is used as the deposit on another property purchase.
The loan supporting the original existing property is refinanced in order to tap into the home equity as the deposit, which any costs incorporated into the new loan. The equity may have been generated by capital appreciation, or from principal which has been repaid, and substitutes for a traditional cash deposit which the borrower saves up.
Refereed to in some quart3ers as cross-collateralisation (because the equity in one investment real estate is used as collateral, or security, for another investment) this equity tapping is arguably one of the purest forms of a Nothing Down or Zero Down transaction in property investing. It’s conventional, widely accepted and understood and highly effective. Home equity loans, redraw facilities and lines of credits when used as the security on an investment real estate are applications of this technique.
Other less conventional Nothing Down techniques include:
• Using your credit card to lay down some or all of the deposit on a deal (including having several credit cards and using one to pay off another in a ‘cycle’ of credit payments).
• Borrowing from friends or family to acquire a deposit or down-payment on a real estate investment.
• Borrowing the deposit from the seller (in other words, the vendor finances the security)
• Bartering goods or services as the security
• Using loan types which defer repayments (notably so-called balloon loans, more commonly used in the US, in which no repayments of principal or interest are due until the loan matures, at which time both the entire amount of principal and all accumulated interest are payable), and
• Using a real estate property or piece of land you already own as security for a vendor, either as property that you part with, or which you use as a form of guarantee to which the seller can lay claim in the event that you, the buyer, fail to meet some condition of the deal.
These techniques can be used on their own or in combination with each other for Zero Down or Nothing Down real estate investing. Other techniques exist which are sometimes lumped in with Nothing Down techniques but which aren’t actually such. An example here is the purchase option (not to be confused with lease options used by positive cash flow investors) where an investor ties up a property by buying the right, but not the obligation, to buy a real estate property at a certain point in the future at a certain price. A purchase option means you have some degree of control over the real estate investment (notably by excluding other buyers until the option expires) and enables you to place a bet as to whether a property will appreciate in value by a certain amount. However, you have to pay to buy an option, so whether an option qualifies as Nothing Down investing technique is questionable.
The description ‘Nothing Down’ covers a broad array of real estate property investing, but here are a few specific techniques that give you the flavour of the approach:
• Convincing the vendor to fully finance a deal, so that the vendor acts as a bank and gives you a loan for the property they’re selling to you, including the deposit
• Using a non-cash item as security for the purchase, whether that be another real estate property which you (the buyer) own, or some other item such as a boat, car, plot of land etc.
• Providing the use of your services (for example, if you’re a carpenter or accountant), to the vendor in lieu of a cash deposit.
• Using other people’s funds, such as those of a family member or friend, or utilising their borrowing capacity when you’re not able to access credit, in exchange for giving them a share of the ownership or profits from the deal.
Here are some key points when it comes to real estate investing in property using Zero Down or Nothing Down techniques. Wealth Tip: Nothing Down techniques in many cases entail heavy borrowing, and hence bring both the benefits and risks of leverage. Nothing Down approaches might be good for acquiring property, but you’ll still need to part with your own funds at some stage after the deal is done. Nothing Down or Zero Down investing in real estate techniques are separate and distinct from positive cash flow investing. Nothing Down methods don’t substitute for a high-return investment. Some commentators critisize Nothing Down techniques on the grounds that the methods are unlikely to work, or will only work under highly specific circumstances.
In the final analysis, it may be that Nothing Down and Zero Down techniques for real estate investors are most useful for credit-impaired people who wish to gain access to buy their own home, or as a spur to creativity for property investors. The intelligent wealth-creator would do well to consider Nothing Down techniques as part of their armoury. These techniques can encourage an investor to bring ingenuity and creativity to the process of deal-making and investing, and this flexibility can make new deals possible or enable an investor to extract extra value from an existing deal.
Sensitising real estate investors to the importance of buying a good property investment from a motivated vendor to gain a bargain purchase price or favourable terms (rather than focusing solely on the property itself) is another contribution made by the Nothing Down school.
To the extent that Nothing Down and zero Down methods in real estate investing enable investors to bring new twists to a property real estate deal and enhance their profits along the way, they are useful additions to a property investor’s toolkit, and their wise and thoughtful application can create real wealth for the discriminating investor.
“Buy a property without putting in any of your own money!” “Own your home even if you have impaired credit!” Both options sound appealing, don’t they? Over the years there have been a swag of books, seminars and the like showing how to acquire property real estate without putting in any cash. These ‘Nothing Down’ methods were popularised by the American author and seminar leader Robert G Allen during the 1980s in his book Nothing Down, although the techniques themselves have been around for many years. There have been a slew of other authors since – for example Joe Crump in the United States, promoting ‘zero down’ ‘no money down’ ‘purchase property with little or no money down even if you have bad credit’ and ‘creative real estate investing’ techniques (although the latter encompasses more than just Nothing Down methods). Nothing Down methods in real estate investing still have some profile and are worth looking into.
The Aim of Nothing Down Methods in Investing in Real Estate
The appeal of Nothing Down or Zero Down techniques is obvious: if you have a choice between acquiring a property without committing any of your own capital, versus having to put your own money in the deal in the form of a deposit, wouldn’t you obviously opt for the first option? After all, why part with your own cash if you don’t have to?
This sentiment is reinforced by the calculation familiar to and beloved to investors in real estate: the cash-on-cash return. The formula simply compares how much cash an investor in real estate gets out of an investment in property with the cash that’s put in. Suppose you put $75,000 deposit down for a $250,000 property and it returns $15,000in rental income in the first year, less $12,250 in interest repayments – a net income of $2750. Your cash-on-cash return for that investment real estate property is 3.7 per cent (2750 divided by 75,000).
But if your deposit is zero, then you’re diving the $2750 net income by zero, meaning that your cash on cash return is technically infinite. (Remember from high school maths that nay number divided by zero is technically undefined). Surely an investment with an infinite return is an investor’s dream? And any real estate investment where you don’t have to lay down a deposit is going to be a winner,right? Well, it’s not as simple as that, for reasons we’ll soon see. But first let’s take a closer look at what Nothing Down or Zero Down real estate investing techniques are and how they work.
What are Nothing Down Techniques or Zero Down Property Investing?
While Nothing Down techniques entail acquiring a property without the investor putting in any of their own cash at the front end of the deal, the term does cover a grab-bag of techniques and methods. ‘Nothing Down’ or ‘Zero Down’ is a general term which covers any method of acquiring a property real estate investment without parting with your own cash for the deposit.
Nothing Down methods don’t mean that the seller doesn’t obtain cash. Rather, the buyer/investor doesn’t put their cash into the real estate deal. These methods were particularly aimed at people who wanted to own their own home but who, for some reason or another (such as poor credit history), weren’t able to raise the funds for a conventional bank loan. The Nothing Down technique which is most familiar to Australian property investors is where the equity in one real estate investment is used as the deposit on another property purchase.
The loan supporting the original existing property is refinanced in order to tap into the home equity as the deposit, which any costs incorporated into the new loan. The equity may have been generated by capital appreciation, or from principal which has been repaid, and substitutes for a traditional cash deposit which the borrower saves up.
Refereed to in some quart3ers as cross-collateralisation (because the equity in one investment real estate is used as collateral, or security, for another investment) this equity tapping is arguably one of the purest forms of a Nothing Down or Zero Down transaction in property investing. It’s conventional, widely accepted and understood and highly effective. Home equity loans, redraw facilities and lines of credits when used as the security on an investment real estate are applications of this technique.
Other less conventional Nothing Down techniques include:
• Using your credit card to lay down some or all of the deposit on a deal (including having several credit cards and using one to pay off another in a ‘cycle’ of credit payments).
• Borrowing from friends or family to acquire a deposit or down-payment on a real estate investment.
• Borrowing the deposit from the seller (in other words, the vendor finances the security)
• Bartering goods or services as the security
• Using loan types which defer repayments (notably so-called balloon loans, more commonly used in the US, in which no repayments of principal or interest are due until the loan matures, at which time both the entire amount of principal and all accumulated interest are payable), and
• Using a real estate property or piece of land you already own as security for a vendor, either as property that you part with, or which you use as a form of guarantee to which the seller can lay claim in the event that you, the buyer, fail to meet some condition of the deal.
These techniques can be used on their own or in combination with each other for Zero Down or Nothing Down real estate investing. Other techniques exist which are sometimes lumped in with Nothing Down techniques but which aren’t actually such. An example here is the purchase option (not to be confused with lease options used by positive cash flow investors) where an investor ties up a property by buying the right, but not the obligation, to buy a real estate property at a certain point in the future at a certain price. A purchase option means you have some degree of control over the real estate investment (notably by excluding other buyers until the option expires) and enables you to place a bet as to whether a property will appreciate in value by a certain amount. However, you have to pay to buy an option, so whether an option qualifies as Nothing Down investing technique is questionable.
Nothing Down Techniques in a Nutshell
The description ‘Nothing Down’ covers a broad array of real estate property investing, but here are a few specific techniques that give you the flavour of the approach:
• Convincing the vendor to fully finance a deal, so that the vendor acts as a bank and gives you a loan for the property they’re selling to you, including the deposit
• Using a non-cash item as security for the purchase, whether that be another real estate property which you (the buyer) own, or some other item such as a boat, car, plot of land etc.
• Providing the use of your services (for example, if you’re a carpenter or accountant), to the vendor in lieu of a cash deposit.
• Using other people’s funds, such as those of a family member or friend, or utilising their borrowing capacity when you’re not able to access credit, in exchange for giving them a share of the ownership or profits from the deal.
Keys to Zero Down Property Investing
Here are some key points when it comes to real estate investing in property using Zero Down or Nothing Down techniques. Wealth Tip: Nothing Down techniques in many cases entail heavy borrowing, and hence bring both the benefits and risks of leverage. Nothing Down approaches might be good for acquiring property, but you’ll still need to part with your own funds at some stage after the deal is done. Nothing Down or Zero Down investing in real estate techniques are separate and distinct from positive cash flow investing. Nothing Down methods don’t substitute for a high-return investment. Some commentators critisize Nothing Down techniques on the grounds that the methods are unlikely to work, or will only work under highly specific circumstances.
Summing up Nothing Down Methods
In the final analysis, it may be that Nothing Down and Zero Down techniques for real estate investors are most useful for credit-impaired people who wish to gain access to buy their own home, or as a spur to creativity for property investors. The intelligent wealth-creator would do well to consider Nothing Down techniques as part of their armoury. These techniques can encourage an investor to bring ingenuity and creativity to the process of deal-making and investing, and this flexibility can make new deals possible or enable an investor to extract extra value from an existing deal.
Sensitising real estate investors to the importance of buying a good property investment from a motivated vendor to gain a bargain purchase price or favourable terms (rather than focusing solely on the property itself) is another contribution made by the Nothing Down school.
To the extent that Nothing Down and zero Down methods in real estate investing enable investors to bring new twists to a property real estate deal and enhance their profits along the way, they are useful additions to a property investor’s toolkit, and their wise and thoughtful application can create real wealth for the discriminating investor.
Labels: Nothing Down Investing, Zero Down Property Investing
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