Even as a new investor, you can build your business while simultaneously staying diversified.
From the very first year I started buying and controlling property on terms, I kept in mind the importance of diversity. Aside from the obvious long-term safety reasons, if you recall from past articles or from my bestselling book Real Estate on Your Own Terms, 2008 dealt me a pretty big blow. That’s why it’s super important to diversify and buy properly so as not to ever experience that again.
For those of you not familiar with my reference to “terms,” I say that when referring to controlling property via lease purchase or buying on owner financing or subject to existing financing.
Why do we only buy that way? Because I refuse to sign personally on bank loans and subject my family and my assets to some banker or the economy. We don’t take out bank loans, sign personally with sellers, or use our own cash.
So how can you maintain diversity while building immediate cash flow and your investor business in general?
6 Ways for Real Estate Investors to Diversify Their Investment Portfolios
1. Assign Out Deals
If you’re new to the investing business or searching for a way to get started, you can control a property via a lease purchase, procure your buyer (we call them tenant-buyers), and then assign that back to your seller. We call this type of deal an “AO,” meaning assign out (i.e., assigning the buyer back to the seller).
These are simple deals to do and bring cash flow to you very quickly. When I transitioned into terms deals, I did 13 deals in my first six months or so—12 were AO deals.
Then, with cash flow in hand, I started to delve into lease purchase-type contracts, while keeping in mind there’s a time and place for the AO if the numbers didn’t work. “Didn’t work” for me would be no monthly spread or the owner just doesn’t want us in the middle of them and a buyer, which is referred to as a sandwich lease. Let’s explore that further.
2. Sandwich Leases
This starts to hit diversity because your AO deals are bringing in cash flow and then your sandwich leases (where you pay the underlying debt/seller and collect more from your buyer) are providing you three paydays:
- Payday No. 1 is the upfront nonrefundable down payment that your buyer brings to the table to start their occupancy.
- Payday No. 2 is the difference between your outgoing payment to the mortgage company or seller and the amount you collect from your tenant-buyer.
- Payday No. 3 is interesting because it’s made up of (a) the price markup from what you have it under contract for and (b) principal paydown incurred during the term.
Now picture this diversity. You string together 12 of these, and you have staggered paydays.
I’ll fast forward this for you so you can see how it plays out. I’ve been putting together these terms deals as our main focus since 2013 and we have one or more closings (payday No. 3s) per month—and will have that happening for the next five to six years even if we stopped doing deals right now.
This is far different than doing wholesaling or fix and flipping, which is, in my opinion, nothing more than another job. (That’s unless you have scaled it to a large business, doing several hundred deals and having a staff that runs it). With these staggered paydays and massive cash flow happening, you can diversify more into owner financing and subject to existing financing.
3. Owner Financing
Let’s explore owner financing first. When I refer to “owner financing,” I specifically target properties that are free and clear—there’s no mortgage. We buy these with little to no money down, and we make monthly principal-only payments.
Think about this from a diversity stand point—you have massive principal paydown happening, thus dramatically improving your payday No. 3 at cash out. You can create these deals without large amounts of cash, so you’re creating huge equity per deal.
For more on that subject, see the article I wrote for BiggerPockets about not needing a mansion to create six-figure profit on deals. The exit or sale on these is just like the sandwich lease, the only difference being you’re further diversifying by now being able to depreciate and write off things since you are the owner of record.
Why did I wait to mention this until the third way to diversify? Well, if you are buying these with no money down, it’s not likely that the seller will agree to pay their own transfer tax. So, you’ll need a tiny bit of cash on hand to pay the sellers’ transfer tax—if that is applicable in your state. Even if it’s not, you’ll have some recording and misc closing fees.
4. Subject to Existing Financing
Purchasing property subject to the existing financing is similar to owner financing in that you’ll be the owner, but you are paying on the sellers’ mortgage, which stays in their name. Those deals are neither easy to negotiate when you’re new nor easy at any point in your career.
The little diversity piece here is when you take a sandwich lease that you’ve been paying the mortgage on for 12 or so months. At that point, you’ll have credibility and rapport built up with the seller. Convert that to a subject to as they now know you and trust you.
The sale and other attributes of this are the same as owner financing, except that your principal paydown is whatever is built into the existing loan versus full payment applying to principle.
5. Notes or Multifamily Properties
Use your profits to invest in notes or multifamily properties. If the latter, only buy on terms.
6. Self-Directed IRA or 401(k)
After you fix your cash flow and don’t need it beyond a few properties, you can do these same deals using your self-directed IRA and 401(k) plan. That gets super interesting.
One of our six-units we did with our self-directed IRA. Because of how we timed the closing, we were paid a nice check at that time. And then, when we sold less than three years later, $116,000 was put back into our IRA, plus the monthly net operating income. We use a self-directed Roth IRA, so that investment will now grow tax-free—and we’ll do many more deals.
How are you diversifying your investment portfolio as a real estate entrepreneur?
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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.
