The Dangerous Game of No Money Down Deals

The “salesmen” in this arena – the people selling you on buying real estate assets with no cash, those that sell the sizzle with no steak, make their money from getting you to spend a small amount of money with them before going for the “upsell.”  No money down applies to them, not you – you are expected to pay upfront. They ask you to commit even more money to get the training you need to buy or flip houses using other people’s money (OPM).

No Money Down Will Cost You

At the end of the day, you are out $1,000 to $10,000, and you have not purchased property.  But, not to worry, you’re all trained to go out into the world with your new “learning” and get busy!  Yay, you. At this point, the person that sold you the knowledge has your money and NO downside.  On the other hand, you have spent some serious cash and are on y0ur own to go to the next step, actually buying property.

I have strong opinions on this topic so much that I recorded two podcasts about the subject with my good friend George Eaton.  George has purchased more than a dozen investment single-family homes over many years and has broad experience in a robust marketplace, Baltimore, Maryland.

Attempting the standard “by the book” cookie-cutter no-money-down tactics lamely taught repeatedly for single-family investing and applying this to a commercial multifamily deal is a recipe for disaster.  It is a dangerous game at any level, with single-family or multifamily assets.  Congratulations, cliff dweller.

When was the last time you were, figuratively speaking, thrown under a bus?  Concerning nothing down deals, too often people go willingly- under the bus.  Year in and year out, we get emails seeking guidance on multifamily transactions where the buyer has limited or no capital, the proverbial nothing down deal.  Lets me be succinct: DON’T DO IT!  There. I said it.

Few people seem to appreciate this response before gushing with deal-specific particulars.  It doesn’t matter- don’t do it. I don’t care if your uncle is giving you the deal of a lifetime.  Sounds harsh, doesn’t it? Let me explain.

With NO MONEY DOWN You Start in a Hole

Maybe your uncle is a nice guy, you took care of him when he broke his ankle, and he’s doing a good deed in return.  With a three million dollar deal where the first mortgage is two million, and Good Uncle is taking back a second for a million, you are toast (good intentions or not).

First of all, on the surface, Good Uncle has set the purchase price at three million.  Are you going to spend a few thousand on a commercial appraisal to validate that a reasonable price is three million?  At this level of leverage (100% financing), every available dollar will be going to debt service.  In reality, there will likely be a monthly deficit.  How will your relations be if the payment due on the second mortgage is $5,000 monthly, but the asset is only kicking out $3,000 regularly?  Uncle wants his money.  After All, you bought the deal.

Second, what makes you so unique?  Why are you being offered this deal? Is it your good looks, because you dress well?  What do you bring to the deal?  Consider the following:

If the answer is the ability to “fog a mirror” and “sign a paper,” these talents have nothing whatsoever to do with acquiring a quality multifamily asset AND having skills to run the deal- no matter the capital stack.  The capital stack is just one component of Multifamily ownership and asset management. Yet so many people get caught up in this segment of the deal that every other aspect becomes diminished; this is tragic.  Why? Because while getting this right is imperative, it is just one leg of the table.  A single strong leg does not a table make.

Most people selling a nothing down deal are looking to get out of Property Management.  They didn’t time to learn about what they were getting into by purchasing this asset, and it’s kicking their butt- property management, vendors, dealing with tenants- this is not what they signed up for.  After trying to seal the deal and failing, they come up with the bright idea to sell the asset to someone they know for nothing down.  This is in the same category as living with your mother-in-law; it works sometimes but is generally a bad idea.

Here you come, with limited input on Deal Structure, maybe some property management experience, and limited to No Working Capital.  You are… crispy toast just waiting to happen.

It boils down to capacity.  Yet, the ability to perform initially is not enough to make the deal work if every other aspect is out of whack with reality (including valuation).

So for those un-convinced, for the brave few that wish to proceed, please consider the following:

1. The transaction should be provided the same or more due diligence than any other deal- more actually because of the significant threat posed to your personal net worth.

2. The transaction should be arm’s length.  Meaning, even if the sellers are known to you, there are no short cuts. Hire the same service providers you would pay for any other deal; appraisal, closing, attorneys, environmental, etc.

3. Listen to your attorney concerning the assumption of existing debt.  Assuming a commercial loan has more thorns than any rose bush.  Getting it right requires quality counsel.

4. If DSC (Debt Service Coverage) is 1.0 or less ($1 of Net Operating Income to pay for $1 of monthly debt obligations), you must have cash on hand to address any shortfalls from day one.  And for the next month, and the next if necessary.  Otherwise, you are dead in the water on the day of closing unless you have a source of funds for that unexpected, unanticipated, yet immediate, $5,000 monthly negative).

5. Identify and price property management. If you have no experience in property management, this is not the time or place to learn the trade.  If you do have property management experience, great, cost out work, and time required to address the asset. If the time necessary to manage is beyond your abilities, then you must hire a manager or PM company.  Factor these costs in.

Miss any of these steps, and you will be as burnt as a pizza left in the oven overnight at 400 degrees.  Note, this is just the starter list.  Seek professional counsel every step of the way.

Mashvisor.com  has a list of ten different ways to buy a property with no money down.  It’s worth a read just to get an idea of what craziness looks like.  I say that in jest because I am 100% sure that people have purchased a property using the tools and options listed.  If we could just do the follow-up and see how those deals ended for the buyer one and five years later!!!  The writer is pragmatic still having this commentary a part of the article:

It is absolutely possible in real estate to purchase a property with no money down. But just because it is possible, it doesn’t necessarily mean it is a good idea.

I couldn’t agree more.

John Wilhoit is the author of the best-selling book on rent roll analysis: How to Read and Rent Roll. See also the companion guide to measuring the quality of rental income: Rent Roll Triangle.  Find JW’s Podcast here.

Add Comment