Land Contract - Viable business strategy for buyers?

17 Replies

Hi BP Folks,

So I am currently in the process of purchasing my first rental property via Land Contract, and would be so grateful for any advice I could get!

Here's the scenario:

  • 3 unit property
  • 1800 SF
  • Built in 1935
  • List price: $55K
  • Monthly Gross Income: $1500 (currently fully rented out at $500 per unit)
  • Owned free and clear
  • In a "C" neighborhood

I am negotiating to get this property for 3.5% down, with 5% interest at $400 a month with an amortization period of 10-13 years and no balloon payment. 

There hasn't been an inspection on the property yet, as I am first waiting to receive a list of all the properties' capital expenditures and the year they've been installed/repaired (unless original). 

As far as I know, the property is in relatively good condition and there aren't any major repairs needed in the foreseeable future.  Either way, I am planning to get a home warranty that should be able to help cover the capex risk, as this is an old property by any standards.   

Based on the above information, I feel that this property should cash flow well if the above criteria is met. I would be able to budget for PITI, vacancies, repairs, and PM and still be able to CF at least $300 per month. The owner is selling because he is older and out of state, and does not want to deal with the property anymore. I also know there has been relatively high tenant turnover, which is most likely another reason he is trying to sell.

I am just curious on if there is any big item that I am missing?   

Also, if this deal were to go through, I believe that this concept could be a great business strategy to get into buy and hold investing;  Finding distressed sellers, offer them relatively hassle free CF via Land Contracts, and be able to make money at the same time.  As long as the contract is beneficial for both buyer and seller.  Any thoughts?? 

You say you're "negotiating" - have you made an offer? 

I don't understand the math on your monthly payment? $53,075 at 5% for 13 years is $468.38 before taxes, insurance, or closing costs.  

It sounds like you know little about the condition of the property, and you're planning on a home warranty as your fail safe? A home warranty is a gimmicky pseudo-insurance product geared towards consumers / homeowners- not multi-unit investors.

You should get more details on tenant turnover- I find most tenant turnover is the result of scant attention being paid to tenants.  We have a dedicated property manager who ANSWERS THE PHONE.  But it could also be because the rents are too high (people paying a fair rent amount will generally not move due to minor inconveniences)-- or, it could be because of ongoing maintenance issues- or worse- crime in the area, or on the property.  People tend to move after they're broken into, or their cars are broken into.  You should get to the bottom of the tenant turnover.

Vacancy is my biggest expense- nothing is so likely, and so costly as a vacancy. Locking down vacancy issues is my job #1.

Thanks so much for your response Paul!

Earlier today I spoke with the listing agent and told him roughly what terms we would need to agree on, and he is going to speak with the seller and let me know.  I basically said I cannot pay over $400 a month, would not agree to a balloon payment, and would need the amortization to be between 10-15 years. 

I was also going to try and negotiate something to where whichever CAPEX expense the home warranty didn't cover, we would both split 50/50 (since I am already taking a risk by even purchasing such a old home). I may or may not do a home warranty.

I believe the high turnover is simply due to lack of tenant screening, as this property is located near a community college, and is not in too bad of an area.  As you suggest I will definitely be investigating further. 

At the end of the day I am just really curious to know if this strategy is even worth the hassle, and if it can be easily replicated so long as the seller wants to sell bad enough and the property has been on the market for a significant amount of time..

A big item you are missing with a LC is that you don't own anything until it's paid off.  See if you can't get title to the property through a note and deed of trust/ mortgage.  LCs are bad for buyers, good for sellers generally.

Agreed Steve! That's a great point I didn't think about..

Even though LC's usually benefit the seller, I feel like it's mostly dependent on what's negotiated in the contract? If the seller was very motivated, I think LC's could be a win win for all parties, unless the seller is only looking to cash out..

For me, LC's seem much less risky than using a bank loan, as I can still have the opportunity to own the home and cash flow, without the potential for a deficiency judgment should something go wrong and I had to "strategically default" (not that I would ever plan to).   

I agree with steve. If the home is owned free and clear, then you can create a promissory note secured by you holding a trust deed on the property, with the seller's note being recorded as a first lien holder position on the trust deed. That is a far more advantageous position to be in rather than a LC recorded with a memorandum of contract on the deed. The only time I'd really buy with a LC is on a deal that currently has a loan balance, AND the seller wasn't willing to sell via sub2. Other than that, for homes owned free and clear it makes far more sense to go via a promissory note and a trust deed.

Also did I hear you say you were talking to the listing agent? That's red flag number 1. In my experience, listing agents aren't a good way to negotiate a creatively financed deal. Not to mention, the listing agent is likely owed a 5-6% commission (especially if they are also your buying agent), which your 3.5% wouldn't cover. 

Casey,

I've been talking with listing agents only to inquire if the current owner would entertain a LC.  All the properties I call on (within my target area) have all been on the market for awhile, so I guess I never thought it would be a major issue to directly speak with the listing agent..

I am not too concerned with "owning" any of the properties, but rather be able to take over the property and renting it out for CF.  I definitely agree that receiving the title via deed of trust would be the best option, as it would transfer ownership to me, but I feel like I would still go thru with the deal so long as the downpayment was not substantial and the monthly payment left enough room for me to make money at the end of the month..

I am glad to see you are not concerned with "owning" the property. It is not a prerequisite to making money in real estate. Having been on both sides of this fence, we can say from experience and depending on the county/state in which the property resides, we would not offer to finance a deal to a buyer under a warranty deed. Exmple: A recently completed foreclosure took 18 months at a cost of $9500+ in legal fees, plus an additional $9400+ in HOA and Taxes required at foreclosure. How quick would you be ready to provide another warranty deed to a buyer under those terms? For us, we are willing to finance the sell, but only under land contract. The cost/benefit for us to finance a warranty deed under these circumstances just isn't in the deal. As for your proposed deal, since you are not concerned with "owning", you are good with condition, and you get the terms you are seeking, then maybe have an attorney review the contract just for comfort. Your last response was a great way of looking at everything.

Good luck. 

@Jimmy Campbell good point about seller foreclosure time/costs and risks with a Warranty Deed.  Here in WA, we have a hybrid called a Real Estate Contract.  Dumb name, but it gives the buyer title yet still allows the seller to forfeit the buyers rights if not cured in 90 days from notice of default. No foreclosure process. Deed is in the form of a Warranty Fulfillment Deed.  This deed is not recorded until loan is satisfied but in the meantime property is titled to buyer by recording the RE Contract.  Wonder if MI or PA has anything like that?

@Samuel S. Based on statements you made I believe this house is listed on the MLS. In the financing terms does it have Land Contract listed? If so, homes on the MLS with Land Contract listed as a financing option tend to sell in a week if priced right so if you are targeting homes that have been on the market for a while something tells me that more due diligence may be needed on this property. First I highly recommend you find your own agent and not deal with the listing agent until you have a few closes under your belt. If you are going to work with the the listing agent are they an investor? Have they sent you the comps they used to price the property and recent comps to justify the price is still valid? What is listing history of this property? Has it gone pending multiple times but always ends up back on the market? None of the answers to these questions is going to get you the final result but what we are trying to due is build up a history of the property to determine if this is in fact a deal. If you have questions about what I posted or need to bounce some things off someone send me a PM. Full disclosure I am a Realtor, I invest in St Clair County and help other investors in Macomb, Oakland and Wayne Counties as not to mix business :D

I have a rental that I purchased on a land contract for $5000. I put $1000 down and financed [email protected]% for 3 years. It needed $1500 in repairs which I did at my expense. I am over 1 year into it and it's working out great so far. Rented at $450, cash flow after PITI & PM is $254.85 and will go up over $100/month once I pay off the LC. I had a tenant in it before we even closed escrow and so far the same tenant is still there. As of last month I have broke even on what I have put into it with closing costs, down payment and repairs so my cash flow is now pure profit (minus anything that comes up in the future of course). So, IMO, it can work. And, while I don't normally like to work with agents on my investments, this property was listed on the MLS at $10k and the agents commission was a flat $2k which the seller paid. Motivated sellers sometimes do things you wouldn't expect but you don't know until you ask.

Originally posted by @Steve Vaughan :

A big item you are missing with a LC is that you don't own anything until it's paid off.  See if you can't get title to the property through a note and deed of trust/ mortgage.  LCs are bad for buyers, good for sellers generally.

 Not quite right Steve...A land contract IS a sale.  The only thing not happening is the transfer of the deed.  In fact, some states refer to a land contract as an "installment sale contract."  The IRS certainly treats it as a sale and the seller (and buyer) must report it as such.  All benefits of ownership transfer to the buyer (via the contract) and the deed is transferred once the stips of the contract are met.

Hi @Bill Walston .  It may be a sale, but with it remaining in the seller's name, judgements and liens, voluntary or involuntary, through no fault of buyer can attach to the property. 

Example: Joe seller gets sued 5 years after the LC 'sale'.  All his assets now have liens, including 'your' house.  The creditor may very well be the IRS that considered it a sale.  I would find a better medium.  Do as you all wish.  Peace!  

@Steve Vaughan judgments and liens may be a problem in some states - not all - which is why you need to have a well-drafted CFD. That said, I was addressing your statement that a land contract is not a sale - which is patently incorrect. Your post didn't address judgments and liens - nor did I. For my business model CFD's have never been a problem and have been a viable strategy for nearly three decades. For you, they may not work - and that's fine. And Peace right back at ya :)

Thanks everyone for the input!! Learning so much from this open dialogue.

Just for the sake of understanding all scenarios, LC's would essentially be "Non-recourse" loans correct?   

Reason I ask is because what would happen in the event that after the LC was executed, the tenants were to completely trash the property (or some other scenario causing extreme property damage) and the expenses to repair would be so high that it would not make any financial sense to repair and re-rent out, and so the new owner decided to cut their losses and strategically default? 

Now that the original owner would repossess the property, could they sue for property damage?  Since they would be re-claiming the property, but in much worse condition than it was sold at? Or is that just the risk/cost of doing business for the original owner?

I guess I am just wanting to know what the worse case scenario would look like for the LC owner..

Loans funded by equity under an installment sale has no deficiency allowed as a cash advance, purchase mortgage has. The installment contract becomes invalid debt upon default when the property sold is reclaimed by a seller. Yes they can sue you for damages to the property as you agreed to keep the property in good condition, not allow waste or its value to decline by your negligence. 

A contract for deed is a sale for tax purposes, it is an installment sale and it is not completed until all amounts due have been paid and when legal title transfers. The equitable interest and use of property is what constitutes a "sale" for tax purposes, just as an option may be considered a sale transaction for taxes. 

A CFD is no longer a good way to go. There can be title insurance issues with deeds executed simultaneously a grant deed the a quit claim deed, deeds can be effective when made, not filed. Public notice is irrelevant to the purpose of a deed. Some states will require perfection of the deed to be valid, perfection being the filing. Another issue, a CFD circumvents foreclosure laws. States have also adopted laws that require foreclosure in the event a buyer reaches a certain amount of equity, like 10%. Your CFD doesn't have a non-judicial trust arrangement for a foreclosure, so that means a judicial foreclosure.

A CFD I know has been used for 50+ years, I bought my first on a CFD! That doesn't mean they are go to go today. Those giving advice based on experience and historical transactions can be dangerous today.

As Steve pointed out, you can have a "performance deed" or use conveyance deeds vesting legal title when conditions are met, better said, rights may revert back if conditions are violated. That's not a contract for deed! Such are state specific. Such deeds can still be subject to buyer's equity/foreclosure laws. 

While I used CFDs, I can say I have seen very few out of over a 1,000 that were well drafted, bar none, drafted by an attorney or title company or some Realtor, I've pointed issues out to some and they simply replied they would not do them anymore. 

Now, all real estate is local, but you better check "local" against state and federal requirements, pitfalls and tax matters before going there. 

And, BTW, going into real estate or transactions with the idea of walking away as a strategy is not a good attitude, really misses the mark as to fair and honest dealing, dealing in good faith and honest intentions. :)      

Thanks Bill!

I would never use "walking away" as a strategy, but I only asked so I can have a full understanding of both sides of the spectrum, so to speak.  The last thing I would want to do is enter into a LC not knowing the best and worse case scenarios..

Based on your reply, it seems that as long as the contract is well drafted and the terms are beneficial to both parties, a CFD is still a viable option. Especially when considering cash on cash returns, as I the buyer would able to bypass a significant amount of up front costs. I could also potentially get as many deals as I have down payments for, vs traditional financing.