Posted by Ben (NJ) on December 17, 2000 at 11:17:33:
it is much appreciated
L/O from the tenant/buyer’s perspective… - Posted by Ben (NJ)
Posted by Ben (NJ) on December 16, 2000 at 17:01:34:
I never really pay attention to the L/O posts because it has no bearing on what I do but my brother is considering
renting a house. The rent is quite high ($2300 per month).
He also would like to buy the house at some future time. How is an l/o structured? Isn’t a portion of the rent applied to the purchase price? How is the purchase price determined? What if the value of the house is less a year from now than it is now? Since the rent is high should we suggest a portion of it be applied to the purchase price or is the owner going to be looking for even more money? Thanks
for the help.
Re: L/O from the tenant/buyer’s perspective… - Posted by JPiper
Posted by JPiper on December 17, 2000 at 09:23:08:
If I were going to advise my brother, here?s a few areas for consideration:
The primary areas of negotiation are price of the house, monthly rent, monthly rent credit, upfront money, time period for the option, and repairs.
Price of the house: Obviously you know all about looking at comps. This transaction is no different. In fact, from the buyer?s perspective one of the mistakes typically made is to overlook the fact that when the option is exercised the house will need to be appraised. Therefore, price needs to be set with that reality in mind. The Seller may be tempted to want to price the house at something over market. But understand that if you permit this, then you?re counting on appreciation to take place over the course of the option. If it doesn?t take place, your brother will have trouble financing and will lose his deal.
Monthly rent: This is another area to negotiate. Look around the area at the rental comps. Sellers often want to price this as if they were calculating a mortgage payment. However, at these higher levels rents are often lower than equivalent mortgage payments.
Monthly rent credit: There are two different considerations here. A rent credit can be applied to the purchase price. It can also be used as down payment money?.but ONLY at the discretion of the lender. Lenders set down payment requirements based on the particular loan and borrower in question. But one certainty that you will face is that they will ONLY apply rent credits to down payment to the extent that the rent EXCEEDS fair rental value. In other words, if the fair rental value is $1700?and your brother is paying $2100 the lender would apply $400 if you had negotiated that into the contract. If you had negotiated a rent credit higher than this $400, it could be used to lower the purchase price, but the lender would not count it toward the down payment.
Upfront Money: You could put up option consideration which would be applied toward the purchase and could be used as part of the downpayment if carefully documented. Most sellers would want the option consideration to be non-refundable. Obviously here the problem is that if your brother doesn?t go through with the deal, or CANNOT go through with the deal because of financing, the money is lost. What I would suggest instead is that you put up a larger security deposit?which of course would be refundable. If the size of the security deposit EXCEEDS that permitted by state law, then this is more of a concern for the landlord than for your brother. At exercise, this money could still be applied toward the purchase or downpayment?so it could end up functioning the same as option consideration?the difference being that it?s refundable.
Time period for the option: The longer here the better for your brother. A lot of sellers want to do a one-year deal. But from your brother?s perspective if he?s not ready to finance, then he needs time. Time also gives rent credits time to build up, appreciation to take place hopefully, etc. You might want to negotiate a 2 or 3 year period, with the right to renew for another period. A justification that might be given is that there is no guarantee what lending programs might be available at the end of the option, or what the value of the property might be so it could be financed?.both true. So if this guy truly wants to sell this is simply putting some flexibility into place ?just in case? the worst happens. You can always exercise earlier if you want to.
Repairs: One of the selling points for a lease option is that you will take care of maintenance. However, in the contract you want to put a dollar cap on this. Obviously the higher the dollar cap the more attractive it is to the seller. What I would be most interested in here if I were your brother is inserting an annual cap that would keep me out of the expensive repairs like roof, furnace/AC, etc. You might try negotiating a ?credit? against the purchase price for all repairs made if a receipt is provided.
Other considerations:
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You will note that the negotiations regarding any of the above items can dovetail with others. For example, you could pay more for the monthly rent, but take it away in a monthly credit toward the purchase. You could pay more for the house, but take it away by rent credit over time.
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One of the problems with a lease/option is that it doesn?t involve a deed?.a fact that could lead to complications later on. For example, what happens if this guy doesn?t make his mortgage payments? What happens if he?s in a car wreck, incurs a large judgment, and then can?t transfer the deed? What happens if he files bankruptcy? For this reason I would suggest recording a performance mortgage against the property (probably available at Bronchick?s website). This functions like a second mortgage in that it gives you a recorded interest in the property, securing the agreement instead of a note. This mortgage would give you the right to foreclose if the seller incurred a judgment as an example and couldn?t convey title. If the seller later down the road decided he didn?t want to transfer the deed because for example, the property has now appreciated?.you could foreclose. Further, the seller can?t overencumber the property, or sell it twice, etc. Now the seller may balk at this?.and if he does you could agree to enter into a release (or whatever it may be called in your state), a document that could be held by a 3rd party to be recorded if your brother doesn?t exercise. You could also agree to subordinate your mortgage to a new first, as long as the total indebtedness doesn?t exceed the exercise price. If you are unsuccessful at recording this document, I would at a minimum want to record the option. Further understand that BEFORE you record any document you want to run a title search?.make sure for example that when you record this performance mortgage, that it is actually in second position.
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Have the payments collected by a 3rd party, who will then pay the underlying mortgage(s). This serves two purposes?.one is that you KNOW that the underlying loans are being paid from your funds. But further, it provides a documented record from a 3rd party of timely payments?which may be of interest to a future lender. I would also instruct your brother to keep careful documentation of all upfront money and rental payments or other expenditures (keep cancelled checks and any invoices).
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Financing. Down the road when your brother decides to exercise he obviously may need financing. Understand that what exists today, may not exist tomorrow. Further, the loan process will entail ALL of the standard requirements that any loan would entail. Rent credits can be used as down payment to the extent that the rent is higher than fair market rent. When you enter into the deal look at the end price and how much money for down payment is there. Will this meet the down payment requirement that your brother will have in a loan program that he will qualify for? For example, if the seller prices the house 10% above fair market value, gives rent credit that give back this 10%, and your brother would only qualify for 90% financing, he will need 10% down PLUS closing costs. Check this out carefully. And again, remember that loan programs and requirements change.
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Finally your contract is going to be important. I?d take a look at some of Bronchick?s forms available on his website for ideas. One of the contracts is designed in the buyer?s favor, and creates the possibility of an equitable interest in the property.
Hey Ben, if you want more than this?.go buy a course! Bronchick has a good one I hear. Understand that are no rules?.it?s all negotiable.
JPiper
Re: L/O from the tenant/buyer’s perspective… - Posted by Brian Mac
Posted by Brian Mac on December 16, 2000 at 18:21:09:
Ben,
In that bracket of a monthly payment, I’m sure your brother would be able to benefit from the potential interest deductions from his income. Your brother should consider using a PACTrust or come up with some similar version of it on your own. If you find a landlord willing to do a lease option, you can accomplish the same financial arrangement, but also shelter title when you make the arrangements within a land trust. By having the seller/landlord grant title to a land trust in his name, and your brother becoming an additional beneficiary of the trust via assignment, and then leasing the property from the trust, he would be eligible to take the deductions associated with the property. Go to:
cal-equity.com or landtrust.net
Happy Holidays
Brian Mac