Sale of Primary Residence - Lease Option

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Sale of Primary Residence - Lease Option

Marcus Auerbach
Investor · Milwaukee - Mequon, WI · Member since 2010 · 5k+ posts · 7k+ votes

I am at a decision point and would appreciate your thoughts (I am so glad I am a bigger pockets member right now): I have a home on ten acres for sale. It has been a three year / 200k fix and it is set up for horses. If the house would have been in a subdivision it would have sold a long time ago, but there are only so many people interested in a horse property. Showings have been rare and we have not seen a single offer, so we kept lowering the price from 625 to now 550. The house gets excellent feedback and Its a good deal at this price, but it needs a special buyer I guess. (I had people complain about the size of the yard - too big). I also have bought a new home last winter and really would like to move at some point and take the equity of my old home.

By chance I found a buyer, he happens to be a real estate investor, who is interested, but cant get a 30 year loan at this point. The story: C-corp, small W2, waiting for next tax return. We agreed on a 6 month lease option, with 3k rent and 5k monthly (!) option money. I asked him to get a bank pre-approval, and that seems to be an issue, because he came back and asked for 18 months.

While I am inclined to consider the request (at 3+5k monthly) my problem will be that I will not be able to obtain another 30 year mortgage, because of my own debt/income ratio. I should mention that I am a fast growing buy&hold guy and also my bank wants to see a full year worth of taxes before they are willing to acknowledge the additional income. So, I am limited to 5 year ARMs..

I like 18 months better than 12, because it would put the end of the terms into spring and not fall, so asking for 12 month would no serve me that well.

Though nut to crack... Would really appreciate your thoughts guys! 

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Anthony Dooley
Investor · Columbus, GA · Member since 2014 · 2k+ posts · 1k+ votes
12y

I've done it, but I wouldn't do it if I were you. Lease/Purchase Option is not "rent to own" as Brian eluded to. Dodd Frank does not apply.

The guy is basically renting your house on an 18 month lease. If he can qualify for a mortgage during that time, he has the option to buy it, but he doesn't have to. It's his option.

What I don't see in your description is option money. The tenant/buyer buys the option with cash up front, which is non-refundable. I would want 5% of the purchase price.

 If he buys the property, the $25,000 option money goes toward the purchase at the closing table. If he doesn't buy, or violates the terms of the agreement, he forfeits the option money. This way, you are happy if he buys it, and happy if he doesn't. Otherwise, you are taking your house off the market for 18 months to rent it out. Not a good plan.

The other answer to your problem is sales price. You are asking too much. Lower your price and sell the property to a qualified buyer. The lease/purchase option is the long way to sell it.

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  • Brian Gibbons
    Investor · Sherman Oaks, CA · Member since 2008 · 6k+ posts · 3k+ votes
    12y

    Where is the property?

    In Mil WI?

    Whats market rent?

    Can you get a lease for something nice for 18 mo and then go buy something then?

    You could buy something on land contract in WI.  Pay down debt.

    Sell on Lease Option.  Bank the difference.

    Caution, when selling on lease option, when financing the option, get a 1003 done by a Reg Mortg Loan Orignator, will cover your ASSets with Dodd Frank.  And realize if he defaults, it really is a financing arrangement, so you MAY have to foreclose vs evicting.

    You could look at a lease and a ROFR (right of first refusal) instead of the option.

    See

    http://www.biggerpockets.com/blogs/3/blog_posts/38...

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  • Marcus Auerbach
    OP
    Investor · Milwaukee - Mequon, WI · Member since 2010 · 5k+ posts · 7k+ votes
    12y

    Thanks Brian. Just outside Milwaukee and I already have built a new home for me. Market rent is hard to pin down for this type of property, there are barley any comps, but I would say in the 0.7% range. 3k are on the easy side, but I've been looking at this in combination with the non refundable option money. Financing the option opens up a whole new  can of worms, no appetite to even print out Dodd Frank ;-) 

    I was going to keep keep the contracts separate, a standard lease and a WB24. My issue is that I am going to make it harder to myself to obtain financing for rental properties as long as I carry two large mortgages on two primary homes, plus I cant access my equity. I thought about a wrap, but I guess it's easier to evict than foreclose. Thoughts? 

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  • Anthony Dooley
    Investor · Columbus, GA · Member since 2014 · 2k+ posts · 1k+ votes
    12y

    I've done it, but I wouldn't do it if I were you. Lease/Purchase Option is not "rent to own" as Brian eluded to. Dodd Frank does not apply.

    The guy is basically renting your house on an 18 month lease. If he can qualify for a mortgage during that time, he has the option to buy it, but he doesn't have to. It's his option.

    What I don't see in your description is option money. The tenant/buyer buys the option with cash up front, which is non-refundable. I would want 5% of the purchase price.

     If he buys the property, the $25,000 option money goes toward the purchase at the closing table. If he doesn't buy, or violates the terms of the agreement, he forfeits the option money. This way, you are happy if he buys it, and happy if he doesn't. Otherwise, you are taking your house off the market for 18 months to rent it out. Not a good plan.

    The other answer to your problem is sales price. You are asking too much. Lower your price and sell the property to a qualified buyer. The lease/purchase option is the long way to sell it.

    1Reply
  • Brian Gibbons
    Investor · Sherman Oaks, CA · Member since 2008 · 6k+ posts · 3k+ votes
    12y

    Any time you finance an option payment, you have a financing arrangement as per the cfpb and Dodd Frank.

    1Reply
  • Anthony Dooley
    Investor · Columbus, GA · Member since 2014 · 2k+ posts · 1k+ votes
    12y

    I don't recommend financing the option money. If the guy can't get $25k, he can't afford a $500k property. Better off to reduce the price and sell it to a qualified buyer.

    1Reply
  • Marcus Auerbach
    OP
    Investor · Milwaukee - Mequon, WI · Member since 2010 · 5k+ posts · 7k+ votes
    12y

    The way we had the contract drafted we were using the extension clause in the WB24. I am not quite sure how this is considered financing. Originally we discussed a lump sum optionpayment and it just came out of a discussion. Maybe I should consider to back paddle.

    The underlaying issue seems to be income to debt ratios. He is looking to expand his assistet living RE portfolio and the banks are looking at debt to income. Not having a primary residence on the books helps. Thats why they are willing to pay a premium. And from my side I am looking at over 50k extra , plus cash flow and debt pay down.

    The drawback of course on my side is that it screws with my ratios and I am also on a fast growth path..

    Finally now my broker has an issue, because they want their comission now and not in 18 months. we will have to talk about it on Tuesday, I have no intention to screw them out of the deal, but I cant be expected to pay comission for a sale that did not happen yet.

    I am not sure that lowering the price further will help. We have systematically decresed the price over the last six months and we are now below appraised value. The issue seems to be that there are only a small group of buyers interested in a high end home with farm land.

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  • Leng Thao
    Investor · Clovis, CA · Member since 2012 · 44 posts · 11 votes
    12y

    IMO if you want your cash back and to improve your DTI, I think lowering the price would be a good idea. I agree with Anthony.
    As you noted, your home definitely requires a special someone to purchase this type of property. It may appraise for a certain price but if no buyers are out there for this type of property, it will be hard to move. A better price may entice others to reconsider the property though they were looking for something else. Just my thoughts and best of luck.

    1Reply
  • Karen M.
    Hales Corners, WI · Member since 2013 · 229 posts · 80 votes
    12y

    Have you tried networking / marketing to some horse people in Wisconsin?  They're around…

    0Reply
  • Marcus Auerbach
    OP
    Investor · Milwaukee - Mequon, WI · Member since 2010 · 5k+ posts · 7k+ votes
    12y

    Thanks for all the great comments and suggestions! It was a difficult process, but we finally found a solution. And like always in real estate I have learned a couple things along the way. When I rent a property I have adopted a standard process that is based on the experience of others and that works pretty well. I just did not realize how well, because I never did it any other way. One of the most important parts of that process is running a full background check very early, actually right after I get a filled out application. In this case I did not do that - we were too busy negotiating the deal. Probably because I was emotionally involved or did not want to insult my potential buyer by questioning his background, after all we were talking about my home and not just some rental property! Of course - not a good excuse. 

    Things started to turn around when I began following my process again. Turned out there were some issues from a divorce four years ago that were never properly addressed. My buyer knew that there might be some old issues, but I believe they did never pull the report to actually look at it and address the issues. Cash was not the problem for my buyer, so we agreed on a sizable non refundable option payment (up front lump sum - thanks Brian) and they started working on cleaning up their credit. The rest of the background was fine and the references came back positive, so we went ahead with the deal. The property is cash flowing and between option payment and security deposit I feel sufficiently protected. However, I will ultimately find out if I made the right choice in 6-12 months.

    The second lesson here is that when rehabbing a property it has to be done with the buyer in mind. I did not do that in this case, because it the home was designed to meet our personal needs at the time.  The house is short of a bedroom, because we did not need another one. However in this price range and market an additional bedroom is expected. The other issue was the horse set up - most buyers who are looking to have horses at home (for all of you who have never enjoyed this - its a lot of work and a huge commitment: every single day, and there is no vacation day, sick day etc without having someone else to jump in and do the work) are looking typically in a lower price range. People with more money usually have their horses boarded. Once you break the two million mark, horses are again part of the property - but then there is also staff on site to take care of the daily chores. Lesson learned: always rehab to what the market wants - or be prepared to pay the price.

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