Lease option

11 Replies

Hello I have a potential customer that has been approved for a Short sale on his current home.  (he is upside down big time- owes $220K worth $105 ) and has $15K to put down on a house.  I am looking into purchasing a home to sell to him with a lease option for 2years.  My question is does the rent that he gives during the 2 years does it come off the agreed sale price or is the rent just straight income to me?

Any advice is appreciated. 

Yes any down payment & monthly payments goes towards the agreed purchase price of the property. Now if there is any spread in between the down payment & monthly payments goes to you. Ex: (numbers are not accurate according to percentages for standards, I'm just throwing numbers out there)

Seller

Purchase $: $100k 

$90k

Down payment: $10k

monthly payments: $850

Buyer/Seller (you) 

End buyer (your potential customer)

Purchase $: 115

$100k

Down payment: $15k

monthly payments: $1000

your profits would be....

P.P.= $10k

D.P. = $5k

M.P. = $ 3600 = (1000 - 850 = 150 x 24mos.)

I'm still in my learning process but I do believe that is correct...:)

That is up to negotiation. Rent payments do not have to go towards the ultimate purchase price. Often it is structured so that some but not all of the rent payments are applied. 

Unless I am wrong, applying any part of the lease toward the purchase price can trigger issues under Dodd-Frank. It is my understanding that you have to structure a separate purchase option (with consideration) and standard lease.  @Brian Gibbons might be able to clarify that better.

Walt is correct, that can be the case. While the application of rents is negotiable care must be taken that the rent is close to the fair market value as excess rents, while they can be applied to the purchase, the lender at the end of the term won't allow such to establish equity. That puts the buyer in a position of not having the required LTV and can kill the deal, then you have a ticked buyer and you designed the deal, here come's da judge.

Use separate agreements. You lease should not be tied to an option and your option can not include any performance required by the buyer/optionee. Your lease can be up to 3 years without issues.

Do some searching here as to aspects of these agreements, I've posted tons of information on this topic. Be aware of predatory practices, ensuring the buyer can qualify, that your agreement is not a financing agreement under the tax code or consumer lending laws. See an attorney! :)

Hi @Walt Payne  

There are aspects of 

1) the mortgage company

2) the IRS

3) Dodd Frank

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1) The mortgage co will want market rent  and an exercise price that is pretty close to the appraisal, as the borrower needs to have the property appraise.  The term should be 1 year with possible extensions.

Re: Avoiding the Due on Sale...

According to 

12 U.S. Code § 1701j–3 - Preemption of due-on-sale prohibitions

http://www.law.cornell.edu/uscode/text/12/1701j-3 "

(d) Exemption of specified transfers or dispositions

With respect to a real property loan secured by a lien on residential real property containing less than five dwelling units, including a lien on the stock allocated to a dwelling unit in a cooperative housing corporation, or on a residential manufactured home, a lender may not exercise its option pursuant to a due-on-sale clause upon—........

.....(4) the granting of a leasehold interest of three years or less not containing an option to purchase;.....


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2) the IRS 

Here’s what the IRS looks for in determining whether there has been a disguised installment sale:

(1) Whether the amount of the purchase price and right to the purchase price is fixed and unqualified;

(2) Whether the obligation to convey title on final payment of the purchase price is absolute;

(3) Whether the vendee/optionee has taken possession or has the legal right to possession;

(4) Whether the vendee/optionee has otherwise assumed the benefits and burdens of ownership. This includes paying any non tenant expenses as in maintenance, etc. 

It is clear that the presence of all of these factors would compel the conclusion that a sale has occurred; moreover, since a single factor is not controlling, the absence of any of them would not compel the conclusion that a sale had not occurred.

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3) Dodd Frank

Well, Dodd Frank has no case law.  There will be law suits from Tenant Buyers saying they were not "properly underwritten as per the Ability to Repay Rule" enforced by the CFPB.  See http://www.consumerfinance.gov/regulations/ability...

As I understand it, if there is a financing arrangement, such as a wrap, contract for deed, lease option with rent credits, etc, the penalty for sellers if the Owner Occupant financed buyer gets an attorney and sues the seller and gets awarded up to 36 payments plus court costs plus attorney's fees plus down payment.  Yuk!

So getting a RMLO to bless the Owner Occupant financed transaction is the only way to go.  Finding a RMLO willing to bless the transaction is no "mean trick".  The best starting place for finding a RMLO is Mindy Henderson, Dallas Texas, who is an authority on Seller Financed transactions.  See http://www.reiexpo.com/2012-classes/how-to-offer-s...

Mindy does 37 states.

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I like a "Contract for Option" type of transaction, where the tenant has a normal lease and a "contract for an option", but the lease has to be satisfied to get the option.

See http://www.biggerpockets.com/forums/83/topics/9130...

Another idea is look at a ROFR, or Right of First Refusal, and a lease.  See http://www.biggerpockets.com/blogs/3/blog_posts/38...

Hi Jaimie.

I am new to this, but am curious about why you would actually buy a house to sell to this gentleman, rather than finding a motivated seller that was willing to enter into a lease option agreement.

Couldn't you set up the deal to:
- give the seller thier asking price (deferred for a couple of years);
- create a percentage of the rent as a seller concession to reduce the price at time of closing; and
- include a non refundable deposit (say the $15K) that you get to keep.

This way you are in and out and don't have to worry about buying a house, maintaining it or worrying about whether the buyer can actually close two or three years down the road. The seller gets a responsible tenant that will keep the property well because they plan to buy it and the buyer has a new house that they likely wouldn't be able to get given their present economic circumstances. Win/Win/Win.

Stephen

@Jaime Frausto 

As @Stephen Fryer  was saying, lease option assignment or sandwich lease option could be a better plan than buying and lease optioning.

There is less risk with the assignment, you as the middle man are on the hook with a sandwich.

In my experience, having any portion of the rent go to principal is a can of worms.

We've seen deals run into problems when the optionee tries to perform on the back end with conventional financing.  Payments toward principal cause nothing but grief.

We tell optionees that if we were to apply payments to principal, the payments would be higher.  They should instead save this money and work on rebuilding their credit.  And, if something should go south, they are not out that extra money as well.  They are usually ok with this.

We've purchased several properties for optionees and done quite well with it.  Just make sure that if you're the buyer, you purchase it like you would any other RE investment.  We would look for a much bigger equity spread than @Jay S.  's example in case we're stuck with the property.

Wm

Great information.

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