Professional · Henrico, VA · Member since 2008 · 25 posts · 12 votes
I would love any feedback on this subject. I am checking out a company that will purchase a distressed seller's home and rent it back to them at a reduced rate, lowering their monthly payment significantly. They will execute an option that, in 5 or 10 years, the original seller can buy back the home at the original price they paid for it.
The first question I have is... Is that strategy legal?
I am still doing research, but I thought banks had serious issues with approving a short sale and allow the original sellers remain in the home.
Las Vegas, NV · Member since 2009 · 197 posts · 32 votes
15y
Yes, it is 100% legal as long as disclosure is made to the lender. And therein lies the challenge; some banks don't care (the ones that make sense), and some banks are out to prove a point by wanting to "punish" the borrower by blacklisting them from the property via a document called an "arm's length affidavit". It is utterly ridiculous and should be banned. But that's the topic of another conversation.
This strategy definitely works and is the RIGHT thing to do as an alternative to what the banks SHOULD be doing in the first place - allowing principal reductions!
Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes
15y
If the seller doesn't pay their rent, and you try to evict, a judge may decide its not a lease at all, but a mortgage. This sale/lease/repurchase strategy can be viewed as a equitable mortgage. The investor is not buying the house. Rather, the seller is viewed as having retained title and the investor is making a loan for the amount of the short sale. The "rent" is really the payment. The repurchase price is the balloon amount. Do the math and figure out the interest rate. You may find it exceeds the usury rate for your state.
So, even if the lender that's taking the short agrees to this, which is unlikely, the investor can be shafted later if the owner stops paying. This is a bad strategy. Just say no.
Professional · Henrico, VA · Member since 2008 · 25 posts · 12 votes
15y
Originally posted by Jon Holdman:
If the seller doesn't pay their rent, and you try to evict, a judge may decide its not a lease at all, but a mortgage. This sale/lease/repurchase strategy can be viewed as a equitable mortgage. The investor is not buying the house. Rather, the seller is viewed as having retained title and the investor is making a loan for the amount of the short sale. The "rent" is really the payment. The repurchase price is the balloon amount. Do the math and figure out the interest rate. You may find it exceeds the usury rate for your state.
And then the investor would need to be a licensed mortgage broker....
Originally posted by Jon Holdman:
So, even if the lender that's taking the short agrees to this, which is unlikely, the investor can be shafted later if the owner stops paying. This is a bad strategy. Just say no.
And we have NO idea if the parent company is getting the lender to agree to a sale/leaseback which would put the original seller in a dire situation. Thanks.
Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes
15y
With so many possible deals available, why take any chances with a deal that has all these risks? Almost all short sales are going to have statements from the lender who's taking the short saying the sellers must receive no benefit from the deal. Living in the house and potentially buying it back is certainly a benefit.
Being a licensed mortgage broker isn't going to get your around usury laws. Its not going to help at all if you have to evict and the judge decides its not a lease but a loan and you are forced to foreclose.
Further, a break even rental is one where the rent is twice the P&I payment. The seller is going to know what you're paying for the property. They're going to expect you to lease it back to them at what you're paying for PITI, not realizing you're taking all the risk for a deal that has no profit.
Do the short sale, sure. Just lease it to someone else, if your plan is to hold rentals.
Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes
15y
I wish I had a reference to a specific case where this went bad. I know some have been posted in the past, but I didn't bother to bookmark them.
Think about the situation, though. An investor comes in and buys the house. The premise is "purchase a distressed seller's home and rent it back to them at a reduced rate, lowering their monthly payment significantly." How, does that happen? Say the investor buys the place at half of the loan balance. The investor is going to have to put in a down payment and is going to pay investor rates on the loan. A knowledgeable investor has to treat this like any other rental. That means the 50% rule kicks in and rent has to be double the investor's P&I payment. Further I know I wouldn't want a 25% down payment setting there returning nothing, so it has to be even higher to give me a return on the down payment. To apply the simple calculation I often use, I'd calculate P&I based on 100% financing and want double that in rent just to be break even.
So, how realistic is it that the investor can lower "their monthly payment significantly"?
Now, the seller, who's in a bad situation and desperate to stay in the house, may agree to this deal. When the deal happens, the investor is the white knight riding in on a horse saving the day. But at some point the former owner now tenant is going to start doing they math. They will do it from their homeowner perspective. They will assume OO rates on the loan, homeowners insurance rather than landlord insurance, and ignore anything else. Knowing what the investor paid, they will compute what they think is the PITI the investor is paying. Their rent is likely to be much higher than their estimated PITI. So, its only a matter of time before the white knight turns into the evil villain who stole their house.
When that happens, the investor becomes just the same as the bank who was trying to kick them out of the house. They stop paying. The investor tries to evict. It goes to court. The former owner explains what happened to the judge. Maybe the judge sides with the investor and allows the eviction. Maybe the judge sides with the tenant and says that this was not a purchase/leaseback/repurchase (a complex transaction that the sophisticated investor understood but the naive homeowner did not) but just a simple matter of a loan. The investor loaned the homeowner the money to buy the house. They charged payment, i.e., the rent. And there's a balloon, i.e., the repurchase price. At best, the investor now has to do a foreclosure.
Rehabber / Flipper · Simi Valley, CA · Member since 2010 · 597 posts · 259 votes
15y
Thanks for the explanation Jon and for the links Steve! After reading the articles you linked to, I'm still not sure I fully understand the issue, but I get the gist of it. The simple conclusion for me is what Jon said - just avoid it. :)