Land Contract Case Studies. Plain Vanilla.

      A land contract (in some States this is referred to as a contract for deed) is a form of owner financing the sale of real estate where the deed to the property remains in the seller’s name until the buyer fulfills the terms of the contract. In contrast, when an owner finances the sale of property by extending the buyer a loan, the buyer’s name is recorded on title at the closing but the seller records a mortgage which gives them the right to foreclose on the property if the buyer does not fulfill the terms of the loan. This is just like a bank financed purchase with the seller taking the role of the bank. There could be instances where the land contract form is more favorable for the seller because they may not always need to foreclose on a property in order to repossess it but, practically, in most States, if the buyer has been making payments for a significant period of time and has an equitable interest in the property, the buyer may force the seller to foreclose if they wish.

      Why do I like land contracts?

• They are common conveyances in Michigan (where I reside and do business) that are well understood by most title companies. There is well established case law governing their use.

• They are easy to close. It is not necessary to open escrow accounts, use title companies, or attorneys. When I close these with sophisticated investors who are also trusted partners the process consists of meeting at a bank to have the land contract and the memorandum of land contract signed and notarized. The land contract is the document which governs the terms of the deal. The memorandum of land contract is for the protection of the buyer. It is little more than a paragraph which states that a land contract has been executed between the seller and buyer. None of the terms of the land contract need be in the memorandum. The memorandum is recorded in the public record so it will show up in a title search if the seller attempts to further encumber the property or to sell it to someone else. Those actions will be disallowed without the buyer being notified and agreeing to them.

• They allow the seller to spread the taxable gains out over several years. (I have done one deal in my self-directed Roth IRA to avoid any tax liability.) This type of sale is treated as an installment sale—taxes are due on the principal collected. If the property were sold under traditional seller financing terms, with the deed transferred to the buyer and the seller holding a mortgage, the taxes on the gain would be due in the tax year of the sale.

• When they are closed without title companies there are no upfront fees. The seller does not have to pay for title insurance until the buyer completes the contract and transfers title. If a deed is not held in escrow there is no escrow fee. (Some title companies insist on holding deeds in escrow even though they may be worthless when the contract is fulfilled.) The seller need not pay State or County transfer taxes until the deed transfers. The tax valuation is not affected. If the sale is at a significantly higher price than that at which the seller purchased the property, the buyer will benefit from lower taxes until title transfers.

• They can be easily tailored to suit the needs of both the seller and the buyer. Any of the terms of the land contract can be adjusted: the price, the amount of the payment, frequency of the payment (monthly, quarterly, etc.), the amortization period, the interest rate, the down payment, the term (duration) of the contract, the balloon payment if there is one, etc. Granted, these terms can also be adjusted when the seller gives a loan.

     What about Dodd-Frank?

     I refer to this ill-conceived legislation as Dodd-Frankenstein. It regulates most seller financed sales of real estate to owner occupants. D-F has effectively eliminated a viable method for those with poor credit or lower income to purchase homes. I have refused to sell a house to a six year tenant who would have been a perfect buyer before D-F. I know there are exceptions in D-F and I could have completed that sale and stayed in compliance. However, the penalties for failing to comply with D-F are onerous. I do not want to give the Consumer Financial Protection Bureau (CFPB) any conceivable reason to look in my direction. If the CFPB sends you a letter, you lose.

     D-F does not regulate the sale of real estate to non-owner occupants for business purposes. I sell to non-owner occupants for business purposes. Most of my buyers have been landlords who intend to rent the properties—several of the properties had tenants in place at the time of the sales

     Now for a case study:

     As the title of this blog entry indicates, this land contract was structured simply. I had owned and operated the subject property for seven years. It was a neglected REO that I purchased from a bank in 2009 (anyone here remember the crash?). The house had an addition that I suspect was built by the previous homeowner—there were some major mistakes that had to be corrected. The fact that the property was winterized improperly, sat unheated during two Michigan winters, and had an actively leaking roof allowed me to get a great price. Over the years I owned and operated the property, all of the structural issues had been addressed and many improvements had been made. In fact, I had just given the property a major rehab when this sale was proposed.

      My buyer is an experienced real estate guy who was expanding and repositioning his rental portfolio. We had little problem agreeing to the market value of the property. I was not willing to hold the contract for more than 3 years so there would be a balloon payment due at the end of that term. I had completed some very profitable deals with the buyer (did you read the blogs about the Cat Piss House or listen to my podcast where I talk about it? The buyer is the man who sold it to me). The buyer has the utmost integrity so I did not require a large down payment—what he offered was fine. The buyer had what I thought was an unusual request—he wanted the payment to be $700. (We have done several more land contracts since this one and the payment for each one is within a few dollars of $700). I would have preferred a 20 year amortization period but since I was not in need of cash flow and that payment would have resulted in a negative amortization on a 20 year schedule (we could have done the deal with a negative am if we wished) I agreed to increase the amortization to 30 years. The interest rate we settled on resulted in this being an interest only loan for the 3 year term. It was acceptable to both of us. Deal done.

     I received a sale at a much higher price than I had paid for the property—I bought this one well. My buyer was an established landlord who would maintain the property in good condition (important in the unlikely scenario where I would have to take the property back) and deal with the tenants (he hired a property management company). He would pay me whether the house was rented or not (no more late rent payments), plus he would pay the taxes and the insurance. His payment was a bit more than the property usually netted for me (when repairs, vacancy, etc. are considered)—it was about cash flow neutral for him.

     My buyer received a house in a strong rental market in rent ready condition. He got a price a bit below fair market value. (We did a series of LC sales—some of those were at the high side of or a bit above fair market value. This one was included in the package to balance out the others.) He also pays taxes at the rate I had been paying. Since taxes in Michigan are capped and marked to the inflation rate this means he is paying significantly less than if the property were uncapped in a traditional sale.

     I wrote a bit more about land contracts in my last blog entry: Don’t Hire a Property Manager. Sell Your House To One.

     My other LC sales were structured and negotiated differently. Some were more complicated. Let me know (in the comments) if you have any interest—I may be convinced to write those up.

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