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Brad Smotherman was 17 years old when he decided to get into real estate.
His family in Tennessee had worked in agriculture for generations, running their operation without reliable irrigation.
“My grandparents used to literally pray for rain,” Smotherman told Inman. “I realized pretty early on even as a child at 5 years old that wasn’t a good plan.”
He remembers his eighth grade teacher earning more money selling real estate part time than as a full-time teacher and realizing the opportunity real estate can provide.
But it was an experience later on that guides his investment strategy today. A real estate developer from his church who was operating with traditional financing faced a cash call from the bank during the 2008 financial crises.
“The Great Recession took him out,” Smotherman said. “It’s the main reason we don’t borrow bank money. I have no bank money in the business.”
Investors typically face higher loan costs than consumers when buying real estate, adding to the risks they take on while conducting business. But Smotherman specializes in creative financing methods that allow him to buy homes without walking into a bank.
“Rates have once again begun to increase above 7 percent. That’s the best case scenario,” he said. “If you’re an investor, the bank of course looks at non-owner occupied loans being more risky. We’re seeing upper 7s lower 8s for longer term holds.”
For short-term investor loans, investors are facing rates above 9 percent, Smotherman said.
“Most people think the only terms that exist are either getting cash or a bank loan and signing a contract,” Smotherman said. “That’s not very good terms.”
Last month, his real estate investing company bought 28 homes, one for every 8.5 leads that came his way through digital marketing efforts, he said.
He did so using a strategy to beat the banks. Here’s how he did it.
The power of creative financing
Smotherman uses what’s known as “creative financing” to operate his real estate investment business.
That often includes finding a source of owner financing or assuming an existing mortgage and taking over monthly payments. One example is a subject-to mortgage.
“Subject-to just means the title is subject to a lien that has yet to be paid off,” Smotherman said. “That can be a mortgage, a judgment, a tax lien. But it allows you to create built-in financing without actually going to the bank.”
Eighty-five percent of homeowners have a mortgage rate that’s far below current rates, according to Redfin. That creates a big pool of possible homes for investors to acquire without assuming a new mortgage at existing rates.
Another method is known as a “carryback,” or seller financing.
“We need a free and clear property and a motivated person,” Smotherman said.
Sometimes, a judgment lien on a property can create a distressed seller who’s unable to settle the issue. But that doesn’t necessarily mean the buyer has to pay it off.
Timelines vary by state, but liens often have a sunset date when they expire.
“If you buy a property that has a lien that’s 7-years old, in three years that lien pops off and it’s almost like it never existed,” he said.
Smotherman said he expects to double the size of his business in the next 18 months using largely those same tactics.
Searching for term equity
With traditional interest rates much higher today than they were in 2021 and 2022, there’s a gap in interest rates that is valuable.
“Everyone looks at equity in terms of price, and I think that’s true but incomplete,” Smotherman said. “Right now term equity is far more important.”
“If we can take over a loan that’s subject-to at 2.75 percent, we may have some equity in the price, but we’re really looking at the equity in the rate in that scenario,” Smotherman said. “That’s the thing I think a lot of investors miss is term equity.”
Investors pay capital gains taxes on profits, so there’s an incentive to hold onto cash-flowing properties over the long term.
“We’re buying equity and holding it,” Smotherman said. “We’re not exiting everything. Part of that is the tax consequences and secondly where do you put the money?”
The five big motivators for sellers
In the beginning, Smotherman printed yard signs advertising his business and would place them on a Friday and pick them up after the weekend. But that’s a lot of time and energy, he said.
Now he prefers a more passive approach, relying on paid digital ads that target people who are searching online for ways to sell their homes quickly.
“If someone is typing in ‘sell my house today,’ that’s indicative of a certain motivation,” Smotherman said. “You want to be in a position to be found. The easiest way to do that is through search marketing – digital ads.”
There are a handful of common situations in life that fill the pipeline of homes that can be acquired through creative financing, Smotherman said.
“We call them the big five,” Smotherman said. “The vast majority of our transactions come from one of the big five motivators: Pre-foreclosure, inheritance, divorce, tired landlords and health or safety.”
The foreclosure pipeline is still historically very low, with the number of seriously delinquent mortgages in the U.S. falling to a 23-year low in March, according to property data firm CoreLogic.
Still, when it happens, owners who are nearing foreclosure can be motivated to work with an investor using creative financing because it can act as “built-in credit repair,” Smotherman said.
If a property is nearing foreclosure, the owner’s credit will have been negatively affected. The loan will show that it’s being paid on time month after month before the investor eventually sells the home.
“They can show it was behind, then it was caught up and paid on time for a period of time afterwards,” he said.
He added he can also pay more money for a house through creative financing than a traditional loan or cash.
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- Source: https://www.inman.com/2023/06/06/how-1-real-estate-investor-beats-the-banks-amid-rising-interest-rates/
