Options Trading Question

I was explaining option trading to a friend and came up with a question that I don't know the answer to. Perhaps someone out there can help me.

The question concerns how dividends are handled in an option contract. Suppose it is now March and I write a covered call with a May expiration. In April, the stock pays a dividend. In May, the option is in the money and is exercised. Who keeps the dividend? It was paid to me in April, since I held the stock then, but if the option is exercised, do I have to pay the dividend to the new stock owner?

The last covered calls I wrote were for SFI, a dividend paying stock, but no dividends were paid between the time I sold the option and the expiration date, so I did not face this problem. However, if I decide to write some longer term covered calls, this issue will come into play.

Property Management Set Up For Rental #1

My first choice for property management did not work out, so I've signed up with another property management company. The terms are almost identical to what I had planned on with my first choice: the monthly fee is 10% of the monthly rent, there is no fee when the property is empty, and when a new tenant is put in place, there is a charge of 75% of the first month's rent. The only difference between my original PM choice is that the new tenant fee would have been 50% of the first month's rent. I need to send in $250 to be held in a contingency account for any repairs (which I would have had to do, no matter which PM I used).

I wanted to get all this done this week, before the first of the month so that the tenants could start sending their rent to the new manager.

Tenant Complaints

My first rent checks from Tulsa were actually two money orders. Before I deposited them, I noticed that the names on them were not the same as the name on the lease. Hmm.. That's not good. So I asked my property-manager-to-be to have these people sign an addendum to the lease showing they were living there as well. This is mainly for legal reasons in case I need to evict them or take other action against the tenants. They did sign, but of course, when the property manager showed up, they had a couple complaints. They said one toilet and the dishwasher leaked. Also, they said they saw some bugs.

So I've contacted a pest control company and a plumber to fix this. I've given them the tenant's phone number so they can set up an appointment.

AZ Number 2 In Subprime Mortgages

The Arizona Republic today had a front page article that said Arizona ranks number 2 in the nation for percentage of subprime mortgages, second only to Nevada. But the delinquency rate on those loans in Arizona is 9.26 percent, which is less than the national average of 13.3 percent.

What does this mean? I think it means the worst is still yet to come for the Arizona housing market. I expect foreclosures to continue to increase, especially since the recently announced inflation rate was higher than expect, meaning the Federal Reserve likely won't lower rates for some time and may still raise them.

Of course, one person's bad news is another person's good news. If you are looking to pick up houses for cheap through foreclosure and preforeclosure sales, start amassing your funds now to go on a buying spree.

SFI Options Expire Worthless

About a month ago, I sold some call options for some SFI stock I own. Those options had a strike price of $55 and expire tomorrow. Unless the stock shoots up 9 points in the remaining 3.5 hours of trading today (highly unlikely), those options will expire out of the money and I won't be required to sell my shares. I get to keep the $625 I got for selling the options (actually, around $611 after commissions) and on Monday I can turn around and do it all again!

WSJ Article On Foreclosure Investing

The Wall Street Journal has an article today about foreclosure investing. Actually, it's more of the story of how one man invests in foreclosures. This guy buys foreclosed houses in bad neighborhoods, sight-unseen. He doesn't bother to fix them up. Instead, he sells them for low down payments and monthly payments that are lower than neighborhood rents. He sells them as-is and lets the new owners make repairs. Last year, he bought over 1,400 homes.

In reading the article, I can't help but think this is the type of investor that gives other real estate investors a bad name. He's doing nothing illegal and you could argue that he is filling a need, but overall, I think most people would accuse him of taking advantage of the less fortunate. Funny, but normally, foreclosure investors are accused of this when the buy properties in pre-foreclosure. This guy would get accused of that when selling his properties post-foreclosure, which just goes to show you can't please everyone, I suppose.

First Rent Check Arrives

My first rent check for the Tulsa house arrived today. And it was a postal money order, no less. No need to worry about bouncing checks!

Update On Louisiana Project

Sometime last month, I got word that the mortgage payment on the commercial properties in Louisiana was going to be missed. That payment is now 35 days past due. In that time, the mortgage investors (of which I am one) and minority property owners have had several conference calls discussing in what direction to proceed. The situation has been pretty fluid and I didn't want to post anything about it because it was changing so rapidly.

It looks like now we have a course of action that everyone agrees on - mortgage holders, minority owners, and the majority owner. The main issue is that the new majority owner is in a cash crunch. He is still actively rehabbing the property, but most of his money is tied up in other buildings and until he sells one of those, he's short on cash. In looking at our options, we discovered our mortgage note wasn't as strong as we would have liked - it specified only that we could collect the maximum amount we loaned, not any additional foreclosure costs, which could be in the tens of thousands for the amounts we are dealing with. (The note was provided by a title company, not a lawyer, and although it does have some nice points, we've learned from that mistake.) The value of the property has never been an issue and there would definitely be enough equity in the property to cover the mortgage loan, but foreclosure is a long process and the majority holder suggested the process would be even longer if bankruptcy was involved - a not-so-veiled threat.

So to get payments started again, the minority investors have proposed underwriting a second mortgage on the property. This mortgage will have stronger language, should a foreclosure still be required down the road, and it will be large enough so that the missed payment(s) and penalties on the first will be covered. There is still plenty of equity in the properties, as verified by a recent appraisal. The parking lot is in the process of being refinanced at a 50% lower interest rate. Since it already has a positive cash flow at hard money rates, the refi will not only get back some of the investors' money, but also increase the free cash available for meeting the mortgages on the other three buildings. It could take another month for the second to get hammered out and funded, so I may end up with two missed payments, but they will be made up shortly.

All in all, it's been a great learning experience for me. I get to listen in to how much more knowledgeable real estate investors handle problems and work out solutions that benefit everybody. I get experience with commercial lending and multi-million dollar deals. I am also impressed with how the minority owners are looking out for the mortgage holders. All of the minority owners have sold part or all of their interest to other investors, as Les did to me, so there are roughly 30 investors in this deal, although there are only about 5 owners. Even those owners that no longer have an interest in the mortgage note (i.e., they are in it for the capital gains, not the cash flow) are concerned that the mortgage holders start getting payments again and are brought current. They have been on top of this since the moment they found out a payment would be missed.

There are a lot of details I've left out, including the many other options that were investigated, but I feel confident the solution that has been reached will benefit everyone. Of course, being the detail-oriented person I am, I won't feel 100% comfortable until the second mortgage is signed, but I'm feeling much better about the situation than I was a month ago.