Skip to content
Welcome! Are you part of the community? Sign up now.
x

Posted almost 7 years ago

Land Contract Case Studies. 2 LCs on 1 House.

     This is the third installment in my series on land contract sales. The first introduced the concept of land contracts: Don’t Hire a Property Manager. Sell Your House To One. The last explained why I like to use land contracts and provided a basic case study: Land Contract Case Studies. Plain Vanilla. The deal I discuss here preceded the one discussed in the last blog and was a little more complicated.

     I was contacted by an aspiring investor who remembered me from a meeting a couple years back. He said he sat next to me and I reached out to him (he must have caught me on a good day)—I didn’t remember him but I did remember the meeting. (Folks the best part about meetings is networking—you never, never know the potential that can come from the contacts you make.) He had some questions. We exchanged some e-mails and had a couple phone conversations. At one point, he stated he wanted to explore purchasing his first rental. We discussed the features that a rental property should have (as an exercise, this was all very preliminary, neither of us thought we were negotiating a sale). I didn’t have any properties available but I expected to get one back in a couple months that had most of the features we discussed that made a good rental. This property had been managed by a property manager. I was having some communication difficulties with the manager and was thinking it was time to make a change. I had also started to think about cashing in some of the profits from some of the purchases I made during the crash. (There are great profits available if one survives a severe market downturn with the resources to buy.)

     We started discussing possible sale scenarios for this property, purchase price, financing options, etc. but this was still preliminary. The tenants had not vacated yet and I had not been inside this house for a couple years. We arranged a quick tour of the property. The structural condition was good. (I had replaced most of the mechanicals when I purchased the home. I had to. The previous owner lost the home in foreclosure and took the furnace with him.) However, the home was quite a mess. The carpet was new when these tenants moved in—it still amazes me how much pizza sauce a carpet can absorb. It would all have to be replaced. The tenants had a couple dogs, huskies. This was winter in Michigan. Apparently, the owners simply let the dogs do their business in the basement so they wouldn’t have to go outside. (I thought huskies liked cold weather.) Our visit gave us a strong indication of what would need to be done to prep the house for a new tenant. The current tenant hadn’t left yet but we knew it was unlikely the condition of the house would improve much.

     My new colleague (I will refer to him as Bill from this point) was very interested in this house. Bill got pre-approved from his credit union and knew what loan amount he would qualify for. I wasn’t willing to sell for that amount. What Bill did next made the deal possible. He sent me a proposal with 3 offers: a low all cash offer, a high long term seller finance offer, and an offer priced between the two with shorter term seller financing. I was thrilled when I saw this. I believe I may have really laughed out loud. This was a great proposal—just like the gurus tell you to make. It was clear that Bill had been doing a fair amount of reading and that he understood how flexible real estate purchases could be even though he had not purchased a rental before.

     I phoned Bill quickly. I let him know how much I appreciated his offer. I could tell he was pleased and he asked which of the options I preferred. I told him none of them would work. The lowball offer was much too low. It might work on a desperate seller but I was not in that situation. The 10 year low interest (maybe it was no interest) loan option showed me Bill understood the power of creative financing but I had no desire to hold the paper that long, nor for that price. The middle offer was interesting. It would not work for me but it was close. The 3 offer scenario gave me a lot of insight into what Bill needed in the deal.

     The next series of conversations was very open. (We had been discussing real estate for a couple months and had grown to trust each other.) I verified what I had into the property, purchase price, rent rolls, etc. I believe I showed Bill the schedule E from my tax returns. Bill, in turn, disclosed the amount of his pre-approval and how much cash he had available to put down. The pre-approval was only $10K-$15K short of what I needed to make the deal. The available down payment was less than I wanted but I didn’t the need the cash immediately. I proposed that I carry back a second mortgage so Bill could take advantage of the low interest rate the credit union offered him. Even though I was willing to subordinate my lien and make the required payments quite low, the credit union would not fund the deal with a second mortgage attached. The deal was dead. Could it be saved?

     I think it was Bill who asked, “What if I financed the balance of the down payment?”. That could work. I didn’t need the funds from the sale immediately but I wasn’t willing to sell for the amount of the credit union pre-approval. I was also not willing to finance this deal if Bill did not have a significant amount of his own funds in the deal. Bill only needed to get the property functioning as a rental so he could approach the credit union at a later date, refinance the property, and cash me out. We solved the problem by creating 2 land contracts that ran concurrently. The longer land contract was for the amount of the credit union pre-approval with a balloon payment due at the end of the 3 year term. The land contract that covered the gap between the down payment Bill had available and what I needed to make the deal work was for $12,000 and was amortized over a year—it would be satisfied with 12 payments.

      This structure meant that the rent Bill received would not cover the payments required on the 2 land contracts. However, once the first land contract was retired, this property would provide a positive cash flow. There was no prepayment penalty on either LC. It turned out that Bill paid off the short term LC a bit early and applied to refinance the property. Now, the original credit union pre-approval would be more than enough to cash me out—the principal balance had been paid down a little. (The credit union actually approved a higher amount than their original pre-approval. Property prices had increased and Bill now had a profitable rental which increased his borrowing capacity.) Bill cashed me out in less than a year, replacing the high interest land contract payments with a much lower interest, longer term loan from the credit union on a profitable rental property. Land contracts can be powerful tools.

     I have done a few more land contract deals which were structured differently. Should I write them up?

                                           Please subscribe to this blog with the button below.



Comments (9)

  1. Love the stories Jeff.  Keep 'em coming.  I've read all your entries from Confessions of a Private Lender.  Not only do I enjoy the real estate info, I especially appreciate your creative writing style.  It's almost literary.   Like reading a novel.  I sat next to you in a restaurant after a MREIA meeting last August.  Had I known about this blog then, I would have started reading and learning much sooner. 


    1. @Todd Moriarty, I suspect you have a bit too much time on your hands but I do appreciate the vote of confidence. Thank you.


  2. Absolutely! Nice twist to this one Jeff. LC's are fascinating with the flexibility and accommodation they can offer to both parties. I'm planning to tap into their potential a bit more this year, your tales are appreciated. 


    1. Thanks, @Garett H.. Real estate allows so many variables that it is rare that two negotiators who want to make a fair deal are not able to.


  3. I agree, please write them up, I am always reading these and think with the right people this will be one of the best ways to build my own rental portfolio. So the best way for me to learn great structures is through seeing what others have done


    1. @Josh Smith, land contracts provide a structure which could make it easier to attract financing. If the deal you find is strong enough to allow a lender to purchase the property (with your approval, of course), step the price up a bit, and resell it to you at the same closing it could present a bit less risk for a lender. I have done a few deals this way and will plan on fleshing out more details in a future blog entry. Thanks for stopping by.


  4. @Jeff Rabinowitz, of course you should write them up!  It is interesting for me to read about (and be involved with) the friendly side of investors.  The two sides, (sometimes more) each with a goal, with plenty of solutions when they both (all) realize there can be a beneficial outcome for both parties.  I've tried to deal with people selling properties who are so rigid in their terms, that they miss the opportunity to make decent money on an easy sale of their property(s) (Just checked the MLS on a 2 house deal I was trying to buy, seller dropped the price to what I thought it was worth and it is pending, the second home was withdrawn from the market). He could have sold both, made a decent percentage on his financing, almost recouped half of his purchase price with my down payment, been cashed out in 2-3 years and made about 250% of what he had invested in the properties.  C'est la vie.    


    1. I have found this business is much more fun and profitable by working with other investors instead of trying to beat them. It sometimes may seem like one gives up too much in the exchange but that is usually short sighted. The new landlord in this story quickly rented this house for more than I ever did. He has, at least, one more rental now and we will be cooperating on his purchase of another house a couple blocks from this one. I alerted him to the property and am helping him purchase it. I hope to be working with him for a long time.