The possibility of financial loss is not eliminated by making a large down payment. Profit is not necessarily assured either. Although most people associate a large equity with safety, the reality of the matter is that the more money you commit, the more you have to lose if things go against you.Making a high profit with little risk of loss is the product of knowledge and good judgment, not money. I know one investor who had a sound and effective strategy that served his acquisition program well. Over a period of approximately eight years he acquired property valued at more than ten million dollars. He began with no money but he was a whiz at math. He did it entirely through his skill as a negotiator.His technique was effective and simple. It was a combination of shrewd negotiation, analysis ability, and good management. It began with a purchase agreement that was contingent on a refinancing of the property in an amount large enough to pay the existing loans and to meet the down payment requirements of the seller. The negotiation key involved convincing the seller to carry a portion of his equity on a second mortgage.He would offer to purchase a complex, such as the American West Apartments, with a $475,000 down payment, provided he could arrange a new first mortgage and the seller would carry a second mortgage for the difference between the purchase price and the new first mortgage. Often he was able to negotiate the price down and the property appraisal and new loan up. This, of course, reduced the amount of the second mortgage. Occasionally he would divert part of the new loan proceeds to do major repairs on the apartments. This increased the second mortgage.
- Original Terms Acquisition Structure
- Price $1,300,000 Price $1,300,000
- Existing Loan -500,000 New Mortgage -975,000
- Equity -800,000 Second Mortgage -325,000
- Balance 0 Balance 0
There is a mathematical requirement that must be met in order for this technique to work. The existing mortgage must be lower than the current loan value by an amount large enough to pay it off and satisfy the seller‘s need for cash. This means that the appraisal of the property, for purposes of the new loan, must be high enough to generate the cash necessary to pay off the existing loan and still leave at least enough for a down payment satisfactory to the seller. Therefore, the old loan ($500,000) and the down payment ($475,000) equal the new loan ($975,000). The sales price ($1,300,000) is the sum of the new loan and the second mortgage. The seller‘s equity ($800,000) is the total of the down payment and the second mortgage.