L/O and acceleration clause - Posted by Bert G

import · December 16, 1998, 1:10pm

Posted by Bert G on December 16, 1998 at 16:47:29:

A couple clarifications on the points you mentioned. The mortgage filed at the courthouse originated n July,'93 $96,469 at 7% for 30 years. If he’s made 65 payments, my amortization software shows an outstanding principal of $90,355. Probably just my inexperience, but I considered 4 1/2 years out of 30 to be fairly recent.
The existing mortgage does require owner occupancy. Its possible he lived there when he bought it. The deed is to “John Smith, a single man”, but he’s married now.
The property has eight 3-bedroom units, with LR,Kit & laudry at “garden level” and bedrooms upstairs. About half of the tenants are single parents w/ kids, and I suspect a couple are section 8. (Thats not a problem) The place used to be a condo, but converted a decade ago. Its in a town of about 2000, and most of the population work either in Grand Forks or on the Air Force Base. (15 - 30 miles.

import · December 16, 1998, 1:10pm

Posted by Bert G on December 16, 1998 at 14:10:55:

First, thanks to all who responded to my long-winded post of yesterday. This is a great resource, especially since there are no investor clubs in my entire state.
There’s a property in a small town near here(8-plex consisting of 2 buildings) that I’ve looked at a couple times. The owner lives 200 miles away, and his on-site manager has let the place go to pot. (I met all the tenants, and they all complained about it.)
The current owner bought the place in summer 1993, and listed it Jan of this year, after only 4 1/2 years of ownership. He has an FHA loan, well 2 actually, one for each building, and going by the courthouse records I guestimate he owes about $90k on the $96.5k loan. Being a recent FHA loan, it has a “Due On Sale” clause. (Somehow he managed to get around the owner occupant requirement)
With the current P&L (2 vacancies and the manager getting free rent) it looks like he’s losing money on the place, and by the condition of the property it looks like he’s anxious to unload it. Seems like a good prospect for a L/O. BUT, would that trigger the acceleration clause? I’m sure he wouldn’t be able to come up with $90,000 cash, and know darn well I couldn’t.
The seller’s agent is kind of sheilding him, and I can’t make any direct contact, plus I have an exclusive representation contract with a buyer’s broker.
Using scheduled rent and his '96 sched E, I come up with a NOI of just over $14,000. He’s asking $149,800, which seems a bit steep considering the condition. There’s nothing within 30 miles for comparison.

Thanks
Bert G
Grand Forks ND

import · December 18, 1998, 10:57pm

Re: L/O and acceleration clause - Posted by Reif

Posted by Reif on December 18, 1998 at 23:57:58:

I’m just a new guy, but to answer your qyestion, I think the whole point of a lease OPTION is that you DON’T own the property, until/unless you exercise the option, so therefore the ‘due on sale’ wouldn’t be applicable anyway.

The neat thing about the L/O is that you can tie it up, fix it up, increase the rents, and now show a history to a lender two-three years down the road and refinance it on your own.

And, if you work the deal right in the first place, you should be getting positive cash flow to boot, so even if you decide not to buy it, you’ve made out on it.

Reif

import · December 16, 1998, 2:30pm

Re: L/O and acceleration clause - Posted by Jimbob

Posted by Jimbob on December 16, 1998 at 15:30:28:

Bert,

I’m a little confused, you mentioned he ows $90,000 on a $96,000 loan? Also you mentioned he owned the property for 4 1/2 years but it has a relatively new loan on it?

Anyway, yes the lovely due on sale clause has surfaced again. Well typically the more recent FHA loans are assumable but it all depends on how the loan documents were written up. If the loan(s) are assumable you will have to go through a normal qualifying process to assume the loan(s). Depending on who is holding the mortgage, they may say you must live in the property or they may say you don’t have to, it depends on the loan docs and the lender.

One thing I’d like to point out about the property, if the majority of the units are one bedroom each, you will have constant turnover unless the property is located in a highly desirable rental area where there are very high rent pressures. Two bedroom units are much better as long term rentals. By the sounds of your note, it doesn’t sound like the property is in such a location.

Look at the assumable angle first, and if you run into roadblocks you might think about buying the property in a Land Trust or something similar, but that will definitely require a competent attorney to handle.

Jimbob

import · December 19, 1998, 1:59am

Re: L/O and acceleration clause - Posted by Brad Crouch

Posted by Brad Crouch on December 19, 1998 at 02:59:24:

Reif,

Whether you own the property or not is not necessarily the issue. The Garn St. Germain Act says that a lease of more than three years violates the “due on sale”.

The lender may not find out about it if the lease were longer, or the lender may not find out about an option being involved, either. But you need to understand that these things “technically” violate the “due on sale” clause, and you should be aware of the risk involved, no matter how slight. You cannot just stick your head in the sand and keep the positive thought that this will remain unknown. Always be prepared for the worst to happen, and have a plan to deal with these kinds of happenings.

Also, any length lease when coupled with an option to purchase violates the “due on sale” clause, “technically”.

It might be a better strategy to have the seller put the property into a trust, and then fill out the documents assigning the beneficial interest to you. These documents can then be held by an escrow company or loan service company with the irrevokable instructions to release the documents to you (the buyer) when the total amount agreed upon has been paid.

I would wonder about the wisdom of “fixing up” a L/O. Why not just advertise it as a “handy man’s special” and let the tenant do the work. Have him submit the receipts for materials, and credit his purchase price accordingly. You get free labor that way. Plus the cash flow begins immediately, since you don’t have to wait for repairs/upgrades to be done before sub-leasing.

As far as “increasing the rents”, I would think it would be better to take over the property empty. Unless the current tenant wanted to L/O the place. And was ready & willing to sign an agreement and put up the maximum initial option consideration. If there is already a tenant in there when you take over, you would have to honor whatever lease they had. Then if they were unwilling or unable to come up with the option consideration, you’d have to spend the time and money to evict them. Better to start out with an empty house, in my view.

Rents should be at least the going rate for that area. More if you are giving a rent credit.

You will need the deed to the property before you can refinance.

Good luck,

Brad