Lease Option--Is it the best option for this deal?

16 Replies

I am going to be meeting with a distressed seller about solving her problem with an upcoming sheriff sale.  The property is currently listed as a short sale.  My plan is to purchase it, and then sell it back to her, possibly on a lease option agreement.  I have seen the horror stories of this strategy on this site, but this particular seller appears to be a victim of a perfect storm of circumstances.  I haven't asked all questions yet, but the gist I got was this.  The woman bought the house in 1996, yet has no equity.  She had subtly implied it was due to the husband, who controlled the finances.  They refinanced at the height of the market.  Since then, they divorced, and she was laid off from her job.  She says the bank isn't working with her (I'm not sure why, but will find out).  Sheriff sale was originally scheduled for May, but had been postponed to the end of July, and it is listed for a short sale.  She has since gotten a professional job (Google search of her name shows her working at an accounting firm), as well as a fiancé with income as well.  I believe she is heading the right way, and she would like to stay in the house she has had the last 20 years.  Here's the numbers:

Listing price:  $105,000

Comps:  $135-140,000

Market rent: about $1,000

From the pictures, the house looks pristine.  Nice, shiny HW floors, modern kitchen and bath, etc.

How would you structure this deal?  I know Dodd Frank can come into play if any portion of rent is applied to principal.  So, should I see if we can agree on the option purchase of $140-150,000, with $1,000 or so and rent?  Then, if she wants to give any more per month, it would go towards lowering the purchase price?  I know I can not make it mandatory to pay down the balance and I can't credit the balance monthly.   Maybe an option fee of $3-5000?  The agreement would have to be at least 2 years, as I believe that is the minimum time after a short sale that is needed to qualify.

For sake of this discussion, let's  assume this seller/buyer is the perfect fit to perform in this situation.  The debate of whether or not she is will be debated on another thread.  Here I am mostly looking for help structuring a deal IF she fits.  By "fits" I mean I would take her to an RMLO to gauge the probability of qualifying for a mortgage at the end of the lease.

Are there other creative options I should look at?

If anyone can tag the usual experts @Brian Gibbons and/or @Bill Gulley, it would be appreciated.

Wish I could give you better advice but you seem to know about as much as I do on this sort of deal. Very interested to see what others including Brian have to say.

I never think sale-leaseback is a good idea, you don't want to problem with the federal authorities

I would buy it at a reasonable price and rent out to someone else or rented out to the former owner

@Bill Gulley  may have other thoughts

@Brian Gibbons

If the intent of the Lease-back is disclosed in the offer, and the bank still approves, what other risks are out there?   

The deal might be a little too thin to rent it out long term. It would do ok short-term, as it appears to be in excellent shape, so there would be low Capex, low/no vacancy, etc. for two years or so. if the option wasn't exericsed, the exit plan would be to sell it, either through conventional means, or seller financing.

What are you calling a sheriff sale? Taxes or bank foreclosure? Do you have cash to buy it? Are you taking title paying off the bank? Did the bank reduce any part of the mortgage, knocked off late fees, interest.....if so, they may have something to say about leaving her in the property under any type of transaction, they need the full payoff.

I would question your comps if it has been listed by a Realtor at that. 

If the comps are correct, looks like you're playing Simon Legree tying Polly to the train tracks bumping the price back to her at about a 40% increase over the value, it's called "predatory dealing".  That isn't helping her. 

2 years isn't long enough, you can lease up to 3 years without it being considered a sale. Having a short fuse only adds to the predator nature. 

No RMLO is going to be signing off on a deal with an unemployed buyer, not if they want their license. Obviously she doesn't have cash in the bank to pay it off. If Dodd-Frank applies, they would have a field day with that. And, it may very well being owner occupied.

If the IRS sees this as a disguised sale, so will the RE and finance regulators,  they can go there without an IRS opinion too. 

If this property is listed any sale price will most likely meet the definition of market value. The option price with a purchase price agreed to today reflects the future appreciation of the term of the option. In other words, the value of buying at today's price instead of the future value is the basis for the value of the option price. 

10% is the customary ceiling for residential option prices, unlike commercial proper valuations for an option are more difficult to ascertain, but can be, it's simply accepted that small valued transaction don't need to go through the brain damage to obtain a fair option price. 

If you increase the purchase price to a higher strike price in the future, due to appreciation over the term, you're reducing the value of the option, exceed appreciation, taxes, maintenance if applicable on commercial/residential you have issues. 

Your option price is fine for the market value today, but paying to buy at your sale price is predatory, a buyer shouldn't be paying anything at such an inflated sale price. 

Again, my assumption is that the listed price is very close to the market value, especially in its condition. The property isn't distressed, the seller is and will underscore the nature of predatory pricing. 

This can be full of issues that can haunt you. Revisit the comps and valuation, your ability to buy and I'd suggest you simply lease it if you do anything with her, being unemployed that's hard enough to justify. A year later you might give her an option. You might give her a first right of refusal just to appease her for now with the understanding she can obtain an option later after the dust settles. She can pay say 3% for a FROR, apply that to an option price and don't finance any option price or credit rents. :) 

@Bill Gulley

Thank you for joining the discussion!

To clarify a few points:  Sheriff sale is meant bank foreclosure sale.  It is currently listed by a Realtor for $105,000.  From my searches, the judgement amount against the owner was just under $156,000.  Interest due is $18,000.  The owner is currently employed.  What happened was she divorced and was laid off at the same time.  So, she went from one owner with no income, to the present, where she is employed, as well as her fiancé.

I have no plans to do rent credits, or anything else that makes it look like I am doing any financing.  I have read that banks typically want the owner out of the premises, but lately have been more open to this scenario, but it needs to disclosed with the offer.  Otherwise it could be viewed as fraud (not something I am interested in messing with).  If I am way off on this, please let me know.

@Jason Krick

Now it sounds like a short sale listing, make sure you fully disclose your plans in the offer! Get specific written consent from the bank. Reselling at a significant higher value than the market value, which will be 105 after you close, not what it might bring, can have consequences. Again, my suggestion stands, just lease and disclose that, that is what you are doing. You can't be 100% sure she will do an option in 12+ months, she could be remarried and gone for all we know. 

I also don't see how she can have a judgment set before the property is sold, unless she caved in and agreed, that's rather strange for a professional I'd say. :) 

@Bill Gulley

Ok.  So, my offer will have not only a purchase price, but a disclosure that I plan to lease back with the seller.  I will also disclose that she will have ROFR (I think that's a better way to go).  Should/Can I put a price on the ROFR?  

No need for a price, you aren't selling, you are leasing and a FROR can be at any price, she has the right to match or beat any offer received, the sale price is unknown. 

You're really getting the cart before the horse not knowing the basics of RE before jumping into foreclosures, buying out a bank and getting "creative", you need to see an attorney there to put this together for you, she (your buyer) can pay the attorney and represent her, or you pay to represent you, better as often, an attorney can complicate the interests of the other party, that's their job. Protect their client. :)

Thanks Bill, what I meant was could we discuss a price where she would exercise that right.  I understand it's not known at that point,  looks like I am having difficulty being clear today.  I really appreciate you and @Brian Gibbons stepping in here with guidance.  Thank you.

If it is worth pursuing, the attorney would certainly be utilized.

Originally posted by @Brian Gibbons :

Search here at BP

Why is a ROFR better than an Option

@Jason Krick

 So Brian, I'm starting to like ROFR, but how will the investor make money using the ROFR  on a Lease Option Assignment? Can the ROFR be assigned/sold for a fee? 

Thanks

Generally a lease can be assigned for a fee.  A ROFR can be part of the lease.

If you buy it cheap enough, then Lease w ROFR, you can profit at the sale, like a lease with option.

@Bri R.

and to Jason, if he;s still around.

A price set in a ROFR may well be construed as an option, I would not mix the two.

A ROFR is pretty much eye wash for a tenant, it is rarely binding as a seller may select the best sale opportunity. The tenant must match or beat another offer, within a period of time, under terms which might be the same as the other offer.

Say a seller agreed to sell for $100K to another investor and seller finance 75K. That tenant must match or beat that price and contract to do so in a timely manner. 

You have a problem, the tenant will be a consumer loan, living in the property with you as an investor. That means the tenant must meet lending guidelines blessed by a loan originator. They don't qualify and that loan becomes an impossibility to perform legally. 

The seller can sell to the investor.

Next, say the tenant goes to rich uncle Harry, Harry says I'll pay the 100K to Mary Lou tenant and she can pay you cash!

The investor can then say, nope, that's not the same deal, you'll need to pay me $144K to make up the difference for the tax hit I'll take on a cash sale and lost guaranteed interest income on the other offer! Reason Harry is rich is because he's smart, he won't buy a 100K property for 144K! 

And, if the owner never accepts another offer on a property with a FROR, there is no obligation on the owner's part to even offer the property for sale, at any price.

There are no ownership rights or interests in title with a FROR. 

All the fruits of the land, ability to profit from any parcel of land is anchored in the rights and interests that are conveyed in the property or a contract. No rights conveyed, there is no economic value. No economic value, then no price can be set and enforced as an agreement. All contracts in RE must show that payment is made for the financial consideration, that can be measured, given in exchange for payment. 

Trying to sell a FROR, what is a worthless agreement beyond a promise, and value that will not likely fly, it's almost like selling moon dust rights. 

An option is completely different, it gives the optionee (buyer) the right to purchase, the value can be established over the term of the option as prices increase or rental income may increase over time. It is an agreement to sell based on today's value at some point in the future where the optionee expects the future value to be greater, that's why we pay for options. 

A lease that may be assigned, it assigns rights of possession and quiet enjoyment, that's why rents are paid.    A FROR simply adds a sweeter ingredient, that IF a owner accepts an offer and agrees to sell, that owner will give the tenant the same opportunity, nothing more. 

A FROR doesn't really tie up a property either, there is not obligation to sell, only an obligation to offer in the event of a future occurrence, receiving and accepting another offer. It is not a lien, it can muddy up a transaction, but it can't stop another transaction from being devised. 

And, generally  a FROR is given as a courtesy not something as valuable.

Always an exception to the rule or custom. 

Say you have a very hot market, you're in a HOA that has a limited amount of boat slips at a marina and everyone in the HOA wants a slip. The prices have been going up, but the price isn't a factor with these exclusive HOA members. A slip owner gives a formal FROR to Ed, then Ed sells his boat, so he assigns the agreement to Bob, the owner consents to the assignment, and Bob agrees to pay Ed for the contract simply in hopes that the owner will sell someday. But, Bob has his unit as a second home, he lives away from the area. To Bob, there is an intrinsic value simply to be notified in the event the slip becomes for sale. That notice is about all Bob gets, so what is that worth? Bob also knows that in this exclusive HOA, he still might end up in a bidding war for that slip against other members, so he's not guaranteed a price that he may have to pay in the future.

Before you get ideas of running around trying to sell agreements or title rights or ownership rights, see your attorney! :)    

@Bill Gulley

Thanks for providing even more info.  This lead dried up quickly after reading through all the advice given by yourself, Brian, and others.

In fact, this was the thread I referenced when I commented on a discussion where a wholesaler tied up a property and couldn't move it.  Some took offense at how your opinion came across, and I referenced your earlier response to me as an example of learning from the content of the post, and not getting hurt by the tone.  

It's always a pleasure to read your insight.

Originally posted by @Jason Krick :

@Bill Gulley

Thanks for providing even more info.  This lead dried up quickly after reading through all the advice given by yourself, Brian, and others.

In fact, this was the thread I referenced when I commented on a discussion where a wholesaler tied up a property and couldn't move it.  Some took offense at how your opinion came across, and I referenced your earlier response to me as an example of learning from the content of the post, and not getting hurt by the tone.  

It's always a pleasure to read your insight.

 Thanks, my comments are never meant personally, it's always about the subject matter, but, everyone has their limits, LOL. Nope. I'm not in any popularity contest, those who have other agendas may well disagree, it could mean money to them you know! 

And, I saw that post, even voted for it, so thanks again. Do good and profit! :)

Originally posted by @Bill Gulley :

@Bri R.

and to Jason, if he;s still around.

A price set in a ROFR may well be construed as an option, I would not mix the two.

A ROFR is pretty much eye wash for a tenant, it is rarely binding as a seller may select the best sale opportunity. The tenant must match or beat another offer, within a period of time, under terms which might be the same as the other offer.

Say a seller agreed to sell for $100K to another investor and seller finance 75K. That tenant must match or beat that price and contract to do so in a timely manner. 

You have a problem, the tenant will be a consumer loan, living in the property with you as an investor. That means the tenant must meet lending guidelines blessed by a loan originator. They don't qualify and that loan becomes an impossibility to perform legally. 

The seller can sell to the investor.

Next, say the tenant goes to rich uncle Harry, Harry says I'll pay the 100K to Mary Lou tenant and she can pay you cash!

The investor can then say, nope, that's not the same deal, you'll need to pay me $144K to make up the difference for the tax hit I'll take on a cash sale and lost guaranteed interest income on the other offer! Reason Harry is rich is because he's smart, he won't buy a 100K property for 144K! 

And, if the owner never accepts another offer on a property with a FROR, there is no obligation on the owner's part to even offer the property for sale, at any price.

There are no ownership rights or interests in title with a FROR. 

All the fruits of the land, ability to profit from any parcel of land is anchored in the rights and interests that are conveyed in the property or a contract. No rights conveyed, there is no economic value. No economic value, then no price can be set and enforced as an agreement. All contracts in RE must show that payment is made for the financial consideration, that can be measured, given in exchange for payment. 

Trying to sell a FROR, what is a worthless agreement beyond a promise, and value that will not likely fly, it's almost like selling moon dust rights. 

An option is completely different, it gives the optionee (buyer) the right to purchase, the value can be established over the term of the option as prices increase or rental income may increase over time. It is an agreement to sell based on today's value at some point in the future where the optionee expects the future value to be greater, that's why we pay for options. 

A lease that may be assigned, it assigns rights of possession and quiet enjoyment, that's why rents are paid.    A FROR simply adds a sweeter ingredient, that IF a owner accepts an offer and agrees to sell, that owner will give the tenant the same opportunity, nothing more. 

A FROR doesn't really tie up a property either, there is not obligation to sell, only an obligation to offer in the event of a future occurrence, receiving and accepting another offer. It is not a lien, it can muddy up a transaction, but it can't stop another transaction from being devised. 

And, generally  a FROR is given as a courtesy not something as valuable.

Always an exception to the rule or custom. 

Say you have a very hot market, you're in a HOA that has a limited amount of boat slips at a marina and everyone in the HOA wants a slip. The prices have been going up, but the price isn't a factor with these exclusive HOA members. A slip owner gives a formal FROR to Ed, then Ed sells his boat, so he assigns the agreement to Bob, the owner consents to the assignment, and Bob agrees to pay Ed for the contract simply in hopes that the owner will sell someday. But, Bob has his unit as a second home, he lives away from the area. To Bob, there is an intrinsic value simply to be notified in the event the slip becomes for sale. That notice is about all Bob gets, so what is that worth? Bob also knows that in this exclusive HOA, he still might end up in a bidding war for that slip against other members, so he's not guaranteed a price that he may have to pay in the future.

Before you get ideas of running around trying to sell agreements or title rights or ownership rights, see your attorney! :)    

**** Brian, thanks for the clarification, much appreciated.

**** Bill G., this is my "Aha! Moment". Thanks for the very detailed reply, just how I like them, much appreciate it. You're one of my favorite poster by the way. If you had a "donation" button on your posts, I'd show my appreciation :) Hope u and Brian don't mind if I ask more questions in the future.

Thanks guys