Monday, January 08, 2007

The Next Investment

I've decided to get a head start on my New Year's resolution to buy at least one rental property this year for my personal investment portfolio. I think I may even be able to do it with no or very little money out of my pocket.

Over the weekend, I heard an investor / businessman on a real estate investing radio program talk about filled lease option properties that his companies sells. Now, I've been aware of these for a while because I've been on his mailing list for quite some time, however, this was the first time I actually got to hear him speak about it in detail and take questions from listeners. In a nutshell, you can buy a property from his company for under fair market value. The property has a tenant in place who has an option to buy the property at your appraised price after 1 or 2 years. The best part is that, at the close of escrow, you get a year or more of pre-paid rent. This means you won't get cashflow since the tenant isn't paying rent, but instead you get all that rent money up front. And thanks to inflation, money now is always better than money in the future!

My plan is to buy one of these properties with hard money, then refinance to a conventional loan. If the purchase price is low enough, I may even be able to completely pay off the hard money loan, thus getting into the property for no out of pocket costs (except for the 1 or 2 months interest I may have to pay on the hard money loan). My investors in my flipping LLC have agreed to be my hard money lender and earn some interest while they wait for their other funds to because available.

Before I embarked down this path, I had a couple of nagging questions. How should I structure the purchase from a paperwork perspective? Should the hard money lender buy the property outright and have a private note between itself and my company for the loan (the easier route) or should an actual mortgage be created and recorded with my company as the property owner and the hard money lender as the mortgage holder? It's helpful to remember that the goal of this process is to refinance later with a conventional lender, so I need to look at the paperwork from that perspective. Is it easier for a bank to approve a new, cash out mortgage on a free and clear property, which would be needed in the first case, or a refinance of an existing loan?

This is the first time I've done a deal involving bank loans from the hard money lender's perspective, so this is fairly new to me. Back in 2002, I purchased my very first rental property using hard money and then refinanced through a bank to pay it off, so I went back and checked the paperwork for that deal. In that case, the hard money lender actually took title to the property and gave me a private contract stating he would sell the property to me for a certain price. So when I "refinanced," what actually occurred was a sale from the hard money lender to me.

I also called and spoke to my friend Les, a real estate investor and former mortgage broker and that call settled the issue. He said it is much easier to do a refi of an existing mortgage than to get a brand new mortgage on a free and clear property - the bank's lending standards are much lower. Additionally, he pointed out that, on jumbo loans (loans for more than $417,000), the most cash back you can get is $200,000. The properties I am looking at are less than that, but it is a good piece of information to know.

Now, it's just time to find a property!


Anonymous said...

Who is the filled lease option properties company? Sounds interesting.

Kenric said...

Shaun, I don't know the details but I think they may be some issues on renting back to the original owners of the property that you just bought. I've read that you should never allow the people you buy the home from in distress to remain in the home.

Anonymous said...

I ditto kenric. I know of three companies in the Phoenix area who "flip" filled lease/options. They are purchased from people in pre-foreclosure, meaning your tenants are former owners. My biggest concern has always been, what happens when the former owner has to re-purchase the house and can't or is not able to make payments once the pre-paids are over? I'd hate to have to rely on a judge to clear this mess up.

Shaun said...

Kenric and anon - I've heard the same thing and, if I recall, the problem comes if you keep the property and loan in their name and they stay in it, such as if you were buying it subject-to and letting them stay.

I would not want to buy a house from someone in preforeclosure, then rent it back to them on a normal (non-pre-paid) basis. (They didn't pay the bank, so what makes you think they will pay you?) But with a year of pre-paid rent, you've got your money up front. If, after the year is up, they don't pay, you evict them. As mentioned on the radio show, you should expect your tenants to NOT exercise the option to buy. (Actually, in the majority of lease option contracts, the option to buy is never exercised and, as an investor, this is what you want.) On the other hand, the tenant has a year to get their finances in order and without a house payment to make, they have a much better chance of succeeding.

But I will be meeting with people at the company soon and I'll bring this up to get their take on it.

Kenric said...

Shaun, I don't believe the issue only arises if purchased subject to. I think that the issue here is that they will claim you have stolen their equity. They are obviously late on payments but have enough equity. These companies will buy the home and use the former owner's equity to give you the cashback (prepaid rent). A year later, when it is time to sell to the former owner, you may be selling back to them at the same price you've paid, but for them they have lost all the equity they gained when they previously owned it. My understanding is where this warning comes from.

Shaun said...

I dunno. I would argue they didn't lose their equity - they used it to pay rent for a year. They had a full year of no house payments because of it. Anyway, I understand your concern and I will bring this up when I meet with the folks at the company.

Shaun said...

Oh, one more thing. If / when you sell back to the tenant, it is not at the price you paid for the house. It is at your appraised value.

Anonymous said...

Two Things...

If these "investments" were truly viable, you would not be invited to the table. The company you're dealing with would retain them. Think it through - if values increase you will have to sell at a fixed price. If values decrease you'll be stuck with your poor investment. Kind of like playing a slot machine that has had the jackpot disabled.

The whole process sounds like it borders on being illegal and unethical. Defrauding a lender is one thing, but being in front of a jury as the evil scam artist is another.

Shaun said...

You do not understand the process. The selling price is determined when the option is due, not when I buy the property. It is at the appraised value. If prices rise, the appreciation will be reflected in the sales price. If prices drop, I still have some protection because I already bought these properties below today's current market value - meaning they would have to drop A LOT in one year. In addition, the tenant may not even buy the property.

As for being illegal and/or unethical, see my post about my meeting at the company titled "Meeting With Live Free Investment Group."

As for not being invited to the table if the investments were viable - you obviously have the mindset that everyone is out to get you and you can't fathom that some people are willing to share the profit. Stick to your W2 day job and keep your money in the bank. You will be blind to other opportunities.

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