Lease Option and “Subject To” - The Investor’s 1-2 Punch - Part 7 2-20
We agree to sell to our LO buyer for $165,000, at the time he exercises the
option. We set his monthly lease payments at $1,000. Homes in our area are
appreciating at an average of about 5% per year, so the purchase price is close to
what the home will appraise for in one year.
Here’s our profit when the buyer cashes us out with a new loan:
Equity: $10,000
Net From Sale Price $15,000
Monthly Positive Cash Flow $ 1,500
Total Profit $27,500
If course we may have to pay up to $2,000 in closing costs from that profit,
but remember… this is basically a no money down deal.
Yes, we have to wait 12 to 24 months to get to that profit. If you could do
just five of those deals per year you would soon have a yearly income of at least
$100,000.
WHAT IF…?
What if the tenant-buyer can’t buy at the end of the year. If they have
sincerely attempted to get their credit repaired we will create a new LO with
additional option consideration due and an increased purchase price and monthly
payment. These won’t be exorbitant increases, but they will produce additional
net profit.
What if the tenant chooses not to buy the home? We don’t offer them a
new lease. Our objective is to sell the property and get our profit. If they don’t
want to buy they forfeit their option consideration and must move.
What if we made a poor choice of tenant-buyer and they begin missing
monthly lease payments? We gently explain to them how sorry we are that we
must ask them to move in five days, but we will pay for a rental truck to help them
move in with their Mom.
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What if the tenant-buyer wants to exercise the option at the end of the
lease and buy the home? That’s exactly what we want them to do. If the
appraisal comes in much below the contracted purchase price we may adjust the
price to make the deal work. We will consider carrying a note to make the deal
work. In other words we are flexible! We will sacrifice some profit to get to the
MONEY… if we must.
We believe in “creative real estate”. Not only when we buy, but also when
we sell. If the buyer is short of down payment money we will accept a car or boat
that we can resell. If the buyer has a coin collection we will take that and sell it on
Ebay. If the buyer has tradesman skills we will except X number of hours of his
skilled labor. If his parents have a summer home we will accept two weeks of
vacation in the home for each of the next two years. If his sister works for an
airline we will accept free air travel. If the buyer doesn’t have all cash ask what
he does have…. or can get… or can borrow?
We don’t try to squeeze all the juice out of every deal. There’s another deal
just around the corner. We don’t want to anguish over every nickel that does not
fall out exactly as planned. Take the profit that’s there and move on.
BUYING WITH A LO
We mentioned earlier that the option and the lease documents would be
worded differently when you are the buyer rather than the seller. You will find both
sets of sample documents elsewhere on this CD. When you read them you will
see the subtle differences. We advise that you study any document you use until
you understand every word in every line. If a buyer or seller should ask for
detailed explanations you should be able to give them without hesitation, and with
complete confidence. Have the documents provided approved by an attorney.
When you are buying with a LO you want to be sure that the seller will honor
your contracts and sell you the property when you choose to exercise the option.
In most cases motivated sellers will be willing not only to agree to your lease
and option, but they will sign the purchase agreement and deed that you must
have when you exercise. The purchase agreement and deed can be held in
escrow until all terms of your agreement with the seller are satisfied.
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The escrow holder will be instructed to pass the signed purchase agreement
and deed to you when you have successfully executed the option and have the
funds to pay off the existing mortgage loan and any money due the seller. This
arrangement protects you if you can’t find the seller when it comes time close the
deal. To afford the seller the same protection, you as the seller, will sign a quit
claim deed. If you fail to exercise the option the escrow holder is instructed to
record the quit claim deed and the seller will again have title clear of anything you
may have recorded.
The escrow holder can be any company or person that is trustworthy and
agreeable to both buyer and seller. Don’t’ put together LO deals until you have
found someone reliable who is willing to act as the escrow holder… and their fee
is reasonable. It might be a title company or an attorney… or someone else. You
may have to search to find one, because many will not accept the responsibility.
After you find an escrow holder you should also record, with your County
Recorder a Memorandum of Option that shows you hold a contract concerning
that particular property. That puts a cloud on title. If the property owner should try
to sell to someone else, or borrow money with the property as security, the
ensuing title search would reveal your recorded Memo and you would be
contacted before the transaction could be completed.
What if you can’t find someone to hold your escrow? Or what if you don’t
want to become entangled in an escrow arrangement? When you put the deal
together, along with the lease and the option, you can have the seller sign (before
a notary) a performance mortgage. Let’s explain what that is:
With a regular mortgage if the monthly payments are not made the mortgage
holder can foreclosure on the property. In other words the borrower has promised
to make monthly payments. If they fail to do that they have broken their promise
and the mortgage holder will foreclose and take the house away.
A performance mortgage is similar, but with a different promise. In the case
of a LO the seller has promised to sell you the home at the time you successfully
exercise the option. If the seller refuses to sell you can begin a foreclosure action
under the power of the performance mortgage. If nothing else a foreclosure under
a performance mortgage will tie up the property until someone settles with you.
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One of the benefits of an experienced escrow holder is that they can make
the mortgage payments. Many times the seller is planning on moving to another
area and they are concerned that you (the buyer) will not make the mortgage
payments during the term of the LO. You can agree to make those payments to
the escrow holder and they can pay the lender. They will notify the seller if you fail
to make a payment.
It works the other way also. If the seller insists that they must continue to
make the mortgage payments how do you know they will continue to do that. You
could pay the seller and the seller could make the payments to the escrow holder,
who then pays the lender.
We prefer to make any required payments ourselves. Sellers will agree to
that if they have a means to check that the payments are being made.
Many lenders now have Web sites or automatic telephone services where
borrowers can check to see that payments are current and what the balance due
on the mortgage is. When you buy you must ask for the seller’s ID and password
so that you can access those sources of loan information. You must have an
accurate figure for the monthly payment , amount of any arrears and the balance
due on the loan before you make the deal. The seller can access this information
to be sure you are making payments.
If the lender does not offer automatic access for those figures you must use
a signed authorization from the seller, so that you can get that information from
the lender. You must know the mortgage balance on any property you are buying
and the exact amount of the monthly payments…. and if the payments are current.
In most of our “subject to” and LO deals we are doing a “kitchen table” close.
We don’t use a closing company or attorney. We prepare and execute (sign) all
documents with the seller at the time they agree to the deal. Often times this
takes place on the seller’s kitchen table, hence the “kitchen table” close.
Under these circumstances we do our own title search. With a subdivision
home that has been built within the last five years the search is generally very
simple. In the County Recorder’s records we can find the deed that passed title
from builder to buyer and the mortgage that secures the purchase money loan.
We then check the records from that date forward to the present date to see if any
other deed, liens or judgments were recorded against the property.
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It’s a safe bet that when the original buyer bought the property with a new
mortgage loan that the bank that made that loan did a through title search up to
that point in time. The fact that they made the loan indicates title was clear at that
point. Our only concern then is what has happened to title from that point forward.
If title is clear there’s no problem. If there are liens or clouds we can tear up the
paper work or try and clear up the title problems. Unless there is considerable
equity the time and expense of fixing title problems is a course we might not
follow.
Older properties that have been bought and sold a number of times can
have a more complicated chain of title. That’s when you should assuredly buy a
professional title search.
We do not advocate doing your own title searching of you are just getting
started with real estate investing. Have a title company do that and buy title
insurance. That’s the safe way to buy real estate.
3 MONEY PUMPS…
Plan an exit strategy for every property before you buy it. Here are three:
Flip some properties. That means sell the home as quickly as possible
after you buy. Usually that means selling to another investor. To do that you must
buy properties that have enough equity so that they will interest an investor. If the
investor will only consider a property with a minimum of $15,000 in equity it means
you must buy home for $20,000 under market value. You then offer it to the
investor for $5,000 in quick cash.
Flipping properties is how you generate cash flow for everyday living
expenses. If you were in a hot seller’s market you might be able to flip the
property to a retail buyer and keep all of the profit.
You make a larger profit when you LO to a tenant-buyer. You can price
the home and the rent above market value because you are giving the tenant an
option to buy the property. That deal has greater value than an ordinary rental
agreement. The drawback is that you have to wait one to three years to get that
greater profit.
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Some properties you should hold as rentals. If it is good house in a good
neighborhood and it produces a nice positive cash flow… it’s a KEEPER! That’s
how you build great real estate wealth – with your keepers. They produce monthly
income, mortgage pay-down, tax shelter and, in normal markets, grow in value
every year. Tenants are buying those homes for you! You may occasionally find
a “subject to” seller who is agreeable to leaving his name on the loan for a number
of years. That could be a property you hold.
The key to buy-and-hold properties is that they should be nice homes in nice
neighborhoods… and you must be a skilled landlord. There’s lots of good learning
material available on landlording. Be sure you add some to your investing library.
FURTHER MORE…
Always provide truthful answers to any question asked by those you are
dealing with. You needn’t go into great detail about leases and options and
“subject to”…but tell the truth.
Always ask the seller to sign a “subject to” disclosure document. This will
explain to the “subject to” seller that their name will remain on the loan and if you
fail to make payments their credit will be harmed, etc. You further explain that
your whole business is built around keeping those payments current, because that
is how you eventual make a profit.
When you buy a property “subject to” you get the deed and you (or your
company) are the legal owner. When you rent or sell you do so as the owner (or
agent of the owner).
That’s not the case when you LO a property. You don’t have title, so you
are not the owner. When you are dealing with prospective tenant-buyers you
must not represent yourself as the owner. Ask the optionor to sign a management
agreement naming your company as the property manager. Then, if you are
asked, you can honestly say you are the manager of the property.
When we LO a property, rather than using an escrow, we use a
performance mortgage. This document and accompanying materials are designed to provide authoritative information in regard to the subject matter covered in it. It is for illustration purposes only and presented with the understanding that the author and publisher are not engaged in rendering legal, accounting or other professional opinions. If legal advice or other expert assistance is required, the services of a competent professional should be sought. |
