A small equity deal

[ZanderRobertson]

Hi fellow REIN members,

Calling FSBOs today, my wife and I came across a free and clear house. We haven`t made any offers yet, so I don`t know if the seller would be receptive, but I`m just trying to think around some of the creative deals we might come across. Essentially:
a) There is not much equity in the deal - according to the seller, it`s worth 340,000 but he`s asking 327,800. I know RLG says that we either need to get significant equity on the front end or know how to get some as soon as we make the deal.
b) My thinking, if we were to pursue this deal would be to offer them a small DP ($10,000) and the rest of their equity in monthly payments, with the option to cash them out at some time in the future. If they would accept 1000-1500 per month for a 5 year term, we could Lease Option (with a $2000-$2200 payment monthly) it on the exit with a minimum DP of 10,200 (3%) and depending on the market, there will be an equity upside to match the medium of two independent appraisals (when TB exercises the option to buy). The exit sale would be for no less than the original $340,000 (numbers to be verified). This would leave us with a $500 to $1200 cash flow spread monthly. We`d borrow the initial DP from a private lender and pay a yearly balloon of around $1000 (10% of $10,000) max.

The deal (with these imagined numbers) is pretty good in terms of cash flow. The front end income (3% DP from lease option tenant) is not great, and depending on the market, the back end is minimal to great!

Is this what RLG had in mind when he talked about creating equity in a deal with little to no equity? If not, what else if anything could we do to create equity in this deal?

Again, the seller has not been approached about this, I`m using this example as a way to try to learn the different strategies.

Thanks everyone,
Zander

 

[lanedry77]

Hi Zander,

If they want a bunch of cash up-front, you could have them apply for a mortgage with an 80% LTV, then wrap that mortgage and give them a 2nd for the difference of whatever they want.

... just an idea.


David.

 

[travis]

Hi Zander,

Is it possible in the option-to-purchase contract to set the purchase price today for the future. So, if you create a 5 year term for your tenant buyer you can agree on the option price in the documents today. Assume a 5% annual appreciation rate on 340,000 so over 5 years you agree to a price of $433,935.

With an investor putting your down payment you just made front end cash. On the back end, in 5 years, you have locked in over 80k in equity.

Travis


QUOTE (ZanderRobertson @ Oct 27 2009, 10:03 PM) Hi fellow REIN members,

Calling FSBOs today, my wife and I came across a free and clear house. We haven`t made any offers yet, so I don`t know if the seller would be receptive, but I`m just trying to think around some of the creative deals we might come across. Essentially:
a) There is not much equity in the deal - according to the seller, it`s worth 340,000 but he`s asking 327,800. I know RLG says that we either need to get significant equity on the front end or know how to get some as soon as we make the deal.
b) My thinking, if we were to pursue this deal would be to offer them a small DP ($10,000) and the rest of their equity in monthly payments, with the option to cash them out at some time in the future. If they would accept 1000-1500 per month for a 5 year term, we could Lease Option (with a $2000-$2200 payment monthly) it on the exit with a minimum DP of 10,200 (3%) and depending on the market, there will be an equity upside to match the medium of two independent appraisals (when TB exercises the option to buy). The exit sale would be for no less than the original $340,000 (numbers to be verified). This would leave us with a $500 to $1200 cash flow spread monthly. We`d borrow the initial DP from a private lender and pay a yearly balloon of around $1000 (10% of $10,000) max.

The deal (with these imagined numbers) is pretty good in terms of cash flow. The front end income (3% DP from lease option tenant) is not great, and depending on the market, the back end is minimal to great!

Is this what RLG had in mind when he talked about creating equity in a deal with little to no equity? If not, what else if anything could we do to create equity in this deal?

Again, the seller has not been approached about this, I`m using this example as a way to try to learn the different strategies.

Thanks everyone,
Zander

 

[Mitch Collins]

QUOTE (travis @ Oct 28 2009, 12:35 PM) Hi Zander,

Is it possible in the option-to-purchase contract to set the purchase price today for the future. So, if you create a 5 year term for your tenant buyer you can agree on the option price in the documents today. Assume a 5% annual appreciation rate on 340,000 so over 5 years you agree to a price of $433,935.

With an investor putting your down payment you just made front end cash. On the back end, in 5 years, you have locked in over 80k in equity.

Travis


While this seems like a good option at face value - doesn`t this strike anyone else as pure speculation? Sure you can have an agreement with a tenant buyer (assumption here is that they don`t have the financial resources to purchase a home of their own at the moment) that they will pay X for a property 5 years down the road, regardless of what happens in the market.

However, what if the market actually drops or stays even for that period of time and now you expect to pull $80,000 equity with your contract from these tenant buyers. Chances are very high they won`t be able to pay for this inflated price, and what is your remedy? A court battle to win a judgement against a defendant who doesn`t have the ability to pay?

This seems very shaky to me and anyone who is using this strategy to `guarantee` their ROI should keep these things in mind.

Admittedly, I`ve never done a deal like this and perhaps I`m mistaken on some facts here, but how do people who put these deals together manage risks like this?

I`d like to know.

Warm Regards;

 

[Jeffrey2144]

QUOTE (MitchCollins @ Oct 28 2009, 05:17 PM) While this seems like a good option at face value - doesn`t this strike anyone else as pure speculation? Sure you can have an agreement with a tenant buyer (assumption here is that they don`t have the financial resources to purchase a home of their own at the moment) that they will pay X for a property 5 years down the road, regardless of what happens in the market.
However, what if the market actually drops or stays even for that period of time and now you expect to pull $80,000 equity with your contract from these tenant buyers. Chances are very high they won`t be able to pay for this inflated price, and what is your remedy? A court battle to win a judgement against a defendant who doesn`t have the ability to pay?

This seems very shaky to me and anyone who is using this strategy to `guarantee` their ROI should keep these things in mind.

Admittedly, I`ve never done a deal like this and perhaps I`m mistaken on some facts here, but how do people who put these deals together manage risks like this?

I`d like to know.

Warm Regards;

Hi Mitch,

With a Rent-To-Own/Lease Option tenant buyer you are giving them the option (NOT the obligation) to purchase at the agreed upon price "X" number of years (typically 2-3 years) down the road. It is you the seller that is obligated to sell to them IF they decide to buy from you.

Before the tenant moves in they will pay you an option deposit (suggested 3% or more of the current market value, i.e. $10K) which of course gives them the option, not the obligation to buy from you in the future. While they are saving up and building their credit (so they can qualify for their own financing) they are renting the home from you.

The added beauty of this is that they will also be paying you a monthly premium in addition to the rent. For instance, if the home would typically rent for $1,500 then the tenant buyer might pay you $1,900 per month with the extra $400 going towards their down payment when they finally buy.

If they decide not to buy then they forfeit their initial option deposit plus all the monthly credits they have built up. So, truthfully -- if they don`t buy then you`ve made your money regardless and still have the house to turn around and bring in another tenant buyer.

Tenant buyers also tend to be more sophisticated and are expected to pay for general repairs and maintenance on the property hence the overall P.I.T.A factor is a lot less and so is your risk.

 

[vandriani]

I don`t want to hijack the thread but

In a RTO scenario, how is the final purchase price decided?

 

[Jeffrey2144]

QUOTE (vandriani @ Oct 28 2009, 06:28 PM) I don`t want to hijack the thread but

In a RTO scenario, how is the final purchase price decided?

It`s determined in advance when you create the lease agreement. I like to sit down with the tenant and determine how long they will need to fix their credit and save for the down payment.

Let`s say we agree on 3-years. I would then take the current market value of the house (i.e. $235,000) and appreciate it by 5% per year. So they can then buy the house from me anytime between 0-3 years for $272,000.

If you desire, you can terminate the option after the 3-year term and if they cannot qualify for a mortgage then they loose their option deposit and monthly credits. I prefer to offer them the comfort of an extension which then carries a price appreciation of 0.5% per month (or 6% per year) after the initial 3-year term. I say... if the relationship is good, you are getting good cash flow and solid price appreciation why ruin a good thing.

Ron LeGrand suggested using the appraised value at the time of sale (not to be less than "X" amount) to determine the final purchase price.

 

[Mitch Collins]

QUOTE (jvarcoe @ Oct 28 2009, 03:55 PM) It`s determined in advance when you create the lease agreement. I like to sit down with the tenant and determine how long they will need to fix their credit and save for the down payment.

Let`s say we agree on 3-years. I would then take the current market value of the house (i.e. $235,000) and appreciate it by 5% per year. So they can then buy the house from me anytime between 0-3 years for $272,000.

If you desire, you can terminate the option after the 3-year term and if they cannot qualify for a mortgage then they loose their option deposit and monthly credits. I prefer to offer them the comfort of an extension which then carries a price appreciation of 0.5% per month (or 6% per year) after the initial 3-year term. I say... if the relationship is good, you are getting good cash flow and solid price appreciation why ruin a good thing.

Ron LeGrand suggested using the appraised value at the time of sale (not to be less than "X" amount) to determine the final purchase price.


I see..

Makes a lot more sense now, thanks for that. This way, even in the case of a drop in market value on the subject property, the investor is still up the initial deposit by the tenant buyer as well as the additional payment recieved monthly to go towards down payment?

I like that - you learn something new every day!

Thanks again.

Warm Regards;

 

[Jeffrey2144]

QUOTE (MitchCollins @ Oct 28 2009, 07:18 PM) I see..

Makes a lot more sense now, thanks for that. This way, even in the case of a drop in market value on the subject property, the investor is still up the initial deposit by the tenant buyer as well as the additional payment recieved monthly to go towards down payment?

I like that - you learn something new every day!

Thanks again.

Warm Regards;

Your welcome Mitch. RTO`s are a great way to offset the risk and front-load your cash flow. The downside is your earnings will be taxed mostly as income, not capital appreciation.

 

[travis]

Hi Jeff,

How can you protect yourself if you purchased the property with an AFS (wrap) and then lease-optioned it to a TB? Ron didn`t talk on this subject.

An example: If you structured your AFS term for, say, 42 months and the lease-option term is 36 months. In theory this is great and if your not binded to an AFS (or mortgaged)and the tenant doesn`t exercise their option you walk away with the deposit + monthly installments, fantastic! But with an AFS you still have a contract with the original seller which you have to honor. With the tenant gone how are you going to make due on the AFS or what are the options in this situation?

Thanks,

Travis



QUOTE (jvarcoe @ Oct 28 2009, 04:55 PM) It`s determined in advance when you create the lease agreement. I like to sit down with the tenant and determine how long they will need to fix their credit and save for the down payment.

Let`s say we agree on 3-years. I would then take the current market value of the house (i.e. $235,000) and appreciate it by 5% per year. So they can then buy the house from me anytime between 0-3 years for $272,000.

If you desire, you can terminate the option after the 3-year term and if they cannot qualify for a mortgage then they loose their option deposit and monthly credits. I prefer to offer them the comfort of an extension which then carries a price appreciation of 0.5% per month (or 6% per year) after the initial 3-year term. I say... if the relationship is good, you are getting good cash flow and solid price appreciation why ruin a good thing.

Ron LeGrand suggested using the appraised value at the time of sale (not to be less than "X" amount) to determine the final purchase price.

 

[ZanderRobertson]

Thanks for your replies everyone.

A couple more items:

1) This is a free and clear house; so this wouldn`t be an AFS correct? It would be straight seller financing with the seller carrying a 1st mortgage. Is that right?

2) For me to proceed on this deal, I must receive minimum $10,000 as a DP from the TB. I will also need minimum $500 monthly cash flow. If values stay flat for the term of the Lease to Own agreement I will be cashed out in a safe position 2-5 years down the road because I`ve paid my seller more in equity than my TB has paid me over the term of the Lease Option agreement. Due to the equity in the deal on the front end, I`ll be able to pay my private lender the DP money back upon exit. Yearly interest payments would be handled by excess cash flow.

Mitch, i agree, speculating on appreciation is not a wise choice in this situation. Does this seem like a legitimate deal based on this scheme?

David, the strategy you speak of seems legit, and I know Ron talks about it too. Perhaps it`s my inexperience, because I don`t currently have the stones to ask a seller to do that. How would you go about it? Have you pulled that off before?

THanks all,
Zander

 

[SC2007]

On a RTO how much of the rent should go towards the purchase price of the house? is the monthly payment the market rent plus a premium agreed by both the owner and the TB?

Thanks,
Shawn

 

[ZanderRobertson]

One more thing; it seems this deal could potentially have 2 of the 3 necessary elements.

1) An acceptable income on the front end (Min 10k deposit)

2) Strong Cash flow during term of RTO

3) It doesn`t have a strong payout on the back end, unless there was a market run-up, something I`m not willing to speculate on.

My feeling is that each deal needs to have all 3 elements. The strong cash flow is not reason enough to pursue the deal.

Thanks,
Zander

 

[EdRenkema]

QUOTE (ZanderRobertson @ Oct 28 2009, 11:52 PM) One more thing; it seems this deal could potentially have 2 of the 3 necessary elements.

1) An acceptable income on the front end (Min 10k deposit)

2) Strong Cash flow during term of RTO

3) It doesn`t have a strong payout on the back end, unless there was a market run-up, something I`m not willing to speculate on.

My feeling is that each deal needs to have all 3 elements. The strong cash flow is not reason enough to pursue the deal.

Thanks,
Zander


Why wouldn`t strong cash flow be enough??
Is the property in a REIN top 10 town?
Does it fit any of the systems you learned through REIN?
In Ron`s book he also discusses reasons why a house will or will not sell pages 119 to 140

Congratulations Zander it looks as if these people will work with you, it may very well makes sense as a buy and hold, hope it works for you.

 

[Jeffrey2144]

QUOTE 1) This is a free and clear house; so this wouldn`t be an AFS correct? It would be straight seller financing with the seller carrying a 1st mortgage. Is that right?
No. You still want to have your purchase agreement state that the sale is "by way of Agreement For Sale". You would then include the AFS portion as a schedule (additional document attached to the purchase agreement). The main reason why you MUST include an AFS is to ensure that THE TITLE REMAINS IN THE SELLERS NAME!!! Otherwise you will have to assume the title which will trigger Land Transfer Taxes (well may be not for your lucky Albertans) and other closing costs. Also, how can the seller carry a mortgage on a property where he doesn`t hold title?

Remember you do not use any of your own money or credit to close this deal.

If the seller wants cash up front then get them to take a 1st mortgage on the property for whatever amount they need (with in reason) and you agree to simply make the monthly payments on that mortgage and possibly give them some more each month with the total amount not to exceed $1,000 per month (or whatever works for you).

Now when your Tenant Buyer gives you $10K (or 3% of the MARKET VALUE for the home) as their option deposit then that is cash right into your pocket. You shouldn`t need any private lender $$$ to support this deal.

If the seller doesn`t want to re-finance then you could try to get them to lease option the property to you under very favorable terms and provided that the terms of your lease option buyer are significantly better then you get to collect a nice spread while the process runs its course.

OR, if the seller is willing to do seller financing then you pay them a $100 option deposit for the rights to buy the house within the next 120 days at "X" amount. With your agreement in hand you run out the door and crank up the selling machine and try to find as many buyers as you can for this property. Just make sure you list it above market value and advertise "owner financing".

Once you find that buyer you then do a simultaneous closing and collect the spread for the difference of your selling price less the purchase price outlined in your 120-day option agreement.

As you can see each strategy has its own advantages but regardless of which one you end up doing you are making money without using your own dollars or credit.

 

[Jeffrey2144]

QUOTE (SC2007 @ Oct 29 2009, 01:21 AM) On a RTO how much of the rent should go towards the purchase price of the house? is the monthly payment the market rent plus a premium agreed by both the owner and the TB?
Thanks,
Shawn

Hi Shawn,
Your correct. The monthly payment doesn`t have to be an exact science. The key is to create something that works for both parties. As a minimum you`ll want to set your minimum monthly rent to ensure your costs plus extra are being adequately covered. Then to determine the monthly payment ask the tenant buyer: "what`s the most they can afford to pay per month." Let them determine the payments.

Regardless of their response, say: "Is that the best you can do?"

As a quick rule of thumb you can calculate the total monthly payment as being 0.9% of the market value for the home (i.e. $200K home = $1,800/month lease payment). Then attribute 20% of the lease payment as their option credit (i.e. $1,800/month = $360 credit to lessee).

 

[powerhouse]

QUOTE (jvarcoe @ Oct 28 2009, 06:14 PM) Hi Mitch,
With a Rent-To-Own/Lease Option tenant buyer you are giving them the option (NOT the obligation) to purchase at the agreed upon price "X" number of years (typically 2-3 years) down the road. It is you the seller that is obligated to sell to them IF they decide to buy from you.

Before the tenant moves in they will pay you an option deposit (suggested 3% or more of the current market value, i.e. $10K) which of course gives them the option, not the obligation to buy from you in the future. While they are saving up and building their credit (so they can qualify for their own financing) they are renting the home from you.

The added beauty of this is that they will also be paying you a monthly premium in addition to the rent. For instance, if the home would typically rent for $1,500 then the tenant buyer might pay you $1,900 per month with the extra $400 going towards their down payment when they finally buy.

If they decide not to buy then they forfeit their initial option deposit plus all the monthly credits they have built up. So, truthfully -- if they don`t buy then you`ve made your money regardless and still have the house to turn around and bring in another tenant buyer.

Tenant buyers also tend to be more sophisticated and are expected to pay for general repairs and maintenance on the property hence the overall P.I.T.A factor is a lot less and so is your risk.

 

[powerhouse]

QUOTE (jvarcoe @ Oct 28 2009, 06:14 PM) Hi Mitch,
With a Rent-To-Own/Lease Option tenant buyer you are giving them the option (NOT the obligation) to purchase at the agreed upon price "X" number of years (typically 2-3 years) down the road. It is you the seller that is obligated to sell to them IF they decide to buy from you.

Before the tenant moves in they will pay you an option deposit (suggested 3% or more of the current market value, i.e. $10K) which of course gives them the option, not the obligation to buy from you in the future. While they are saving up and building their credit (so they can qualify for their own financing) they are renting the home from you.

The added beauty of this is that they will also be paying you a monthly premium in addition to the rent. For instance, if the home would typically rent for $1,500 then the tenant buyer might pay you $1,900 per month with the extra $400 going towards their down payment when they finally buy.

If they decide not to buy then they forfeit their initial option deposit plus all the monthly credits they have built up. So, truthfully -- if they don`t buy then you`ve made your money regardless and still have the house to turn around and bring in another tenant buyer.

Tenant buyers also tend to be more sophisticated and are expected to pay for general repairs and maintenance on the property hence the overall P.I.T.A factor is a lot less and so is your risk.

Hi Jeff,

What a fantastic explanation. Very clear & concise. Don`t stop.
I`m having a hard time understanding a lot of these quick turn techniques but am determined to learn them. With more explanations like your`s the fog will eventually clear. Thank you.

Larry

 

[powerhouse]

QUOTE (jvarcoe @ Oct 31 2009, 02:12 AM) Hi Shawn,
Your correct. The monthly payment doesn`t have to be an exact science. The key is to create something that works for both parties. As a minimum you`ll want to set your minimum monthly rent to ensure your costs plus extra are being adequately covered. Then to determine the monthly payment ask the tenant buyer: "what`s the most they can afford to pay per month." Let them determine the payments.

Regardless of their response, say: "Is that the best you can do?"

As a quick rule of thumb you can calculate the total monthly payment as being 0.9% of the market value for the home (i.e. $200K home = $1,800/month lease payment). Then attribute 20% of the lease payment as their option credit (i.e. $1,800/month = $360 credit to lessee).

Hi Jeff,

Keep it up, keep it up. More fog cleared. Thank you.

Larry

 

[lanedry77]

QUOTE (ZanderRobertson @ Oct 28 2009, 10:47 PM) David, the strategy you speak of seems legit, and I know Ron talks about it too. Perhaps it`s my inexperience, because I don`t currently have the stones to ask a seller to do that. How would you go about it? Have you pulled that off before?
Hi Zander,

I have no experience doing that at all, so I`m only speaking from theory.

But with that being said, if they *would* put a mortgage on it, then it`s just an AFS transaction. You take over the payments and they stay on mortgage & title.

they might not go for it, but unless you ask, you`ll never know. Just phrase it something like "I just had an idea. This might not work for you, but would you consider .....". that will diffuse the pressure of the situation, and then you can tell them the benefits of the plan (they get lots of cash right now, no realtor commission, no people tromping through the house, a quick sale, they get the house back if you don`t pay, etc...).


David.