My first good potential deal 50k equity - Posted by Chris

import · August 25, 2002, 10:29pm

Posted by Ronald * Starr(in No CA) on August 27, 2002 at 16:54:48:

JS–(IN)---------------

Different people have different opinions. I would never claim that property ownership is a sail in the park in a canoe. However, long-term holding of property makes sense to me. If you think that the lease-option approach is better, you can do it.

However, note that when you resell quickly you are considered a real estate dealer. You get no tax benefits of investment property ownership. I know that people think they can lease option the property and thus make it look like an investment property. But we know that is not true. The intent was not there. The intent was to resell the property quickly.

The IRS can recharactize a lease-option as a contract for deed. That means that the taxes must be paid as of the “sale date.” Which would be the time of the lease-option being signed, I would say. If you did it once or twice, you might well have the IRS miss the situation. If you do it many times? I think there is a big risk there of the recharacterization happening to you. Then there is tax to pay, penalties, interest. Would there be a possibility of prosecution for tax evasion? I can’t judge that.

I hope that your attorney and accountant have given you good advise about these issues.

What will you do if it happens to you and you have to come up with huge chucks of change to pay off the IRS? I know, as a rental property owner, that I don’t have to worry about this. I think you, if you do lease-options, should be considering it.

The lease-option approach has exploded in popularity over the past decade or so. It seems to me that when something like this happens, the IRS will eventually alert to it. When they do, what will they do? My guess is that they will do some searching through the tax returns, looking for signs of lease-optioning deals. Then start going after people.

Will this certainly happen? I don’t know. But do you know that it will not certainly happen? Or are you planning to report all your lease options as sales and so avoid the potential of having the IRS unhappy with you?

Good InvestingRon Starr*

import · August 25, 2002, 10:29pm

My first good potential deal 50k equity - Posted by Chris

Posted by Chris on August 25, 2002 at 22:29:32:

Hi,
I read this site all the time but I have never posted anything here. After posting at some other boards with little helpful response, I want to see if you guys can help.
I talked to a lady the other day who was looking for a tenant to replace the one she had just gotten rid of. After hearing all of the problems she had with the last tenant, I popped the question “why not sell the house, have you thought about that?”. She paused, and said, “YEAH at this point I WILL SELL.”.
She had to go quickly but I got her number and so forth and set up a meeting time to see the house. I drove by the house that afternoon to scope it out first, and it looked good from the outside.
The house: Outside the grass is dead, the kitchen needs new floor covering, some windows have the runners bent, some sheet rock needs to be patched and painted and a new piece of moulding in the laundry room. The garage isnt painted on the inside (not a big deal, I think most around here arent anyway). She said that I can have the washer and the refirgerator. Outside paint looks good. The house recently appraised for 110k and 104k The 110 was by a realtors appraiser I think.
So I look at the house and it needs some cosmetic work. Im estimating damages at most 3k and thats labor and the yard and all. Maybe I should bump that up a couple thousand since Im new at this. I use to remodel houses so Im fairly confident on my 3k price.
The price range for this house is median for this area. It is a good area of town, I would live there.
So while Im walking around and looking, the seller wont shut up about all of her problems. Stuff I dont even want to know!!! She is moving out of state soon. As far as I can tell…Im still new, but she seems motivated. I actually pitched her a lease/option and she was totally up for it. We havent come to a sales price, and here is why. She owes 35k on the property! Even with the work that has to be done to the house, it should still sell for 90-95k easy, I think!! 55-60k in equity even with repairs!!
We havent settled on a price so i was thinking of getting it L/O for 90k, have the agreement be contingent on her fixing the needed repairs. Then selling it L/O for 105k. I believe this is something she would go for but maybe my numbers are too tight to make it profit for me.
I was also thinking to offer her all cash for 65k, seeing as the property is still worth about 95k I might be able to get a hard money lender to give me 65k and then I can sell it to a rehabber or other investor for 80k…
I understand most of the mechanics with an L/O but the wholesale thing… Im not fluent with… I thought maybe you guys could help me with these #s and go from there.
Also her mortgage payment is 530 a month, Market rents in the area are 700-750. The mortgage intrest rate is 9%. Would it be a good idea if I told her to refinance, put money in escrow for the damages, let me draw the money out for repairs as they are done, and then let me buy for mortgage balance at the time of close… Im not sure how lenders refi, but dont they only lend a percentage of the propertie is worth, or does it depend on the lender.

All I know is that Im ready to make a big deal happen and jumpstart my investing!!! I hope I can stand to make 10-15k off of this deal, should I LOOK FOR ANOTHER DEAL, or does this sound good to you guys…

Thanks,
Chris

import · August 25, 2002, 11:16pm

Re: My first good potential deal 50k equity - Posted by Ronald * Starr(in No CA)

Posted by Ronald * Starr(in No CA) on August 25, 2002 at 23:16:33:

Chris---------

" I hope I can stand to make 10-15k off of this deal, should I LOOK FOR ANOTHER DEAL, or does this sound good to you guys… "

What deal? You don’t have a deal yet. You only have the preliminaries, talking with the owner. It sounds like this could be a deal, and it is not listed in the multiple listing service. WHY DON’T YOU HAVE A PRICE YET?

Don’t make an offer. Talk to her about what she is interested in doing and from that come together on a price. If you offer $90K she might have been willing to sell for $5K or $10K less. Work with her, talk about the (uninteresting to you) woes she has experienced. It is her feelings of misery that drives the price down. You offer her relief.

Decide, based on what price you can agree on what your strategy will be.

Buy and hold as a long-term rental. You might well want to get a new loan yourself, since the 9% one is not very good.
Buy and resell immediately to an end-user. Probably an owner occupant, since they pay the highest, but possibly an investor.
Buy and resell on lease/option. In my opinion the other two approaches are better. If you do this, you probably should be selling for about $125K, given the figures you have provided.

Good InvestingRon Starr********

import · August 26, 2002, 3:28pm

Re: My first good potential deal 50k equity - Posted by js-Indianapolis

Posted by js-Indianapolis on August 26, 2002 at 15:28:25:

I’m new to REI, and have been reading these boards to gain knowledge. My first thought was the l/o. This is your last. As you know a little (wink, wink) more than me, can you tell me why you think this is the last option? I figured you could get about $5000 down, now, and get the highest price, and get a little rental income for a couple years, why not? What am I missing here?

import · August 26, 2002, 10:24pm

Re: My first good potential deal 50k equity - Posted by Ronald * Starr(in No CA)

Posted by Ronald * Starr(in No CA) on August 26, 2002 at 22:24:43:

J S–(IN)----------------

There are two investment approaches that make sense to me: long term rental holding and quick resale. Anything else is less likely to do well for you. I understand the appeal of buying in a market downturn and then reselling when the market is up. But, that is a mug’s game, in my opinion. It is very difficult to time real estate markets. You usually don’t know when you are at a bottom until the market is picking up again and you don’t know you are at a top until you are already on the downside.

If you planning to resell through a lease-option, you hope and ar counting on property values going up in the near future so that (a) the value will allow your leasee-optionee to get a loan on the new, higher value of the property (b) the higher value is attractive to your leasee-optionee so the leasee-optionee will actually exercise the option and take you out of your position, with a profit plopping into your paws.

What if market prices plummet in the next year and a half? Your leasee-optionee may not be able to refinance you out of your position or may not want to do so. So moves out on you. No rent coming in. You are obligated to pay on the mortgage. You find that, because property values have been going down, and there is no end in sight of them going down more, nobody wants to option the property at a price which will make you a profit you want. So, you are now stuck. Either you resell at no profit or at a loss, or you switch over to doing a straight rental.

Switching to a straight rental is ok. But you don’t get the resell profit you were counting on. You might just as well have moved it to a rental from the get-go.

If you could sell it now for a profit, you are in a good position, you do not have to gamble on the direction of the real estate market during the next couple of years.

So, the lease-option technique is riskier than a direct sale of the property–take your profit and run.

When the real estate market is relently up, the lease-option technique is golden. When the market is not going up? We don’t really know, I think.

I have asked on one post for people’s experiences that do the lease-option technique when the last downturn in property values occured in their investment area. Nobody responded. I think that may be because almost nobody was doing the technique 10 years ago. So what happens when the market does go down? My best guess is that trying to use the lease option to get out of property will be almost impossible.

So my advice: leave the lease-option technique for properties that have no equity, so it is the only thing that will make a profit with a property. You indicate that this property has some profit. So, for this property sell as soon as you can and take your profit. Or else settle in with a long term rental holding property.

Good InvestingRon Starr**

import · August 27, 2002, 3:48pm

Re: My first good potential deal 50k equity - Posted by js-Indianapolis

Posted by js-Indianapolis on August 27, 2002 at 15:48:15:

Very good explanation indeed. I, too have been seeing a market explosion in my are for most of my life. I’m only 27, and remember when most of the strip malls and neighborhoods around me were fields we used to run in at the age of 10. Seems it just won’t stop. Although I figure it could, sometime.

As I said, very good points. I have been a sponge for the last 72 hours, since I decided to do this full time. Soaking up any new material I can get. I do have one question about your response though.

You said, “Switching to a straight rental is ok. But you don’t get the resell profit you were counting on. You might just as well have moved it to a rental from the get-go.”

I say renting, for me, in the beginning, is my last option. The reason is vacancies. Let’s say I find a place that rents for $1000/mo. I’m paying PITI of $800/mo. That’s about an average deal in my area, among rentals. At $200/mo positive cash flow, one month of me having to cover the PITI takes four months worth of profits down the drain. That is $800/$200. Four months, just if I have to go in and clean, run an ad, and release? Not worth it.

That’s why I say do a l/o, before renting. I get $$ upfront to cover things like people moving out, a tenant who has a buyer’s mindset, and won’t wreck the place as quickly, a longer lease (probably), and the ability to collect another option fee if one person flakes.

And if all that fails, then I can become a landlord, and listen to tenants reasons for not paying rent, all the joys of that experience. Am I missing something? Does it sound like I’m getting it, and we just differ on opinions, or have I missed a day here?