Here ye, here ye, let it be known that, Jon Morrow, the Ruler of Real Estate, has thrown down the gauntlet.

He pauses for a moment, daintily pulls off his glove, and drops it to the ground.

His Majesty challenges all Personal Finance Bloggers of friend and foe alike to a duel of words, a debate on the superiority of real estate to stocks. If a challenger steps forth with sufficient insight to merit consideration…

He stops again to snicker at the idea.

… then he will earn a link from this blog and an official response, posted for the world to hear.

Rolling his eyes, the crier stuffs the announcement back into his jacket and pulls out another roll of parchment. He hands it to you. Curious, you unroll it and begin to read:

Why Real Estate Beats the Crap Out Of Stocks

#1: Nothing down Magic

You can buy it with nothing down! For nary a penny of your own money, you can buy millions of dollars in real estate and resell it for an instant fortune. Where in stocks can you turn nothing into something? Nowhere, I say!

#2: The Lazy Way to Riches

With stocks, you have to spend countless hours pouring over data, crunching numbers, and reading the news. It’s too much work! In real estate, you have other people do the work for you. Mortgage brokers get you the money, contractors fix up the property, and realtors find the buyers and sellers. All you do is deposit the checks!

#3 Prettier Women

Have you seen the women in real estate? Vavoom! Invest in real estate and you’ll be surrounded by a harem of long-legged realtors, ready to serve your every need. Where are you going to get that in stocks? I mean, have you seen their women?

#4 Your Safety Is Guaranteed!

Real estate never goes down in value. Even if you have no idea what you’re doing, you can buy a property and sell it for what you paid to break even. People lose money in the stock market every day!

#5 Real Estate Always Appreciates

Sure, the stock market goes up in value, but nothing like real estate. Despite the bubble, prices are still going up, sometimes 20% or more per year. Buy all you can, hold it for as long as you can, and get rich!

#6 Make Enough to Quit Your Day Job

Who have you met that retired before the age of 30 by investing in stocks? Nobody! People in real estate do it everyday. Invest in real estate and you can retire in five years or less, but invest in stocks and you’ll be huddled over a keyboard when you’re 85.

#7 We Are the Master Race!

People that invest in real estate are genetically superior to people that invest in stocks. We are smarter, richer, and better looking. Join us or become our slaves!

—–

Nodding your head, you salute the crier and hand back the parchment. Grinning, he leans forward and says, “Nevermind any thoughts of a serious challenger. I dare any stockholder to step forward and challenge our decree. We’ll obliterate them in the public debate.”

He throws back his head and laughs, walking back into the shadows.

Personally, I think he’s a victim of employing strategies he doesn’t understand. You can buy real estate with no money down, but it’s an advanced strategy that requires foresight and close attention. I’ve purchased several million dollars of real estate using no money down techniques, and I’ve never gotten burned. The difference is, I’ve been involved with this business for my entire life and (most of the time) I know what I’m doing.

To make “no money down” strategies work, you need to:

Understand the Cost of “No Money down”

There’s an old saying in real estate negotiations that goes like this, “You can have your price or your terms, but not both.” In other words, you can buy my house at a discount or I’ll give you financing and you can buy at at a higher price, but you’re not going to get both from me.

People that use seller financing to buy a house with no money down usually go for the terms and end up sacrificing on the price. For example, they might get an 80% loan and ask the seller to finance the other 20%. The problem is, they’re probably paying top dollar in exchange for the good terms.

Then, they mark the property up 10-20%, put it back on the market, and expect to make a fast profit. This is a classic mistake. You can’t expect the property to sell for more money just because you own it. You have to improve its value somehow, such as fixing it up or changing its zoning.

You might occasionally buy a property at a discount with no money down, but it’s exceptionally rare, and I would be suspicious of anyone pushing you to do it.

Pay Close Attention to Your Costs and Timeline

If you want to see a “no money down” proponent stutter, ask them where the money is coming from to make interest payments until the sale. Ask them, “What happens if this takes a year to sell?” Most of them haven’t considered it. They think the need for cash stops as soon as you purchase the property.

Except, it doesn’t. Real estate continues to cost money after you buy it. Generally, you have to make interest payments, improve the property, and pay taxes. Counting on a quick resale to avoid paying any of these expenses is a recipe for disaster, and it sounds like this is what happened to Casey.

Personally, I use the “no money ever” approach. Rather than just financing enough to purchase the property, I factor in the cost of improvements, taxes, and payments. If I think the project will take six months, I borrow enough for one year or longer just to make sure. Then, when things take longer than expected, I’m still safe.

Create a Multitiered Exit Strategy

The upside of no money down strategies is they allow you to minimize your cash investment, thereby maximizing your rate of return. If you invest nothing and make $10,000, then your return is 10,000 / 0 or infinity. It’s a great way to make stellar returns, but there’s also a downside you need to be aware of.

Because you’re leveraging yourself to the hilt, you’ll probably need to get rid of the property as quickly as possible. So, creating a multitiered marketing campaign becomes important. You have sales plan A, B, C, and so on, usually changing the approach or lowering the price at every step.

For example, I’m currently working on selling a large 234 acre development. It’s worth about $19 million, but we’ve been trying to sell the whole thing for a year and no one wants to buy all of it. We do, however, have people that will buy pieces of it, so we are changing the debt structure and selling the residential portion for about $4 million. Then we’ll parcel out the commercial and sell it, piece by piece. It’ll take longer, and we’ll rack up a lot more carrying costs, but it keeps the project moving.

If you’re heavily leveraged, you’ll need a similar strategy. Sometimes you’ll have to sell everything off for less than you’d planned, making little or no money. The key is making sure that you recycle your inventory of properties so that none of them bankrupt you when they don’t sell.

“No Money down” Is Not for Beginners

Imagine that learning to invest in real estate is a series of ski slopes. You’ve got beginner, intermediate, and advanced slopes. In my opinion, no money down is one of the advanced slopes. A beginner might occasionally make it down, but it’s not safe, and lots of them will crash and hurt themselves.

The problem I have with people like Russ Whitney is they push beginners on to the advanced slopes before they are ready. Instead of telling Casey to go out and buy everything in sight with no money down, they should’ve told him to start tracking several real estate markets, saving his money, and building his credit. Then he could’ve made a highly educated, regularly financed purchase.

From there, he could work his way up. Investors like my father and I rarely go on the beginner slopes anymore because it’s just not fun or as profitable. The difference is, we’ve been doing this for a long time, and we both spent plenty of time on the beginner and intermediate slopes before moving up.

So, if you like the idea of no money down but you’re just getting started in real estate, put the strategy on the back burner for a while. Save your money, prepare your credit, and buy the property the old-fashioned way. Then, when you’ve gone through the motions several times, you can move up to the more advanced strategies and try a no money down deal.

• When houses go up for sale, what they’re asking for, and how quickly they sell
• When houses go up for rent, what they are asking for, and how quickly the vacancy is filled
• Improvements to properties in the area and how it affects sales prices
• The type of people living in or out of an area and how it affects sales prices

Not only do you look at the data, but you talk to people. You call every For Sale or For Rent sign, chat with people walking their dogs, and generally get to know everyone in the area. It gives you a tremendous “feel” for the market. Since you know everyone, you’ll also probably get first dibs on any opportunities.

Let me give you an example.

Finding an Unadvertised Opportunity

A good friend of mine specializes in buying homes in the suburbs north of Charlotte. Once or twice a week, he drives around about 20 different neighborhoods for a couple of hours and notes any changes.

Last month, he invited me to invest with him on a deal he’d found through farming. I ultimately turned him down, but the details of the transaction are a perfect example of how to make money with this technique.

The house in question was occupied by a family that had purchased it from an older gentleman 10 years before with 100% owner financing. My friend had been driving around this neighborhood for about five years, and he knew the couple well. They had two kids and never intended to move, so when a for sale sign popped into the yard, he stopped by to ask about it.

As it turns out, both the husband and wife had lost their jobs and they were several payments behind on their financing. The original owner was threatening foreclosure, and they couldn’t see any way to catch up on the payments. So they put the house up for sale.

The house was worth about $120,000, and they were asking for $110,000. Except, he found out they would actually accept anything above what they owed — $68,000. They were also about $3,000 behind in payments and had promised the realtor at least $4,000 in commission, so that raised the balance to about $75,000.

My friend offered them $80,000, allowing them to walk away with $5,000 to get started again. They accepted, and he picked up a house with $45,000 of equity. Not bad for a couple hours of driving around.

As an Insider, You Get Insider Information

The important point is, he would’ve never gotten all of this information if he’d just called the realtor. By law, they aren’t allowed to disclose those kinds of details without explicit instructions from the seller, and everyone was hoping for a much higher price than they eventually settled for.

Yet, because he knew the seller and their specific situation, he recognized that it was odd. He was also able to go directly to them and discuss the situation, almost entirely bypassing the realtor. Because the sellers knew him, he also had a reasonable amount of trust built-up, allowing him to quickly negotiate a good deal.

It’s almost like having insider information, except it’s completely legal. By farming neighborhoods, you can eventually become a third-party member of the community. As a result, you get information before just about anyone else.

The same applies to larger scale deals. In our development business, my father calls every single listing for land within a 10 mile radius. That’s right, all of them. Because we’ve purchased almost 2000 acres in the county, he’s also somewhat of a local celebrity, and everyone knows him. If you have land for sale, you go to Dale.

Sure, it’s an old-school way of doing business, devoid of spreadsheets and Internet data. But it works. If you’re going to start investing in real estate, I’d recommend you start driving around a few neighborhoods now. It may take a couple months before you notice anything, but when you do, it’ll be worth it.

There’s only one problem. Your house may not sell.

In many cities, agents are deliberately boycotting discount listings to keep fee-based brokers from moving in on their commissions. They also despise dealing with sellers without representation because, most of the time, they’re much more trouble.

A couple of years ago, I actually experimented with a flat rate broker, just to see if it worked. The result? Not a single phone call for about five months. Admittedly, both houses were over $1 million, so I was limiting myself to a smaller subset of the buyer’s population. Still, it was a seller’s market, and I should have received some attention. Yet, all I got was phone calls from drive-bys.

In response, I listed both of them with the hottest agents in their respective cities and had both of them sold within three months for near full price. The difference in response was huge, going from no showings to over 60.

Can flat fee listings work?

Yes… eventually. Not only will the discount market continue to grow, but I believe less and less people will use a realtor to find their house because of the amount of information available on the Internet. The old guard will eventually lose the war, and the results will pick up dramatically.

I think it can also work in exceptionally hot markets. For instance, a friend of mine was standing in line for three hours for a preconstruction deal in Sacramento yesterday. If the market is that good, then you shouldn’t have to worry about some brokers boycotting you.

.

You see, the professional makes investing his career. Through hours and hours of experience, he becomes a master of the trade, often gaining and losing it all several times over.

But he never stops.

Regardless of the tragedy or triumph he faces, the professional investor continues, learning, experimenting, and all the while building his empire. He can’t imagine doing it any other way.

Take the movie Cinderella Man, for instance.

At the surface, it’s just an inspirational boxing movie, but if you look closer, I believe it’s a story of what it means to be a professional.

A Professional Cannot Divide His Attention

In the beginning of the movie, James Braddock is penniless, beat up, and seemingly at the end of his career. He’s working every available shift at the docks, but he can’t scrape money together to pay for enough food. Hungry and with a broken hand, he goes his last fight and does so poorly that they revoked his license.

Why?

You could say it’s because he’s hungry and out of shape, and you’d be right, but the reason he’s in that condition is he’s unable to focus exclusively on boxing. Where many of the other fighters are training full-time, he spends all of his time on the docks, struggling to survive.

Later in the movie, he gets a chance to go back into boxing full-time, and suddenly he beats everyone in his path like they’re nothing. Not because he’s received any special revelation, but because he can focus on his profession.

Investing works the same way.

Yes, you can make some money investing part-time, but you’ll never make as much money as a professional investor. You won’t have the experience, resources, or time. The only way you’ll be able to compete is to quit your job and throw yourself into it full-time.

A Professional Investor Accepts the Sacrifices

When Braddock decides to fight Max Baer, everyone tries to dissuade him. Baer has killed two men in the ring, and they’re afraid that the aged Braddock will be the third. They show him a film of Baer delivering the final deadly blow. And what does he say?

“You think you’re telling me something? What, like boxing is dangerous, or something like that?”

Braddock knows the risks, and he’s willing to accept them as part of his profession. Later, he responds to some reporters:

“You don’t think double shifts or working nights on the scaffolds is just as likely to get a guy killed? … In my profession, and it’s my profession, I’m a little more fortunate.”

Professional investors take the same approach. They stake the prosperity of their entire family on their investments, and they recognize it could all end in bankruptcy.

Yet they’re not worried. Why? Because there’s risk involved with everything, whether you’re working a job, investing in stocks, or risking it all on a multimillion dollar real estate deal. They know the risk of their occupation, and just like Braddock, they meet it head-on.

Professional Investors Win through Courage and Perseverance

If you’ve watched the movie, you know that Braddock becomes the heavyweight champion, but quite arguably, he’s not the better boxer. He’s just more persistent and courageous.

In one of the earlier fights, another boxer connects with a vicious uppercut, knocking out his mouth guard. Most fighters would’ve just quit, but he just grins, blood trickling from his mouth, picks the mouth guard up again, and wins the fight.

Investing works the same way. Sooner or later, you’ll take a risk and lose, taking a metaphorical uppercut to the face. Except, what are you going to do? Lay down? No, you’re going to get back up and finish what you started.

It takes a tremendous amount of courage to do this, and everyone will recognize it. If people see you take a financial hit, losing a tremendous amount of money, but your back on your feet again in a year, you’ll gain a lot of respect.

Not Everyone Wants to Be a Professional

I admire Braddock, but I don’t envy him. You couldn’t pay me enough money to get in a boxing ring with a heavyweight champion. Now, would I like to take some boxing lessons and do it to stay in shape? Sure.

Similarly, some folks have no desire to be a professional investor. They can’t imagine risking everything they own. They can’t put themselves or their family through the stress. They’re not in this to get famous; they just want to stay financially fit

And there’s nothing wrong with that.

You just have to decide for yourself which one you want to be.

Currently, Prosper.com has a lending limit of $25,000 — a gigantic sum for your average borrower, but peanuts to real estate investors. We borrow several times that on individual properties, and my companies frequently carry over $1 million in unsecured debt from private investors. Another $25,000 doesn’t do me much good.

To give Prosper some credit, they’ve started in a great niche. People are using the money to pay off high-interest credit cards and start small businesses, both of which are underserved in the lending community. Private lenders are also making a much better return than they would receive from their savings account or CD.

So yes, congratulations are in order. Now it’s time to expand.

Destroying the Hard Money Monopoly

Currently, the only source real estate investors have for fast, flexible funds is hard money lenders. They charge an average of 15-18% interest with 1-3 points of origination fees upfront. If you borrow $100,000 for six months, you can expect to pay $3000 on the front end and $7,500 over the course of the loan. Annualized, that’s over 20% interest.

Sound expensive? It is. The only way you can justify it is to make a much higher return on your investment. Many investors also pair hard money with lower interest first mortgages. For example, you might buy the house through a traditional lender and then borrow hard money to make repairs.

It’s still expensive, but real estate investors don’t have much of a choice. If a hot deal pops up that you need to jump on within a few days, then you have to suck it up and pay the hard money lender their fee. That, or pay cash for the property, which only a small percentage of investors can afford.

It’s a monopoly, and frankly, we’re sick of it.

If Prosper.com would move into the hard money market, it would substantially reduce our dependence on hard money lenders, reduce the rates we have to pay, and provide substantial profit at minimal risk to the individual lenders currently thriving at the site. The market is ripe for the picking, and I think Prosper should go for it. Speaking only for myself, I’d be willing to send about $3 million of business their way immediately.

How to Set It up

The first hurdle to overcome would be securing the larger sums with liens against property. I’ve browsed through Prosper, and I don’t currently see a way of doing this. They may have to partner with a national title search and closing company to make it happen.

Inevitably, some properties will also go into default. When this happens, someone will either have to negotiate with the borrower or begin foreclosure proceedings. If it’s a lien behind a first mortgage, then the lender will either have to pay off the first mortgage holder or negotiate a reduced settlement.

This brings up the problem of manpower. Who is going to do all of this extra legwork? I have three ideas:

1. Prosper.com: Handle everything for the lender, probably collecting a fee from the title and closing companies in exchange for sending them to business. They could also charge an increased fee to the lender or borrower for this kind of transaction, covering the cost of the additional employees this solution would require.

2. The Lender: Traditionally, the hard money lender handles the entire proceeding for themselves. They make sure the closing documents are in order and foreclose on the property, if necessary. The only problem is, this requires specialized knowledge that many Prosper lenders won’t have.

3. Specialized Groups: Currently, Prosper.com has lending groups that specialize in certain types of transactions. They could form the group specifically for loaning money on real estate. Once it has reached an appropriate size, the group could appoint someone to handle closings and foreclosures.

Isn’t This More Risky and Complicated?

Yes, and yes, but it’s worth it.

I can certainly understand why Prosper started in the personal loan niche. It’s accessible to a greater number of people, and it also takes the fullest advantage of their distribution model. Except, they’re missing out on the other underserved niches that could provide a huge amount of profit for both themselves and their lending members.

What I’m recommending here is the next generation of Prosper.com. They should target other specialized niches, such as the hard money lending industry, and develop a presence in those. Just from real estate investors, I’m sure they would pass over $1 billion in loans the first year, as long as that much money is available.

From there, they could move into the mainstream lending market and become a truly dominant competitor. Imagine getting your home loan or financing your car through Prosper.com. I think it’s a possibility, but I also think they’ll have to grow through a set of niches before reaching for the larger markets.

In my opinion, hard money lending is next.

What do you think? How should Prosper continue to expand and improve?

Other Prosper.com Resources:What’s It like to BORROW Money with Prosper? - Account of borrowing money

- Account of borrowing moneyProsper: People to People Lending Marketplace - Potential problems with Prosper

Prosper.com: Person-To-Person Lending Review - Two-part review

Most investors stop budgeting after adding up the downpayment and carrying costs, forgetting to include taxes, maintenance, improvements, and commissions when selling the home. If you add it all up, they’re not making nearly as much as they think they are.

Over at Consumerism Commentary, Flexo breaks down the costs of a typical home over a 30 year period. If you buy a house for $300,000 and sell it for $1 million 30 years later, are you really making good money? Not really. In his article, he breaks down $710,000 of fees over a 30 year period, meaning the homeowner is actually losing money.

The same type of thinking applies to your real estate investments.

Debunking the Famous 100% Return

Go to any real estate meeting and you’ll hear investors bragging about making over 100% on a recent investment. Now, I believe it’s possible to consistently make 100% on your money, especially with proper budgeting and leverage, but these investors are usually making much less than they think they are. They’re forgetting to add in all of the expenses.

Let’s break down a typical house deal.

Purchase Price: $95,000

Downpayment: $9,500 (10%)

Principal: $85,500

Closing Costs: $1500

Repairs: $10,000

Interest: $3,500

Taxes & Insurance: $1000

Sales Price: $125,000

Commission: $7,500 (6%)

Closing Costs: $500

Timeframe: 6 Months

Not really thinking about it, most investors use the following formula:

(Cash Back at Sale - Downpayment - Repairs) / Downpayment

In this case, it would look something like this:

($30,000 (Estimated) - $9,500 - $10,000) / $9,500 = 111% Return

But their formula is wrong. To simplify, it’s more like this:

(Cash Back at Sale - All Cash Invested) / All Cash Invested

You have to add up every dollar that came out of your pocket, including repairs, interest payments, taxes, closing costs at purchase, and your initial downpayment:

($30,000 (Estimated) - $25,500) / $25,500 = 18%

Now, 18% still beats your average six-month return anywhere else, right? Yes and no. If you factor in the amount of time that you spent on the investment and subtract an hourly rate, then you might have been better off working overtime at your job.

Develop a Detailed Budget before You Invest

If you’re only making that much money, should you take your money out of real estate and put it in something else? No, I still don’t think so. I just believe you need to develop a detailed budget before you invest in any property, so you can see how much you’re actually going to make. Factor in the time involved and see if it’s worth it to you.

For instance, I’d never invest in the above property. From start to finish, it’s safe to say it would take 40 hours of my time and if I billed the project my hourly rate ($500), then I would end up losing a lot of money on the deal. Even if I used a credit line and other people’s labor to better leverage the investment, nothing could justify the tiny return.

So, don’t get fooled by the large equity spread when you’re looking at the property. Put every dollar you expect to spend in a budget and make sure it’s still worth it.

But it has its advantages.

In my last post, we covered three reasons why paying down your mortgage is a bad idea, but there are also three equally good reasons that it’s a good idea:

You’re Less Likely to Face Foreclosure

Going into foreclosure sucks.

You’ve spent years paying for your house and something happens where you can’t make a few payments. You get lots of ugly notices in the mail from the bank, threatening you unless you pay them off, but you just can’t do it. You’re forced to sit back and watch your house auctioned on the courthouse steps. Then the sheriff comes and kicks you out. So much for having a home.

The best defense against foreclosure is actually paying off your mortgage. It’s a simple equation. If you don’t owe them anything, then they can’t take your house. Even if you’re just paying down the mortgage by a few percentage points, it can still make a big difference because the properties that go into foreclosure usually have too much debt for the seller to pay it off by selling the property. Otherwise, they’d just sell it.

For example, if you owe $120,000 on a house that’s only worth $105,000, then you’re sunk. It’s unlikely anyone will pay you above market value. On the other hand, if you owe $70,000 on a $105,000 house, you can probably sell it for $80,000 relatively quickly to an investor, avoiding foreclosure and walking away with a little bit of money to get started again. It’s a much better situation.

You’re Able to Buy More Profitable Real Estate

From an investment perspective, the problem with your primary residence is it’s not making you much money. Sure, you might see some appreciation, but it’s hard to predict. You’re better off borrowing money on properties that produce some sort of income or profits. You’ll make more money.

Why not just borrow money on both?

Lenders have a little variable called your debt to income ratio. On average, they’ll only give you a loan with payments that comprise about a third of your gross monthly income. So, if you’re making $3000 per month, the maximum you can borrow is a loan with a payment of about $1000 per month, assuming your credit score, documentation, and everything else is in order. You can technically borrow more, especially as a professional investor, but a third is the general rule of thumb.

The point is, if you’re paying $1000 per month on your primary residence, then the bank won’t want to loan you any money for an investment property, unless it’s also producing cash flow. It limits your options and might prevent you from buying the most profitable properties.

By paying down the debt, you can reduce your payment and use the money to buy other properties that create income for you. For example, you might buy a house and rent it out for a small profit. Not only will you make money from the rental, but you’ll save a little on the mortgage for your primary residence.

You’ll Have Greater Peace of Mind

In the movie Office Space, there’s a great scene where Ron Livingston decides to stop paying his bills. Not because he’s unable; he just doesn’t want to pay them anymore. They’re a headache and he’s tired of worrying about them. So, the simplest solution is to just stop paying them.

I wish we could do this in real estate. Unfortunately, it doesn’t work that way. Whether you’re up or down, making money or not, you have to pay the mortgages. Even if you have the money, it’s still a headache to make sure they’re in on time. Automatic bill payments don’t help, either. It’s still in the back of your mind — something that’s supposed to be taken care of but you continue to fret about anyway.

If you can pay off your mortgage, it’s actually a tremendous relief. As Forrest Gump would say, “And that’s good! One less thing to worry about.”

The Bottom Line: It Depends on Your Lifestyle

What’s the verdict? The tax refund check is sitting there. Should you pay down your mortgage or not?

The answer: it depends on your lifestyle.

If you’re investing to increase your net worth as quickly as possible, know what you’re doing, don’t mind extra debt, have a great debt to income ratio, and so on, then you shouldn’t pay it down. Take the money, invest it, and enjoy the dividends.

On the other hand, if you’re looking forward to a life with less obligations, don’t want to risk losing it all, invest in only low-risk vehicles like CDs, and the reduction in your payments would make a difference in the quality of your life, then go for it. Pay the sucker down.

It’s all up to you and how you want to live.

This is the question that JD over at the Get Rich Slowly blog asks his readers. I’m going to give my take on the issue, looking at it from both sides. Then you can decide for yourself.

First, let’s go over why paying down your mortgage is a bad idea.

1. You Won’t Save As Much As You Think

If your mortgage is locked in at 6% interest, then paying it down by $3000 dollars will essentially save you 6% or $180 per year, right?

Actually, no.

In most cases, interest payments on real estate are tax-deductible. You can write off the $180 in interest, so in actuality, you’re saving much less, if anything at all.

2. You Can Make More Than You’ll Save

As a real estate investor, if you can’t make more than 6% on your money then you’re doing something seriously wrong. You could probably invest that $3000 as a portion of a downpayment on another property and make a lot more.

For example, let’s say you have an additional $10,000 in savings. You find a little fixer upper for $60,000 and make a 10% downpayment of $6,000. Combining your tax refund money, you have $7,000 left to make repairs and cover interest payments.

With about $67,000 in it, you sell it for $95,000, subtract a 6% commission for the realtor, and net a clean $20,000 or so. That’s over a 100% return — clearly much more than you would save from paying down your mortgage.

Now, if you’re just beginning to invest in real estate, I can understand how this might be difficult, but you should still be able to make much more than 6%, even if you’re just loaning the money to an experienced investor. For example, investors with perfect track records pay about 15% per year (paid annually) in Charlotte.

It’s still better than the minuscule savings.

3. You Can Use It to Create a Safety Net

Even if you don’t invest the money, you can still put it in savings to serve as a safety net. Unexpected tragedies happen all the time that cost lots of money, and it’s always good to have several months of income saved up. Personally, I recommend having six months of living expenses in the bank.

If you’re spending an average of $3,000 per month, then a $3,000 tax refund gives you a one-month safety net. It’s not much, but if you lose your job, go through a divorce, or end up in the hospital, it may be the difference between surviving and bankruptcy.

Use the money to pay down your mortgage and you’ll have to pull out a credit line to get it back. It’s not only time-consuming, but the problem with unexpected tragedies is they typically impact your credit. So, you may have to pay a high interest rate, or you might not be able to get the money at all.

That about covers the downside of paying down your mortgage. Tomorrow, I’ll post another entry, going over the advantages. Stay tuned.

I can’t tell you how many negotiations come down to a few percent difference between what the seller wants and the most a buyer will pay. You come across a great deal, ripe with opportunity, but the seller won’t budge on the price.

So, what do you do? Walk away?

Sometimes, yes, but the good news is there’s a way you can shave 3% off just about any purchase price. It’s a little secret that real estate agents don’t want you to know because it technically takes the money out of their pocket.

Let’s go through it, step-by-step.

1. Understand the Commission Split

In a typical real estate transaction, the buyer and seller are represented by different agents. Each side wants their own counsel, and neither want to talk directly with each other, so the agents go back and forth between themselves. If you’re the buyer, then your buyer’s agent negotiates on your behalf, and the seller’s agent negotiates on behalf of the seller.

Each agent is also employed with a brokerage company, such as a Re/Max or Century 21 franchise. When the negotiations are finished, both brokerage companies split the commission — usually 6% of the sales price — and then the agent receives a piece of the brokerage’s portion. Then the seller collects the rest, minus any encumbrances (such as a mortgage), taxes, and closing costs.

OK, it’s a little confusing, so let’s do an example.

If you’re buying a house for $100,000, then the brokerage firm for your buyer’s agent would receive $3,000 (3%). Then your agent would receive a portion of the $3,000, depending on their employment agreement. Typically, it’s 50-80%, or $1,500-$2400. The seller’s agent would also receive a portion of their company’s $3,000, once again depending on their employment agreement. Out of the remaining $94,000, any mortgages or liens would be paid off, and the seller would receive the balance.

But here’s the wrinkle. What if you don’t have a buyer’s agent?

No one is forcing you to have one. Depending on your state, you can agree to dual agency, where the seller’s agent represents you as well. In this case, you’d think that the brokerage company would only receive 3%, since they are only paying one person, instead of two. Except that’s not the case.

In most listing agreements, the seller is still required to pay the full 6%. Normally, the agent is ecstatic because you’ve doubled their profit. They quietly walk away with both sides of the commission, and usually, neither the buyer or seller raises an eyebrow. As real estate investors, however, we make a lot of money by raising our eyebrows.

2. Agree to Dual Agency

Disclaimer: I only invest in North Carolina, South Carolina, and Mississippi, so some things here may not be accurate for your state. For example, in some states, dual agency is illegal. Check with the seller’s agent for the laws in your state.

In dual agency, you and the seller are represented by the same agent. Usually, both of you have to agree. In other words, if you want the seller’s agent to represent you, then the seller has to agree. The technical reason is the agent won’t be able to (legally) help the seller to get the upper hand in the negotiations. They’ll have to abstain from giving a lot of advice to either of you.

Then there’s the real world.

If the agent thinks they’re going to make twice as much money off of you as any other buyer, then they’ll secretly become your biggest fan. They’ll work harder to convince the seller to accept your offers, and they might even turn away other buyers that can offer more money. Technically, it’s illegal for them to give you that kind of favoritism, but it also happens everyday, and you might as well take advantage of it.

A few sellers know this, so they’ll refuse to sign a dual agency agreement. If that happens, you’re sunk — this strategy won’t work. Still, it’s pretty rare (I’ve never been denied), and most sellers will happily agree. Once you have the dual agency agreement signed, you can move onto the next step.

3. Negotiate the Seller down to Their Bottom Dollar

The next step is make an offer. An extremely low one. You have to push the seller as far as they’ll go and still have a difference in what you’re willing to pay.

You can do this several ways:

• Ask the seller for their rock-bottom price and then offer less
• Ask the seller how much they owe on their property and then offer less
• Just offer less than anyone would reasonably accept

For believability, you should also justify your offer. Tell them that you know the house is worth more, but you’re an investor and you have to make money. If you’re buying a house to live in, you can also tell them you can’t get financed for any more, and you’re just trying to make the deal work.

Eventually, you’ll come to a point where you’re not going to go up and they’re not willing to go down. This is where you move in for your extra 3%.

4. Ask for a Reduction in the Commission

By this point, you’ve probably negotiated several percentage points off of the purchase price, but it’s probably all you’re going to get from the seller. So, you move to the next person: your agent.

Tell them that you want to make the deal work, but there’s just not enough room for the full 6% commission and you need them to go down to 3%. Remind them that they would’ve only gotten 3% if someone with a buyer’s agent bought the house, so they’re actually not losing any money.

Plus, if they don’t reduce their commission, then you’ll have to walk away from the deal. This puts them in an interesting position. They can reduce their profit or get nothing at all. Obviously, they’ll take the 3%, even if they’re not happy about it.

Their employer, the brokerage company, may also have to authorize the reduction in commission, but it’s rarely a problem. I’ve used this strategy several times, and it works like a charm with everyone.

An Example of Buying a Primary Residence

Let’s say you’re shopping for a new home to live in, and you come across a beautiful little house selling for $200,000. You call the real estate agent and find out they’ve had it on the market for several months and they have an appraisal for the full amount, but no offers are currently on the table. So, you decide to purchase it.

The first thing you do is tell the agent that you’re not represented and you’d like them to represent you as a dual agent. Seeing dollar signs, they should happily agree, but they’ll have to run by the seller for approval. A day later, they call you to say it’s OK with the seller and they’re faxing a dual agency agreement. Look it over, sign it, and send it back.

Next, call your mortgage broker and ask them to prequalify you for up to $200,000. They’ll check your credit, gather some other financial information, and call you back within a day or two. If everything is OK, ask them to send you a prequalification letter for $160,000 — 20% below the purchase price.

Then call the agent. Tell them that you got prequalified, but the mortgage broker isn’t absolutely certain you can do more than $160,000. They’ll be disappointed and they might tell you that it’ll never work, but have them prepare an offer anyway. Say you’ll try to make the deal work for the seller, but you can only do what you can do.

A day or two later, the agent should call you with a response. If you’re lucky, the seller has gone down some. In this case, let’s say they went down to $190,000. Tell them you don’t know if you can prequalify for that much, but you’ll take it to your mortgage broker to see. Then call and ask for another prequalification letter, this time stating you can do $180,000.

Send it to the agent, and tell them that it’s the absolute most you can prequalify for. Have them prepare an additional offer and give it to the seller. You (and the agent) might get lucky, and they’ll come down an additional $10,000 to your price. But it’s unlikely. They’ll probably come back and say $190,000 is the best they can do and wish you good luck.

At this point, the agent is having a nervous breakdown because they see the deal falling through. This is where you move in for your extra 3%. Say the following:

Gosh, I really want this house, and I’ll do anything to make it work, but I doubt I can get more than a few thousand dollars more. If I could come up another $5,000, would you reduce your commission to make it work for the seller? You would probably have to reduce it to 3%, which is what you would’ve gotten if I had a buyer’s agent. In the interest of putting this all behind us, is that something you would be willing to do?

They’ll probably stutter or sit silent for a few minutes, but just wait for them to say yes. Put it all in writing, deposit your earnest money into escrow, and buy your next house with a whopping $15,000 of equity.