Disturbing Realization

[CC Rider - MI 0]

[ To Mike C - thanks for your previous response. I hope this one doesn't come across as someone with a negative attitude, rather someone looking for answers. ]

 

As I continue gaining as much background knowledge as I can before I begin a Lease Purchasing business I’ve been a little bothered by the assertion that we create win-win situations for all parties. Unless you can show me otherwise, I believe the traditional sandwich leasing approach is really a win-win-lose situation; the loser being the seller. Here’s why:

 

Pretend Seller has a house FMV of $100,000. As a motivated seller you convince him to accept an option to buy for $95,000 good for 3 years. You agree to pay him $650/mo to cover the “ITI” of his PITI, thus his monthly cashflow is zero. Of course you get 100% rent credit for any option consideration you pay up front, and for rents paid.

You find a willing T/B to sign a LO to purchase for $105,000 and $800/mo, with 50% rent credit, along with full credit for the option consideration he pays you.

There’s no arguing what happens if the purchase doesn’t happen. You and Seller are the winners. The T/B loses, but everyone knows this up front, and everyone is satisfied with the arrangement.

Who wins if the sale is executed in three years?

At the end of 3 years you receive your spread of $10,000 plus the net difference of the “non-credits” paid to you: 36*400 = $14,400, for a grand total of $24,400. You win.

At the end of 3 years your buyer has paid out a total of $28,800 (plus option), to build a down payment of $14,400 (plus option) to go towards the purchase price of $105,000, for a home that may have appreciated beyond than that. Buyer wins as he needs financing for only 90,600 (minus option).

Who loses (big time)? Seller received some option money up front (but must credit it towards your purchase), and has received $650/mo for 36 months ($23,400, but it is also credited toward your purchase), leaving him with $71,600 (minus option) to be received at closing. His total received over 3 years totals exactly $95,000, but during those three years he had to pay three years of interest, taxes, and insurance. This money is not recaptured. He paid out $650/mo in interest, taxes, and insurance to keep the property going. No matter how you look at it, the sellers net is $71,600, for a house he had wanted to unload 3 years ago for $100,000, has probably since appreciated, and was already taking a hit by selling for $95,000.

Do you think this individual is going to be praising your name and sending you references? You screwed him royally.

 

Now, there are ways to lessen the blow, and perhaps this is addressed in your or other LP professionals’ packages. The biggest negative for the seller is giving you 100% rent credit for your purchase. If the situation were 0%, you have made an honest deal for the seller. Even at $650/mo zero credit, he is just breaking even holding onto the house, but at least he gets his full $95,000 for it, even if deferred for 3 years. But this leaves you with a rapidly vanishing bottom line. Every month that passes, your spread is shrinking by $250 (650 non-credit out, 400 non-credit in). If T/B waits 36 months to purchase, your profit on the deal shrinks to 10,000 – 36*250 = $1000.

You could also offer little to no rent credit for your T/B, but this won’t exactly get them beating down your door, and there goes your extra “on-time payment incentive”.

Perhaps your contracts stipulate the T/B taking the burden of the taxes and home insurance. This evens the playing field somewhat (owner still falls behind by the sum of interest over 3 years), but makes it a harder sell to the T/B: monthly rent AND taxes AND insurance AND utilities AND maintain the place AND save up for a downpayment. Some would argue this is priming them for homeownership – but their monthly is likely higher than their future mortgage would be.

Competitor’s products imply the usage of a special type of living trust the seller places his home into and thus allows T/B to assume all mortgage, tax, insurance liability (and tax benefit) even though they do not yet own the home. Does your system utilize this approach? I’m not sure where an investor would fit in aside from perhaps as a consultant to set up the deal.

 

Anyway, if you or anyone can shed some light on this, it would be greatly appreciated. I would like to go into this business, but only if I know for sure I can truly help all parties involved and not knowingly take advantage of someone who doesn’t see through the numbers.

 

CC Rider

[MichaelC 160]

CC, terrific and thoughtful post! In fact, I like your question so much that you have just won a free copy of The Naked Investor! Congratulations, CC. PM me with your name and mailing address and I'll get it on its way.

Now, as much as I appreciate your post, there is a flaw in your reasoning, which explains why you are seeing the homeowner almost as being a victim in these deals. Let me explain.....

Pretend Seller has a house FMV of $100,000. As a motivated seller you convince him to accept an option to buy for $95,000 good for 3 years. You agree to pay him $650/mo to cover the “ITI” of his PITI, thus his monthly cashflow is zero. Of course you get 100% rent credit for any option consideration you pay up front, and for rents paid.

Where did you read that the homeowner is giving you, me, the investor in the deal, 100% rent credit? In all my years I have never received 100% rent credit from any homeowner. (I've given that alot, but I have never received it. When you receive my manual you are going to read my approach to this issue, and why I do it this way.)

My usual deal involves me locking in the best price I can negotiate with the homeowner for the length of the lease. No rent credits received, and usually no option consideration paid by me, either. I also agree to pay all closing costs and since I am not a Realtor the seller pays no commissions. Thus, my price is a true net price to the seller. Not a bad deal for either party, in my opinion.

If the seller was using a Realtor and was able to sell at that same $95K, he would net about $87K after commissions, fees, and closing costs. Not to mention the monthly payments he would be making while the house sits on the market. With us, he waits two years to net an additional $8K or so, while also retaining the tax benefits of homeownership during that time.

I assume the seller feels the same way or they wouldn't agree to the deal. We are providing a solution for the homeowner: debt relief. This is the number one reason most sellers will work with you. They need that monthly payment covered. In exchange for my providing this help I am receiving something in exchange: control of the property with terms that work for me, too. Little or nothing down to take this control, and for a period of, usually, two or three years. The seller understands all this, accepts it, and views it as a good deal, also.

Appreciation over that two or three year agreement? Possibly. But the market can also remain flat or even tumble. Interest rates can go up and slow the market. That's the great unknown in these deals, and I don't worry about what I can't control. The terms are negotiated on what is fair today. The seller is well aware that his property might be worth 30% more in three years. But, if he really felt that way he would hold it himself, lease it, and deal with the tenant and toilet problems personally. But he doesn't want any part of that. So, again, I am providing a solution to his needs, and in exchange have put together a deal that works for both of us.

As I see things.........