Single Family Homes - The No Risk Investment! - Part 9 What you have just learned are the basics of lease/options in the way
you will most often use them. Here’s another important bit of information.
There is a Due On Sale clause written into all current mortgage
documents. Remember? This means that when a property is sold the lender
can demand that any remaining loan balance be paid in full.
Nothing in the law prevents you from buying an option to purchase
the property. An option with a lease of three years or less does not trigger a
Due On Sale clause! That gives you plenty of room to make money without
worrying about legal entanglements.
Suppose you are near the bottom of a real estate cycle in your area.
Homes are hard to sell, prices are depressed and interest rates are high on
new financing. You should be able to contract very favorable terms on a
lease/option. At the end of the three-year term the market has recovered and
you can either arrange new financing and rent the home, or sell for a nice
profit. If the real estate market has gotten worse you just walk away.
The Internal Revenue Service Code influences many aspects of real
estate investing. The IRS bases the requirement to pay taxes, take
deductions and exemptions upon what is actually taking place rather than
what any contracts say is happening. For example:
Anytime that the term of a lease exceeds 30 years, including the base
period and renewal options, the lessee (the person leasing, not owning) of
the property is entitled to all of the tax benefits to which an owner would be
entitled. In other words, the IRS treats the lessee as if she were the owner.
You may never have the opportunity take advantage of this ruling, but
you should understand it. Leases exceeding 30 years are treated as sales for
tax purposes.
If for some reason a seller wanted to be completely free from
responsibility for a property, but did not want to sell (perhaps not wanting to
realize a large, taxable capital gain), you could structure a lease/option that
would provide the Lessor with a steady monthly income and yourself, the
Lessee with all of the tax responsibilities and benefits. You could do this
with an eleven-year lease that contained four options of five years each. To
be completely safe there should be no existing “due on sale” loans involved
with this deal, but even if there were the lender would probably never learn
of the deal and call the loan due.
Here’s another idea. You find a small apartment building where the
owner is a poor manager. Rents are lower than they should be and there are
too many vacant units. The owner is sick of the problems he’s been facing
and would like to get some relief from the problem.
You make a one-year lease offer with an option to extend the lease for
an additional five years. Your offer is based on the current income. Let’s
say there are 12 units and four are vacant. The eight units are producing
$250 each for a monthly total of $2,000. You agree to lease the property for
$2,000 per month, the same as he is now collecting. He remains responsible
for any debit service, taxes and major repairs. He still has to right to all tax
deductions for interest paid, etc.
You do some minor fix up and cleanup. You raise the rent to the
market level of $325 per unit and you rent the vacant units. You now are
collecting $3,900 monthly. $2,000 goes to the owner and you pocket $1,900
or $22,800 per year. That’s $136,800 for the six-year term of the lease!
You have one year to be sure that you can get the property onto a
profitable footing, so your risk is small. At the end of the lease period you
can negotiate a purchase or return a more valuable property to the owner.
That’s not a bad trade for the $136,000 you made with a near zero
investment.
Of course you should have attempted to obtain a purchase option
during the initial negotiation. But even if you couldn’t get that you still
produced a very profitable deal with little risk.
This kind of deal allows you to control the income of a valuable
property with a very little out of pocket cost. To secure the lease you might
suggest to the owner that he keep all of the security deposits that he has
collected from the current tenants. You agree to refund those deposits (if
required) when the tenants move out with proper notice. This would amount
to about $2,000. Since the tenants would move at various times over the
next few months your payments would be like installment payments. Plus
your increased rents and newly rented units should leave you with plenty of
cash flow to cover those costs.
You can do the same type of deals with single-family homes on
occasion. Some people are just not cut out to be landlords. They buy
properties that become management nightmares and welcome the person
who can give them some relief from their problems.
Good property management skills have value. Use them profitably.
Options and leases are powerful tools for the single-family home
investor and they can be the key to your success. Understand and use them!
OPTION TO PURCHASE REAL ESTATE
THIS AGREEMENT is made and entered into this day of
by and between
hereinafter referred to as "Optionor", and
and/assigns, hereinafter referred to as "Optionee".
WITNESSETH, that for and in consideration of
and the mutual promises and covenants hereinafter set forth, the parties hereto
agree as follows:
1. Option to Purchase Real Property. Optionor grants unto Optionee the
exclusive right to purchase the real property described exhibit "A" annexed
hereto.
2. Term of Option. This option shall commence on 20 and expire
on 20 .
3. Terms of Sale. The terms of sale shall be:
The following items shall be prorated at closing:
All personal property, appliances, attachments and fixtures shall be included in
said sale except:
The Optionor shall convey title by a good and marketable warranty deed and
shall furnish a policy of insurance from a reputable title insurance company.
4. Extension of Option Period. Upon payment of $ , Optionee
shall have the right to extend this option by years under the
same terms and conditions.
5. Notice of Exercise. This option may be exercised at any time during the
option period as described above, and Optionee may exercise said option with or
without notice to Optionor.
6. Escrow of Closing Documents. All documents necessary for title transfer,
including, but not limited to a warranty deed and bill of sale, shall be executed
and held in escrow with an escrow agent of Optionee's choosing. Optionor shall
execute a deed of trust or mortgage in favor of Optionee to secure performance
of this agreement.
7. Insurance. Optionor shall protect Optionee's interest by maintaining hazard
insurance upon the property, naming the Optionee as additional insured. In the
event of destruction in whole or in part of the property, Optionee shall have the
option to proceed with the closing and accept the insurance proceeds for said
damage, or to declare this agreement null and void, releasing both parties from
any obligations hereunder, except for the return of monies paid by Optionee
which shall become immediately due and payable from the insurance proceeds.
8. Other Encumbrances. Optionor representing that the following liens and
encumbrances currently exist on the property:
Optionor covenants that he will not further impair or encumber the property
without Optionee's express written permission. In the event Optionor defaults on
the payment of any of said security instruments, Optionee shall have the right to
cure and/or satisfy said security instruments, and, in this event, shall be entitled
to a 18% interest on actual expenses incurred in doing so.
9. Assignment: Optionee shall be permitted the right of assignment of this
option.
10. Agreement Binding. This Agreement shall be binding upon the parties
hereto and their respective heirs, administrators, successors, and assigns.
11.Governing Law. This agreement, and all transactions contemplated
hereby, shall be governed by, construed and enforced in accordance with the
laws of the State of .
In the event that litigation results from or arises out of this Agreement or the
performance thereof, the parties agree to reimburse the prevailing party's
reasonable attorney's fees, court costs, and all other expenses, whether or not
taxable by the court as costs, in addition to any other relief to which the prevailing
party may be entitled.
IN WITNESS WHEREOF, the parties hereto have hereunto set their hands
and seals the day and year first above written.
Optionor Optionee
On ___________, 20 ___ , before me, _________________, a notary public in
and for said state personally appeared _____________________________,
personally known to me (or proved to me based upon satisfactory evidence) to
be the person(s) whose name(s) are subscribed to the within instrument and
acknowledged that (s)he/they executed the same in his/her/their signature on the
instrument the person(s) or entity on behalf of which they acted, executed the
instrument.
Signature of Notary NOTARY SEAL
My commission expires__________
LEASE
THIS LEASE, made and entered into this_____day of ______________, 20____,
by and between___________________________________________________,
The Lessor(s), and_________________________________________________,
____________________________________________________, the Lessee(s).
WITNESSETH: That the Lessor(s), in consideration of the covenants of said
lease, hereby lease(s) to Lessee(s), under the terms and condition set forth, the
property described as follows:
THE PARTIES COVENANT AND AGGREE AS FOLLOWS:
1. Terms: The term of this lease shall be for a period of_________months/years,
commencing the ______day of_____________, 20______and ending the _____
day of __________________ 20_____.
2. Rent: The total rents payable under this lease shall be the sum of __________
dollars ($_____________), payable as follows:
3. Assignment/Subletting: This agreement is fully assignable and the property,
during the term of the lease, may be sublet.
4. Breach: a) If the rent is not paid when due and Lessee(s) fail to pay the rent
within fifteen (15) days after written notice, Lessor(s) may exercise
his(her)(their)(its) right to terminate this lease and recover possession of the
property by appropriate court action, including the right to recover all costs, Court
costs and attorney fees
b) The failure of either party to fully perform under any or all of the
terms and/or conditions of this lease shall constitute a breach of this lease,
entitling the offended party to bring an appropriate Court action and recover all
equitable relief available under law, including attorney fees and Court costs.
5. Maintenance: Responsibility for the maintenance and repair of the property
shall be as follows:
If any maintenance or repair cost is not paid that is the responsibility of the
Lessor, the Lessee may deduct said cost from the next lease payment(s) due
under this agreement, and receive full credit for the lease payment(s) being
made on time.
6.
Notices: Any notices or demands to be given to Lessor(s) under this lease,
shall be given at _______________________________________________.
IN WITNESS WHEREFO, the parties have executed this lease this_______day
of______________ 20_______.
Lessee
Lessor
Lessee
Lessor
Memorandum of Agreement
The next document is a Memorandum of Agreement. You and the
Optionor would sign this agreement in front of a Notary Public, so that you
could enter it into the records of the county recorder. Once it becomes a part
of the public record you are protected from any effort the Optionor might
make to sell the property to a third party without your knowledge. It would
also prevent the Optionor from placing any additional liens on the property.
Any buyer or lender will search the title records before agreeing to
any transaction. Your recorded Memorandum of Agreement would be
discovered and would not proceed without your cooperation.
MEMORANDUM OF AGREEMENT
This agreement is made between ______________________________,
hereinafter referred to as the “First Party”, and ________________________,
hereinafter referred to as the “Second Party”. The First Party and the Second Party
have on____________ 20________ entered into an agreement under which the real
property described below is hereby leased, and is to be sold, transferred and conveyed,
but only at such time as the terms and conditions of said agreement have been satisfied
or otherwise complied with. Said agreement is incorporated here in as if it were fully set
forth herein, and it affects the following described real estate situated in the City
of___________________,
County of_________________, State of__________________, and is more particularly
described as follows:
Should there be any inconsistency between the terms of this instrument and said
agreement incorporated herein, the terms of said agreement shall prevail.
IN WITNESS WHEREOF, the parties hereto do this _______________day of
_______________, 20________, cause this instrument to be executed.
First Party__________________________ Second Party______________________
First Party__________________________ Second Party______________________
(Notary)
Separate Contracts
You may run across contracts that combine the lease and the option in
the same document. It is wise to make separate contracts for the lease and
the option when you are the lessee/optionee.
First, you can create the documents so that a default on one is not a
default on the other.
If you have a combination lease/option agreement the contract could
be negated if you missed a lease payment or some other minor violation of
the agreement. You don’t want to be placed in a position where a seller
turns belligerent for some reason and is looking for a way to kill the deal.
Secondly, you could sell either/or both agreements. This is not
something you are likely to do, but it could be an ace in the hole. If you had
a sudden need for cash that could not be obtained in any other way you
might find an investor willing to buy a profitable lease, option or both.
Separate lease and option contracts give you flexibility when you are
buying. 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. |
