How to Structure this Lease Option

31 Replies

Originally posted by @Jack B. :
Originally posted by @Joe Villeneuve:
Originally posted by @Mike M.:
Originally posted by @Joe Villeneuve:

You can't do an option on this property with a mortgage still in place.

 Actually you can do an Option with a mortgage in place. Check out:

https://www.biggerpockets.com/forums/600/topics/58...

 Actually you can't.  Here's why.

When you buy an option, you are buying the first right of refusal to buy the property in the future within a certain time period.

When there is an existing mortgage on a property, that lender has first lien rights on that property.

Can you sell someone an option to buy, and still have an existing lien in place?  Technically you can, however it is impractical, and from where I'm sitting, unethical.  

What if the seller, for any reason, stopped making payments or couldn't continue to make payments, on a property they also sold an "option to buy" to a REI. What value does that Option have? None, when the lender forecloses. In this case, the REI bought a contract with no value.

The object of the Option is to gain complete control over the property during the option period. If there is a mortgage in place on that property, that lien limits (actually makes the Option's Control an illusion) that control the REI paid for.

Both the Loan and the Option people are expecting the have 1st position control, but only the Lender actually has it.

First you said he can't, now you're saying it's impractical and unethical. From what I've seen of your posts on here, you seem to push your subjective opinions as facts but you never have anything to back it up. Case in point, first you said he can't do it, now you say it's impractical and unethical to you. So are you now saying that it can be done you just don't like it???? Are you an attorney??

 People commonly confuse "Options", "Subject To" and "Wraps". It's a common enough mistake. They each are very different and since most people don't do all of these on a regular basis, it can become daunting to the casual observer. I don't think anybody meant any harm in expressing their opinion. And there are some regional differences in how Lease Options are handled, for instance. But, in these types of transactions clarity is essential in order to structure the deal correctly and to explain to the seller and sub-leasee how the transaction works so lawsuits don't ensue from misunderstand or improperly explained financing. 

Here is a link to a video that my buddy had made that we send to perspective tenants to explain lease options. Since it is an outside link I’m not sure if BP will allow it. But if not, you can go to my website and click on the option link at the top and you can get to the video that way. http://blueequities.com/lease-option-properties-rent-to-own-arizona/

Originally posted by @Joe Villeneuve :
Originally posted by @Mike M.:
Originally posted by @Joe Villeneuve:
Originally posted by @Mike M.:
Originally posted by @Joe Villeneuve:

You can't do an option on this property with a mortgage still in place.

 Actually you can do an Option with a mortgage in place. Check out:

https://www.biggerpockets.com/forums/600/topics/58...

 Actually you can't.  Here's why.

When you buy an option, you are buying the first right of refusal to buy the property in the future within a certain time period.

When there is an existing mortgage on a property, that lender has first lien rights on that property.

Can you sell someone an option to buy, and still have an existing lien in place?  Technically you can, however it is impractical, and from where I'm sitting, unethical.  

What if the seller, for any reason, stopped making payments or couldn't continue to make payments, on a property they also sold an "option to buy" to a REI. What value does that Option have? None, when the lender forecloses. In this case, the REI bought a contract with no value.

The object of the Option is to gain complete control over the property during the option period. If there is a mortgage in place on that property, that lien limits (actually makes the Option's Control an illusion) that control the REI paid for.

Both the Loan and the Option people are expecting the have 1st position control, but only the Lender actually has it.

 There is a huge difference between a "lien right" on a property and the option to buy. With a Lien you do not own the property. With an Option you do not own the Property. 

A lien gives you the right to foreclose, an Option does not. An Option gives you the right to buy the property at some point in the future for a designated amount. A lien does not give you the right to buy the property, you only have the right to foreclose. A right to buy by Option is exclusive. A right to foreclose is not exclusive, anybody can bid on the property at auction, typically including the lien holder.

The option payoff also pays off the underlying lien. You do not have complete control under an Option, it is only an Option for the future until you exercise the Option. You must exercise the Option to gain complete control. An Option does not give you ownership. Properly exercising an Option gives you ownership when you convert the Option into a Purchase.

The owner always has first position of control with both the Lien and the Option below the owner's ownership. The seller can pay off the lien, can sell the property and satisfy the lien, can negotiate new lien terms, can borrow against the property to pay off the lien. The lien is a finance issue (not a title ownership).

Title ownership and financing or liens are two entirely different things and the courts treat them as such.

Someone who has no ownership on the property can sign a note for financing on a property if the lender is willing to accept it. It's commonly called cross collateralization. (I once was a loan officer.)

Respectfully.

 When the owner sells an option to buy to someone else, the owner relinquishes control over any future sales of that property during the option period.  The seller can't sell the property to anyone else during that time period, thus, the buyer of the option "controls" the purchase of the property during that time period. 

Other than that, you are correct with your comments.

However, it doesn't change the fact that if there is an existing loan, with an ability to foreclose, that potential foreclosure eliminates the Option.  This negates the "control to buy" that is the Option agreement.  If the property is foreclosed on by the lender, the Option Agreement can't be exercised...and is worthless.

Since this potential situation exists with a loan in place, to me, this means that buying an option to buy on a leveraged property is at the very least...a stupid thing to do.

this is why folks will record options  .. and if they are smart will monitor the payments on the underlying.. but your right there is risk in optioning a property with debt and the amount of debt makes a difference..   if your optioning it for 500k and the debt is only 100k that's no biggee.. I optioned a property in Oregon for 5.5 million and paying 120k a year in option payments  ( 100% credit towards purchase price).. there is 200k in debt.. I recorded this option so that if there is a foreclosure the lenders trustee will have to notify me and I can just pay it off..   that kind of thing.. 

my experience with low value real estate sandwhich deals is they end up being a lot of work for tiny money.. and blow up often..  

so much good info here, i don't see how this small point is being missed; upon doing the option agreement with the seller wouldn't you get the loan information/log in information/ and a signed info release form? why are you not making that payment yourself since your collecting it? Isn't escrow accounts another way to avoid this situation?

 @Shiloh Lundahl and Account Closed - I have a similar situation as the initial poster. Thanks to each of you for clarifying this topic. I was advised to use an escrow or paymaster to collect lease option payments and file the option at the courthouse.  This makes sense to me. Meanwhile, I am looking for a Georgia attorney who specializes lease options.

Originally posted by @Darron Washington :

so much good info here, i don't see how this small point is being missed; upon doing the option agreement with the seller wouldn't you get the loan information/log in information/ and a signed info release form? why are you not making that payment yourself since your collecting it? Isn't escrow accounts another way to avoid this situation?

 No.  Understand what the Option is.  You're not buying the property.  You have no rights to access anything regarding the property...yet.  

All you have done by buying an "option to buy the property" is, an option to buy the property.  That means a contract (piece of paper) that gives you the right to buy the property within a predetermined time period.  

This does not, in any way, represent any action with regard to actually buying the property.  All this is, is the right to buy it.  The "option agreement" must be exercised, meaning a formal PA must be executed.  Until that happens, anyone that owns the "option contract", has the right to exercise that "option".

This means, like any other financial agreement, the "option contract" can be sold or transferred to someone else.  This is essentially what is happening when you do a Sandwich Option. 

@Cheryl Wilson  Joe (@Joe Villeneuve ) answered your question pretty well.  We do not file anything with anyone. The tenant has no rights to the property except for the option to buy the property within a specified period of time. We also make our options exclusive which means that the tenant cannot sell the option to someone else. The reason for that is because we are looking for and buyers to come in who really want to buy the property but in this moment are not able to qualify for a loan but that should be able to qualify with in the next few years. We do this model model because it maximizes the return that we get but also because we like to help people get in a home is now. So far we have done 20 of these in the last year-and-a-half and we have had no evictions.