Posted by Jason(MI) on June 14, 2002 at 11:05:08:
Great point Jeff!
how important is equity? - Posted by Mia
Posted by Mia on June 13, 2002 at 17:49:32:
When doing a lease option, is equity really that important? I keep reading that one of the advantages to selling a home on a lease option is that you get a fair price. Also, a lot of the ads I see say “We take over pmts, no equity, no problem”
So how important is the amount of equity? I’m a little confused, because I had a potential deal where I would have been making $150-200/month on a lease option sandwich, and I was advised by another investor that there wasn’t enough equity to make the deal a good one.
Is there something I’m missing?
Thanks for any input.
Mia
There he goes again… - Posted by Tim Fierro (Tacoma, WA)
Posted by Tim Fierro (Tacoma, WA) on June 13, 2002 at 19:20:16:
Harry buys a house for $100k and it is worth $100k. Harry also paid 0% down on his loan program and his payments are about $665 a month. He also has some insurance of about $35 and maybe taxes of $100; so Harry has a monthly PITI payment of $800.
1 year later, Harry gets tranferred to California for his job. He asks you to buy his house from him, just take over his payments. His house now has risen from $100k to $103k, and his balance is now only $99k. There is $4k; yet with transfer taxes and holding costs; there is still no equity.
You decided to sandwich lease this and put a new price tag of $110k for the sales price in 1 year with a tenant/buyer. Now in a year from now, the payoff balance is down to $98k, and you are selling for $110k; thus making $12k in perceived equity at this point.
You know you can rent this out for $1k a month and that means you will have $200 a month cashflow, but still no equity to speak of. So you put it out as a L/O and you lease it out for 1 year at $1k a month. It takes you 2 months between taking possession, getting it ready, and advertising for a t/b. You are now out $1,600 so far. The t/b stays one year and doesn’t exercise the option because he decided that since his option price is $110k and he can get a similar house down the street for $105k that is bigger, he is going to buy that house with his now restored credit. This area only went up 3% this year when you ‘expected’ it to go up 10%, now this house has FMV of $103k. You now get 2 months to find a new tenant and pay for any cleanup and repairs needed to sell again. Gone is $1,600 for the 2 months and you had to paint, clean the carpets, and fix the holes in the wall that your t/b made during a mad rage. You are out $500 for this. Last year $1,600, this year $1,600, and you had the repairs of $500 and at this point in your position; you have spent $3,700. Monthly cash flow of $200? Well, gee, you spent that each month for that new car payment; so you haven’t got any of that; only what’s left in the bank from your own personal funds.
So do you have $3,700 sitting around to some day get the perceived value of $12k in equity; minus costs? So with your L/O, you ask for 3% option money so you can recoup this upon each new t/b. Good thing you got that $3,300 up front from your last t/b because you are already out $3,700.
Now here comes t/b #2. You are getting mad because nobody is looking at the home and you finally accept the next t/b that looks half way decent to qualify during the next year so you can get out. But he only has $2k. You think about it, and since you only need $400 to break even up to now; that would still leave you $1,600 in case this guy blows you off next year. You will have those next 2 months covered! And you figure you can just sell that new car you hardly drive and don’t need a status symbol when you need money to cover your housing position. You sign him up for his $2k and put an option price of $113k.
After 2 months, you decide you are keeping the car and you feel this guy is going to work out and cash you out in less than a year, so that $200 a month is still going to be used to pay for that car payment.
Next year comes around, and guess what. This T/b who now has his credit restored has decided that he is getting married and his new wife really wants to move to another city 28.3 miles from where they are now. It is closer to her mother than this house, so this t/b gives notice that he will not be exercising his option.
Hey, no problem, you still have that $1,600 in the bank from last year. You got 2 months reserves sitting there for you and you are on cloud nine. You know in advance this time that the t/b is not going to exercise so you advertise ahead of time and get the t/b to allow you showings routinely for new t/b’ers.
You found the perfect couple. They are already pre-approved for funds and want to buy right now. You sign a P&S for $116k and they want to close 2 weeks after your t/b in the home now, have left. This is so sweet, you can smell success around the corner.
Oh no, because the current t/b just lost his job, they decide to move into the new wife’s apartment close to her mom instead of a new house. Buying a new home in the new location with the new wife is out of the question. In fact, I am sorry Mr. Landlord (Remember, they will call you the landlord even though you are the owner and they were supposed to treat the house as if it was their own), but I can’t pay this last month’s rent because without my job, I can’t pay it. Shoot, now you have to pay $800 for that month’s payment but you want him gone because you have a buyer lined up. That $1,600 you had in the bank; you now have less than $500 as you spent $300 fixing things and advertising to get the new buyer coming in.
Wheeewww! You got $500 profit so far, and you got that big payday coming in the next few weeks for $116k. You probaby have a balance of about $97k for the mortgage, so that is $19k profit. 28 months later, you are finally making things happen.
2 week before closing the buyer tells you that the mortgage company says the fmv is only $106k and that prices haven’t risen that much in that area. Oh, now that just really ticks you off. You only have $500 left, nobody in the house, and the perceived $19k profit just got wiped out.
That’s it, you agree to sell at $106k since that is what the FMV is in today’s market. Yeah, the books say mark it up 10%, but are they in your market? Well at least with $106k and balance of $97k, you still get $9k and you don’t have to make any more monthly payments.
Oh wait! When you signed the P&S, you agreed to pay up to 3% of the buyer’s closing costs and kick to their buyer’s agent 3% because you were going to make $19k. That’s over $3k gone from the top just to help the buyer out and another $3k for the buyer’s agent for bringing their buyer to the table. Your $19k has dwindled down to $3k, but at least you still have equity and thus you have profit.
Uh oh! Seems like the mortgage company is backed up with all these refi’s while rates are low that the buyers need another 2 weeks to close. What are you going to do? Start over? With hesitation you agree to go 2 more weeks, but at least you finally get your $3k profit for the the aggravation over the past 29 months. You have $500 left from all the transactions over the course of the past 29 months, but the mortgage is $800 and you didn’t get the monthly spread from last month so you are out $300 for the mortgage and $200 to pay for the car payment since you have no tenant to help make that payment for you. $0 money sitting in reserves and you are out $300 to boot!
CLOSING DAY!!! YIPPPEEE!!!
You finally made it. You go to closing and you fully expect to pick up your check for $3k. What do you mean you didn’t read the fine print for real estate and taxes in your county? You didn’t know about that? Wasn’t that in the course and manuals you purchased? Well, you see, for your county there was a 2% transfer tax and you also had some incidental closing fees that was equal to about 1%. Yep, you know what is happening, that 2% and 1% = 3% and that was all you had. You sign on the dotted line and you walk away with $59.21. Somehow it just doesn’t seem fair.
But wait! You still have the car payment due in 2 weeks and no house, no tenant, and no buyer.
Don’t you wish there was some real equity in the property before you started?
Re: how important is equity? - Posted by jeff
Posted by jeff on June 13, 2002 at 18:43:14:
that all depends on your reasons for owning the property. if your just after a nice cashflow, then equity has very little bearing on that. but if you plan on resaling the place, more equity means more profit usually. if your gonna be flipping, equity is nice also, but not necessary. ni a retail flip situation you can buy a property with no equity and sale your contract to your end buyer for a couple grand and have them pay full price to the seller. this puts the end buyer a couple grand behind, but end buyers have emotional strings involved with residential purchases. if they like the house, then a couple grand will be a minor expense for their happiness for the next 30 years. there are strategies for profit in every situation, a successful investor learns how to make money with every situation. equity problems can be overcame if you know how.
oh yeah, i almost forgot. a properly structured L/O will give you about 10% in equity even if there was none to begin with. would that extra 10% bring your equiy up to where you want it to feel comfortable making 200 month while you wait for your big equity pay-off? looks to me like that other investor may have just cost you about 10K plus the cashflow while you wait. learn different strategies for investing, theres money everywhere, you just have to know where to look.
Re: There he goes again… - Posted by Donald
Posted by Donald on June 13, 2002 at 21:00:25:
Tim
Great post!
These folks buying or L/O at or above appraisal will get an education.
Donald
Re: There he goes again… - Posted by Ronald * Starr(in No CA)
Posted by Ronald * Starr(in No CA) on June 13, 2002 at 19:52:22:
Tim Fierro–(WA)---------------
I gave up reading fiction decades ago. But, I did read your post. Enjoyed it too. Looks like you have a future in writing. Maybe you could invent a new
genre, The Investing Novel.
Good Investing and Good PostingRon Starr****
This needs to be an article (Great Post)(NT) - Posted by JR
Posted by JR on June 13, 2002 at 19:31:51:
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