[Nov/2022 | RE] Wendy Patton – Real Estate Lease Options & Subject-to deals Notes

  • 4/5, Good concept though the holding period is relatively short (exit strategy) is mostly lease-option. Initial chapters good, later chapters not as good. Some advanced strategy (Medicaid based nursing home + Section-8 lease-option) seems very interesting. 
  • Subject-to: buyer gain property but have the mortgage remain with seller. 
    • Mortgage company usually not aware of the change in ownership. 
    • New owner just pays the mortgage.
  • Short-term strategy in this book means full monetization in <= 1 year. 
    • Subject-to / lease-option usually not a short-term strategy.
  • Standard lease option := wrapper lease option 
    • Variable lease purchase := it’s not an option, it’s committed to purchase, hard to enforce, have to sue – time & money consuming. 
  • Example Lease-option Deal:
    • Seller
      • Traditional negotiation: price-only. Currently Seller won’t budge on price. 
      • Out of pocket with seller, 1K option fee, 4K rehab. 
    • Tenant buyer: poor credit + seven dogs, ask tenant-buyer for non-refundable option fee. 
      • Option fee spread + rent spread
      • Set option sale/strike price: 10% premium on top of market price, 6-7% appreciation in 18 months. 
  • Example Subject-to Deal
    • Seller: 3 months behind mortgage, have first + second mortgage and a small assessment fee. 
      • Because seller missed payments, they couldn’t even refi the property (interesting) 
      • The mortgage is a bit costly, bad for cashflow. Either (1) Refi to lower rate / lower monthly payment or (2) Buyer credit trick;
    • Buyer: Lease-option strategy, one year period, originally rent $1600, but if rent $2100 per month, get $500 credit and get $250 extra credit on top. Buyer accepted. Solved the cashflow problem.
    • Don’t pay off the mortgage until the backend sale happens (option striked). 
  • Revenue sources: option fee from buyer, monthly cashflow, back-end settlement
    • Need contingencies because of holding
  • Ideal house: Median Price And Above, in cosmetic condition (easier to sell/leg-2).
  • Two levels of motivated sellers
    • Extremely motivated (Desperate & Distressed) [FINANCIAL DISTRESS] –  behind on payment / job-loss / divorce / foreclosure etc. 
    • Not desparate / distressed – Not troubled financially but motivated for other reasons – two house payments / inherited a house / burned out landlord / job transfer etc. 
  • Usually lease-option for people in second category, subject-to for people in first category. 
  • Marketing
    • Tear-off flyers
    • Realtor
  • Author thinks Out-Of-State owner + vacant houses + motivated landlords shall be targeted. 
  • Corporate Relocation Department – they need to sell the houses for employees who relocate – (for the houses that aren’t sold) can be a potentially good target for lease-options. 
  • In year 2003, FSBOs on average sell 20% lower price on average (per National associate of realtors study – potentially suspicious) – How’s it now?
  • Calling landlords who’re looking to rent whether they’re selling – script:
    • Key: pretend you’re renting & build rapport. 
    • Info gather. Turn renting question gradually into buying question after establish rapport.
    • Don’t answer directly you want to rent to someone else, but don’t directly deceive.
  • Lease option vs. Subject-to
    • Don’t lease option when seller have bad debt, i.e. when seller has judgement/debt, want to get rid of seller from the title of property. Because judgement can reach the property if seller is on title. 
      • Prevention method: Check seller’s credit, might use a Private Investigator
      • File/Record a memorandum of option : seller can’t sell to someone else / refi.
      • Prefer seller with lot of equity as cushion. 
    • Seller who don’t have bad debt are less desperate, more motivated by change of life. 
  • Subject-to:
    • Risk: Due-on-sale clause of mortgage – ask an attorney what to do!
      • Some methods:
        • 1. no-protection – small risk when interest rate is low;
        • 2. land-trust based protection;
          • Often lender notified by insurance company change, so one approach is to keep two insurance. (One additional insurance on top of existing owner’s). 
        • 3. disclosure – send a certified letter & see if lender respond, if not then they didn’t call due-on-sales, if yes, refi. 
    • Sometimes you can get the seller pay you to get the deed (if seller’s equity is negative). 
      • They will pay realtor commission & other misc costs of sell on market; 
      • If seller don’t have cash to pay you (to get rid of the property), you can have an option with seller (assuming seller pays you 10K on installment) such that: when seller stop paying the buyer, you have the option to give the property back to the seller. 
    • Escrow balance (for existing mortgage) is also a (minor) source of profit margin for subject-to deals. 
    • Mortgage Payment
      • What to make sure (1) seller is protected that you pay the mortgage; (2) if you pay the mortgage to seller and seller pays to mortgage company, how to make sure they indeed pays the mortgage company?
        • One method for type-2 is to write down that if seller doesn’t pay mortgage company for certain period of time, then buyer shall pay the mortgage company directly. 
        • Another method is pay the mortgage company directly & mail the receipt to seller. 
    • Seller’s potential objection: you get the deed, I keep the mortgage, why?
      • Need rapport
      • Example answer: “I can understand your concern, and I would probably feel
        the same way if I were in your shoes. All I can tell you is this:
        The bank will not let me assume your mortgage, and in order
        for me to make a fair return on this deal, I can offer you $___.
        I’ll be glad to buy it right now at the price I’ve quoted, but
        then how would you cover the difference to pay off your current loan? You are actually being very savvy and getting top
        dollar for the property by letting me take over your payments;
        we both save all the costs that we’d incur—commissions,
        closing costs, and so on—if I were to just buy it from you.
        The minute you okay this paperwork, I kick into owner
        mode. I will be doing everything possible to sell this house as
        quickly as I can, using my expertise. I’ve spent thousands of
        dollars on training to do this business, legally and morally. It
        would be futile for me to let this property go back to the bank
        just because I didn’t make the payments.”
    • If seller ask too much, can find an appraiser you know and ask them to give lowest priced appraisal. 
    • Ask seller to pay a part of mortgage (esp. when there’s second mortgage)
      • Example script:
        • I see you have two mortgages on the property. Why did you
          feel it necessary to take out a second mortgage and where was
          that money spent? Well, I can certainly empathize with you,
          but since you have already spent your equity for this reason,
          not only do you have no equity left, but in order for this deal
          to make financial sense to me, I’m going to need you to continue to pay only the second mortgage for the next two years. I’ll take care of the first, but as you already know, there is no
          way I can rent the property for the amount needed to cover
          these two payments. I won’t even have enough to pay any
          management fees. If you were in my shoes, would you want
          to take all this risk for a negative cash flow? If I were in your
          shoes, I would not like to have to do this either. But look at it
          this way: Isn’t it going to be more financially feasible for you
          to pay just $244 per month instead of the whole $1,179 you
          are paying now? If you step in and do your part, I’m willing
          and able to help you by taking the other $935 burden off your
          back. Together we’ve created a win-win situation now, don’t
          you agree?” 
    • Point of time when agreement locks-in: i.e. seller pays a few more payments while you find a tenant-buyer. 
  • Lease-option:
    • author says seasoning starts with memorandum of option date. 
    • When someone has equity with a relatively nice home. Find a buyer who wants to lease option. 
    • Need to estimate appreciation to determine “strike price” 
    • Option premium on strike price more close to 10% if housing price is “diverse”, otherwise more close to 5%. 
    • Equity Buydown term – if seller won’t budge for a small profit deal, increase profit margin. One way is equity buy down, at start of option seller owes $100K of the mortgage, and the end, they owe $90K mortgage balance. Ask the credit for $10K at closing. 
    • If in the end of lease option, no purchase happen, it reverts back to the seller. 
    • Deed in escrow – psychologically gives seller the sense they’ve sold the property already and less likely to back out
    • Performance mortgage – seller pledge property as collateral for lease option. Some seller would object to this.
  • Interesting comment regarding pay-off:
    • If seller equity 50K, and owes 70K IRS tax lien. Then close still fine. IRS take 50K and remaining 20K still owed by seller. 
    • IRS wouldn’t stop the sale as it’s attached to a person. – https://www.biggerpockets.com/forums/70/topics/502365-irs-tax-lien-question
  • Inheritance situation:
    • When there’s 5-6 people inheriting a property, likely one is broke and need the cash now. Hard to make “long term sale strategy”.  And when divided among many people, the monthly cashflow seems too small to them.
      • Thus easier when “outright purchase” when lot of people inheriting a house. 
  • Lease-option : could add contingency for finding a tenant
  • Multi-dimensional negotiation
    • 1. Price 2. Payment 3. Length of Time
    • Seller might be very solid in some dimension & very flexible on others
    • Find seller’s sticking point (seller’s “must-haves”)
      • Some might be specific price, some might be monthly payment. 
  • Determine if rent price too high / too low, post a bait rent price (on newspaper etc.) & see the number of calls. 
  • Risk avoidance terms
    • Termination with written notice within 60 days. 
    • Contingent to finding a tenant buyer. 
  • Insurance policy: change from owner-occupied to non-owner-occupied. Also add buyer/middleman to the additionally insured party. 
  • Seller can list the house during the lease-option / subject-to period, but need to use Middleman’s name as exception (to not pay commission)
  • Credibility Kit – seller’s info manual
  • Closing logistics
    • Pretitle work – commitment for title, title company usually 7-10 days, faster if has relationship : Verify judgements & liens & state+federal tax liens. Show all owners.
      • If too much liens, then more “subject to” than “lease option”.
      • Make sure purchase from all owners.  
    • Lease option with seller: rental agreement + option agreement
      • rental agreement
        • Make sure rent first go to mortgage, make sure it’s the right mortgage, right loan # on check. 
        • Good clause – assignable. 
        • right to make repairs for tenants at tenants’ expense. 
        • homeowner insurance type of fixes shall be using homeowner insurance. 
      • option agreement
        • Good clause – if property uninhabitable, then optionee don’t need to pay rents & the uninhabitable period added to option period. 
      • Memorandum of option – clouds title – seller can’t sell/refi. + seasoning of title. 
    • Subject-to
      • Status of mortgages (how much behind) – get in writing from mortgage company
      • Seller’s acknowledgement: With this document the seller acknowledges important things about the sale of their home. This way they can’t come back later and say they didn’t understand what they were doing or didn’t realize they were really deeding their home to the investor.
      • Letter for due on sale clause: This informs the seller that their home still may be called due, that the investor is not guaranteeing they will pay the loan off in full, and that the owner accepts this risk in selling their home subject-to.
      • Escrow payoff – give investor the money in escrow account of mortgage when it’s paid off. Otherwise by default it will go to seller. 
      • Record warranty deed + bring mortgage current. 
    • Be additionally insured. 
    • Option paperwork recorded – Make certain that you leave a 2.5-inch blank margin at the top of your Memorandum of Option or it will not be able to be recorded. Check your state/county recording requirements prior to completion of this form
    • Quickbooks for check-writing. 
  • Advanced Strategy
    • Nursing home: Old people on Medicaid when selling home cannot be paid, instead shall pay Medicaid. Lease option is a awesome strategy, as a “option triggered by death”. And cashflow will be good because old people on medicaid shall pay the received rent to medicaid as well. Frame as resolve their family the need to maintain the house. 
      • Only works in some state. 
    • Limited POA + modified purchase contract & price – to battle high transfer fee. 
    • Use Capital Gain to be taxed to nudge seller into seller-financing. 
    • Section-8 usage in lease-option, in some cases, section 8 might be used to pay the monthly rent as lease-option & potentially help tenant get a mortgage. 
  • Realtor
    • Have pocket-listings
    • Realtor afraid when listing listed to long and home-owner threaten to remove the listing / rent it. 
    • How to pay realtor commission in lease option deals? 
      • Pay some commission upfront (1-1.5%) and pay the remaining when the deal truly closed. 
  • Finding tenant-buyer
    • Screen tenant-buyers – don’t want “deadbeats” but instead want someone with poor credit for a (one-off) reason
    • Property is delivered “as-is” to tenant-buyer, and they shall fix it up. 
    • Handyman special house 
      • Better be inhabitable, otherwise, might have trouble when tenant don’t pay & fight. Because most judge would require landlord to rent out an inhabitable house. 
  • BKMK P215

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