Lease Option and “Subject To” - The Investor’s 1-2 Punch - Part 8 2-26
As explained earlier it gives you recourse should the optionor refuse to sell
when you exercise the option. In addition, you will be in a better a position of the
optionor should file for bankruptcy during the option period. A bankruptcy trustee
has the power of a god, but she would have to carefully think about overturning a
recorded mortgage. The trustee might take the property if there was plenty of
equity that could be distributed to creditors. If equity was thin you could be on
fairly safe ground.
What about the character of the seller? When you sandwich lease
option a property you can be vulnerable to some unpleasant situations. We’ve
mentioned the possibility of the seller’s bankruptcy. What if the seller is an
uninsured driver at fault in an auto accident and the injured party places a
judgment lien on the property? Things like that can get very sticky. A
performance mortgage gives you some protection. How much? Well, you’ll have
to play attorney roulette to find out.
Can it get even more complicated? Let’s not forget that you have lease-
optioned the property to a tenant buyer, who in good faith, has been treating the
property like they already own it. Perhaps she has been building monthly equity
with rent credits. Now she is ready to exercise the option and you can’t delver title
because of legal entanglements. Do you think she might be able to find an
attorney who would be interested in a case involving a “real estate investor”?
We like to know something about the people we are dealing with. It helps to
avoid future problems. When you are negotiating with a LO seller explain that you
both should know and trust each other. Offer to allow them to check your credit
and criminal background and you would like the same courtesy from them. If you
find the seller has an unpleasant criminal history you could then find a flaw in the
property that would allow you exit the deal. Of course, the problem is that if the
seller has that kind of record they probably won’t give you permission to check.
Look, problems such as these seldom arise, but be cognizant of the
possibility and don’t deal with suspicious people if you can help it.
In any real estate deal read all of the home seller’s documents! During
the time of easy money as we moved into the new decade mortgage lenders
became very creative in an effort to get as much loan business as possible.
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That meant there were various types of adjustable rate mortgages
offered so people with marginal credit could qualify for loans. Many of these loans
have very low payments for the first year or so and then those payments can jump
to a considerably higher figure. If you buy a property and have not carefully read
the promissory note to discover any unusual interest rate conditions, you could be
in for an unpleasant surprise. When interest rates go up the payment on that
home can increase and leave you with negative monthly cash flow. Just be
careful and know details of the loan.
If you are in a market where finding tenant-buyers can be a challenge
you can include a clause in the lease agreement similar to this: “Payments on this
lease not to commence until Tenant/Buyer has found a subtenant or assignee
acceptable to Tenant/Buyer. If an acceptable subtenant or assignee is not found
within 90 days Tenant/Buyer may cancel this lease.”
Tax considerations should not rule your investment choices, but they
certainly should be considered. Here’s an example;
1. Ms. Peach lease-optioned a property from a seller and turned right around and
lease-optioned it to Mr. Tomato (a sandwich lease-option deal).
2. After 14-months Mr. Tomato notified Ms. Peach that he would exercise his
option. Mr. Tomato showed Ms. Peach that he had a commitment for a purchase
money loan.
3. Ms. Peach then exercised her option with the original seller and purchased the
home.
4. She then sold the home to Mr. Tomato. (She might have done this with a
double close… a buy and sell transaction done concurrently by the same escrow
company.)
What was wrong with this transaction? Ms. Peach exercised her option,
bought the home and then sold it hours later. Her profit will be taxed as a short
term capital gain.
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Ms. Peach had owned her option for 14-months. If she had sold the option
to the tenant-buyer and let him exercise and buy the home, Ms. Peach would have
had a long term capital gain. Long term capital gains are taxed at a lower rate
than short term capital gains. Ms. Peach will be stuck with a tax bill higher than
necessary.
LEASE-OPTION SUGGESTED DOCUMENTS -BUYING
Optionor’s Acknowledgments
Investor-Buyers Lease
Investor-Buyers Option
Warranty or Grant Deed
Quit Claim Deed
Performance Mortgage/Deed of Trust
Power of Attorney
Memo of Agreement (if not using performance mortgage)
Authorization to Release Financial Information
Management Agreement
Assignment of Option
LO SUGGESTED DOCUMENTS – SELLING
Rental Application
Tenant-Buyer Option
Tenant-Buyer Lease
Security Deposit Agreement
Lease-Option Deposit Receipt
Lease/Option Disclosure
Option Money Note
Surrender of Lease
Of course, the documents listed above are just suggestions. Samples of
these agreements are included elsewhere on this disk. Read them carefully and
make changes if you wish. There is nothing sacrosanct about documents of this
kind. Please remember they are included for educational purposes only and
should only be used after review by a competent real estate attorney.
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The Last Word
When using any method to buy real estate the first consideration should be
“is it a profitable deal?” Don’t get so wrapped up the fancy stuff that you overlook
the basics. We are all in this to make money and avoid as many problems as
possible. We do that by carefully analyzing the physical, legal and financial details
of every property before we buy.
The authors are sure you have other real estate learning material that
present formulas for evaluating a real estate purchase. Use the forms and advice
found there to establish a routine you can follow in separating the good deals from
the bad… eve ry time!
We, in our own investing program, always try first to buy “Subject To”
existing financing. Then we work our way down to Lease-Options. Just those two
techniques will allow you to position yourself where you will be able to buy a good
percentage of the properties that are offered to you.
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Cash always attracts the most attention. In addition to the two techniques
explained here, we suggest you begin looking for private lenders. People you
encounter in your every day life… or by running a few classifieds ads now and
then. When you find a property that has a motivated seller and a large chunk of
equity it may be that a cash deal is the only thing that will work. Private money
can allow you to buy at a deep discount and do a retail flip that produces a
generous profit for both you and your private lender.
Real estate investing is a business and you should treat it as one. It takes
time, patience and hard work to establish any successful business. If you will
faithfully devote a set number of hours each week to marketing your investing
business you will succeed. Just like any business you must grit your teeth and
push through the first few slow months to build momentum. Then your marketing
program will begin to show some traction and things can get very exciting.
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NOTICE: The authors are not qualified to give legal advice or provide documents
that will be used in any real estate transaction. Any document, contract or
agreement included with this publications is intended as an illustrative example
only. You should always have any document reviewed by a local real estate
attorney before using. 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. |
