The Basics of Buying and Selling with Lease Options

The Basics of Buying and Selling with Lease Options

For Realtors®
© 2009 by Wendy Patton

Real estate markets across the  world are suffering right now. Sellers can't sell their homes and buyers can't get mortgages. As real estate agents it's a lot harder to earn a living now. Gone are the days of listing a home and expecting it to sell – it is time to get creative to not just survive but actually thrive in this economy.

What is a Lease Option?      
Lease options are a way to buy and sell homes without an immediate conventional mortgage.  It gives your buyers who can't qualify for a mortgage right now the opportunity to get into a home right away while they improve their credit and build up a down payment while living in the home.  It gives your sellers the ability to beat their competition, which we know in these kinds of markets competition is great.  Sellers can reach a far greater pool of potential buyers.  They will likely be able to sell their home quicker and for a better price. For some sellers it may be the ONLY way they can sell their home in this real estate market.

How Does a Lease Option Work?
A lease option works like this:  The buyer and seller agree to an option which gives the buyer the right to purchase the home during a set period of time.  During this option period the buyer leases the home from the seller.  By the end of the option the buyer must either purchase the home or forfeit their option fee.  While the option is valid the seller may not sell their home to anyone else.

Advantages for the Seller
Here are some of the advantages to your home sellers when selling on a lease option:

1. Allows them to beat their competition.  How many listings have you lost because the home sat on the market and never sold?
2. The seller can collect rent on their home while it would otherwise sit vacant.
3. They can often receive a higher purchase price.
4. They can sell their home in a down market when they otherwise might not have been able to sell at all.
5. Allows the seller to actually sell their home instead of just renting it.  Have you lost any full commissions because the home was just rented instead of sold?

Advantages for the Buyer
Here are some of the advantages to your buyers when buying on a lease option:

1. The buyer can get into a home now, even if they can't currently qualify for a mortgage.  How many potential buyers have you turned away because they couldn't qualify for a mortgage?  No longer!
2. They can improve their credit and build up a down payment while they are already living in their future home.
3. They are not obligated to purchase the home at the end of the option if they decide the home is not for them, that homeownership is not for them or if the real estate market changes significantly.

Advantages for You – the Realtor®
Now as real estate agents we understand how lease options can help our buyers and sellers we need to take a look at how lease options work to our benefit as well (in a nutshell—how do we get paid!). As much as we like to help our buyers and sellers we still need to get paid for our work.

Not only can you still get paid, you can actually get paid more!  I'll get into that in just a minute. But first, let's look at how you get paid. When the seller and buyer agree to a lease option the buyer will pay an option fee. This reserves the right for the buyer to purchase the home at a later date for an agreed upon price. The option fee is paid to the seller, however, when you represent a buyer or seller in a lease option transaction you would have them sign additional addendums for the lease option, part of which state you will be paid part of your commission upfront out of the option fee.  I typically get 2% of the sales price upfront, split between the buyer and seller agents.  The remainder of the commission is paid when the buyer purchases the home at the end of the option period. This creates revenue for you in the beginning as well as at the end.

While this isn't as ideal as receiving all of your commission upfront the way you would in a conventional sale it's a whole lot better than:
1. Turning away a potential buyer that can't qualify for a mortgage;
2. Having your seller just rent their home out because they can't sell it;
3. Losing a listing because the seller blames you for their home not selling.

Additionally, as a listing agent you are providing a premium level of service for your sellers.  Very few agents know how to do this and this will put you head and shoulders above the pack.  It is not unreasonable, therefore, to ask for additional commission as part of this premium service offering.  If you would normally list for 6% commission, when you agree to list the home as a lease option you may want to ask the sellers for 7% commission if it sells as a lease option.

Getting paid extra sure is nice when you would otherwise have lost the listing.

If you want to stay in this business this is the time to get creative. Ask yourself—do you want to be in the business for 5 months or 5 years? Conventional methods are nice when they work, but you need alternative "tools" too.  Adapt to the demands of the market and you'll not only survive, you'll thrive.

The Top 10 Objections Sellers have to “Subject To”

The Top 10 Objections Sellers have to “Subject To”

How to Overcome them and get the Deal!

©2009 by Wendy Patton

Before I start with the list of Subject To objections and how to overcome them, let me say that I understand most people get nervous about dealing with objections from the sellers. They worry that if they don’t have the right answer they will lose the deal. Here’s the thing with seller objections, if a seller is raising objections and asking questions it means they are seriously thinking about giving you their home Subject To.

Over time you will learn to LOVE to hear objections from the sellers because it means you are close to making the deal happen! You just need to give them a little more reassurance to get the deal done.

If a seller makes too many objections they aren’t really motivated and they probably won’t give you their home Subject To. On the flip side, if a seller doesn’t raise any objections, it means they aren’t really interested and you aren’t going to get the deal either.

The other great thing about handling Subject To objections is that after you have handled one successfully it becomes that much easier to handle it the next time. Each time a new objection comes up, it’s a learning curve. As you get more and more experienced your learning curve comes down so you’ll be able to get more deals done. So what if you blow it once? You WILL do better the next time around, and trust me, there are PLENTY of DEALS out there. If you don’t get this one, you’ll get another. Real estate investing is not a sprint race to the finish line to just get one deal, it’s more like a marathon where you will continuously do deals over time.

With that said, let’s take a look at the most frequent Subject To objections you’ll likely encounter.

#10 Can my attorney review the contracts?

“Absolutely! I recommend it.”

Most of the time they won’t do this anyway. But by giving them that reassurance it shows you have nothing to hide.

#9 What happens if you die?

“The contract has provisions that if either, I or you the seller die, it is still binding and our heirs would continue our contract.”

#8 How long will it take for you to get a new mortgage?

“What I can tell you is that I will work as quickly as possible to do this. As soon as you sign this contract I will go to work on finding a qualified tenant buyer for your home. Tenant buyers usually need about 1 year to get their credit back in shape to qualify for a mortgage. However, sometimes tenant buyers don’t exercise their option to buy so we would need to get another one, which could mean it would take longer.”

Sometimes the seller will want a “Not More Than” date, where no matter what happens you agree to refinance their Subject To property no later than that time. For example, you may find an option buyer who closes on the property before this date but if it doesn’t work out after a certain length of time, say 5 years, then you agree to refinance the mortgage to get the mortgage out of the seller’s name.

#7 Is this legal?

“Yes, there is no law against this at all.”

If you need to explain anything further on the “Due on Sale Clause”:

“On your mortgage there is probably a Due on Sale clause, which gives the bank the right to call the loan due if you transfer ownership. As long as the payments are being made the bank almost NEVER cares that the title has changed hands.”

This is especially true during a time when foreclosure rates are very high in the country, as they are now. Banks are less likely to want to exercise the “Due on Sale” clause because it increases the chance of them having to foreclose.

#6 I’m thinking about just listing it with a Realtor™

“That is certainly your option. Let’s take a look at why I’m here today though. You want to SELL your house, not just put it on the market. Based on the comparable sales that I’ve brought you it takes X number of months to sell a home in this area. That means you’ll have to pay an additional Y in total mortgage payments in that time. Plus you’ll have to pay a 6 to 7% Realtor™ commission, transfer fees, and closing costs when it sells. This is not to mention any repairs that need to be done to bring the house up to the same standards as the homes that are selling here. Those will cost you time and money as well. If you add all of that up, plus all of the inconvenience of the months of showing your home, having to constantly keep it clean and presentable and having strangers going through your house, is it really going to be a better deal for you to list the house? It wouldn’t be to me.”

This objection is a stalling tactic. Sometimes they want to talk more before they make a decision to give you their home Subject To. Sometimes they are testing you to see how eager you are. If you are over-eager to get the deed, they will sense it and suspect you aren’t being completely honest with them. If they do decide to list it with an agent make sure they put your name down as an exclusion on the listing. This means that if they end up accepting your Subject To offer down the road, no commission would be paid to the listing agent.

#5 I have to get my asking price or I’m not selling

“I understand that you feel your home is worth $X, but let me show you what is happening right here in your neighborhood. This house at 123 Main Street is 1,480 square feet with a pool and it sold for $X. All the homes on this list are within a few blocks of your house. Remember, these prices are what houses have sold for, not what someone is trying to get for their home. I know you may have seen houses for sale in your area with certain asking prices, but we need to look at the actual sale prices. Based on these comparables we can see that your house is worth $X. I could be generous and pay you the price you want, but in order for it to make sense for me, I must get the following terms.”

Sellers commonly fix the price of their home in mind based on the asking price of neighbors homes, which in a hot market, can be to your advantage if homes are selling for more than asking price and appreciating rapidly. However, in soft markets it’s quite common for homes to sell well below the asking price. You need to help them adjust their thinking and realize that their home isn’t worth asking prices, it’s worth sale prices.

Remind the seller of the risk you are taking in assuming responsibility for their house when you take it Subject To, making payments and waiting to make your profit at some future time. Make sure that even with the terms the deal would still work for you. Just because someone is willing to sign the deed to their house Subject To doesn’t mean you should accept it! If you can’t find a way to make a fair profit on that house walk away.

To find out more on evaluating and determining the profitability of a home, read Chapter 5 of my book “Investing in Real Estate with Lease Options and Subject Tos”

#4 I don’t want tenants in my home

I understand completely. Lots of tenants are not very respectful of the homes they rent. But the people that will be staying in your home aren’t tenants. They are home buyers. They don’t have the tenant mentality. They will look at the house as their own and want to take care of it and keep it nice.”

#3 What if you don’t make my mortgage payments?

“I understand your concern. What would make you more reassured and yet protect us both?”

Or

“I understand your concern. I could make your payments to the mortgage company and then mail the receipt to you. This way I am protected and so are you. Would this work for you?”

Work out a solution with them. This is a valid concern but accommodations can easily be reached. I don’t recommend you sending the payment to them for them to make to the bank. This leaves you very vulnerable. Make sure a bank authorization is signed as part of the Subject To paperwork, allowing you to verify that payments are being made. Also include a signed agreement that says if they don’t pay on time you have the right to switch your payments from the seller directly to the bank.

#2 This isn’t enough money!

A great way to handle this is to first get a full understanding of the question. Ask them what they mean or repeat, “this isn’t enough money?” and don’t say anything else until they answer. Next, sit down with them and do a cost analysis together. Get out a sheet of paper and give them the calculator. Hand them the comps and ask what the average sales price of the house is. They will calculate it and give you the figure. Then ask them what commission a Realtor™ gets in their area. Deduct the commission. Next, ask them what repairs need to be done to the house to bring the property up to current market standards and deduct those costs. Ask them to calculate the average time to sell a house based on the comparable sales and total the mortgage payments for that time. Deduct all of the closing costs. Encourage them to put down anything else that will reduce the value and help them be more realistic also – for instance, what is their time worth? As they do this themselves on the calculator it becomes hard for them to argue about the value of their home and the price you are offering them. You are now working together as partners, not adversaries.

#1 Why should I give you the deed when the mortgage stays in my name?

“That’s a good question. What I can tell you is that different people do it for different reasons. The bank will not let me assume the mortgage on your house. In order for me to make a fair return on this deal I can offer you $X right now. I’ll be glad to buy the house immediately for that price, but how would you cover the difference between what I can pay and what you owe? You are actually being very savvy and getting top dollar for your house by letting me take over your payments. This saves you on the costs that would occur if you sold the house normally, like commissions, closing costs, repairs and so on. The minute you okay this paperwork I will be doing everything possible to sell this house as quickly as I can, using my expertise. I’ve spent thousands of dollars on training to do this business, legally and morally. It would be futile for me to let your home go back to the bank just because I didn’t make the payments.”

This objection is both legitimate and important. Put yourself in their shoes, wouldn’t you be asking it too if someone asked you to give them your home Subject To? It comes in as #1 because it is going to be the most frequently asked and sometimes the hardest to overcome. Does that mean you should fear it? Not at all. Different people will sign the deed over to their house Subject To for different reasons. As you build rapport with the seller their reason will become more apparent and you can tailor your answer to best fit them. Remember if they are motivated sellers and you have built a relationship with them, they will trust you and be willing to sign over their house Subject To to get out of it. You are doing them a service and this happens regularly. If they understand that their options are limited and that you are genuinely trying to help them the idea of signing over their home Subject To won’t seem so outlandish. What you’ll find is that through building rapport and gaining their trust this objection will be much less strenuous. If they are not truly motivated sellers, and are just tire-kickers, this will likely be a very strenuous objection and they aren’t even considering signing over their home. Don’t even worry about those sellers, they might become more motivated over time, but right now a Subject To isn’t right for them.

Lease Purchase Investing

Lease Purchase Investing

© 2009 by Wendy Patton

Lease Purchase investing can be a very lucrative method to invest in real estate, however, it should be used with caution. There are only a few instances where a lease purchase should be used over a lease option.

A Lease Purchase is a guaranteed purchase of a piece of real estate sometime during or at the end of a set lease period.

A Lease Option is the right to purchase real estate sometime during or at the end of a set lease period. There are times when both should be or could be used to invest in real estate.

Here are a few examples of when you may prefer a Lease Purchase instead of a Lease Option:

1.  
   1.  
      1. The market is appreciating rapidly.
      2. The deal structured is a great investment – no matter what happens in the market.
      3. The property has a buyer that is solid and lined up.
      4. As a final negotiation technique on a solid investment.

Let’s break these down further and evaluate them each in more detail.

The market is appreciating rapidly:

When a market is appreciating rapidly, then a lease purchase can be a good choice. After 12 months of payments (with proof of cancelled checks) an investor can use a “lease option refinance” on the home. This enables the investor to buy the property and close on it with their own mortgage based on the appraisal and not the purchase price. This program is available all over the country. For instance if the investor secured the home on a lease purchase for $200,000 and the home now appraises for $275,000, the investor would be able to show $75,000 equity in the home, assuming they had 12 months of payments to the seller. This is over 20% down, therefore no private mortgage insurance (PMI) will be necessary on the purchase of the home either. Normally I would not suggest a lease purchase or lease option with a short time frame with the seller, unless it was a very good deal. I would normally recommend 3-5 years at a minimum, however, in a stronger market sellers may not be willing to go that long term.

Contact www.CatalinaCapitalMortgage.com if you are looking for a lender who can structure this.

The deal structured is a great investment – no matter what happens in the market:

When you structure a lease purchase that is so good it doesn’t matter if the market depreciates a small amount, then you know you have found a good investment. For instance: a seller is willing to lease purchase their home to you at a price of $200,000 and the day you lease purchased the home it was worth $250,000. The seller might have also given you a long time period, low monthly payments, or option credits from each month’s rental payments. Any of these things can create a very strong profit margin for the investor. When a lease purchase deal is structured very strong for an investor, then it is okay to guarantee a purchase.

The property has a buyer that is solid and lined up:

If you already know who will be purchasing the home from you and you know they are solid, then you can consider a lease purchase. Just make sure that your buyer is really solid on the home and is qualified to purchase. Using lease purchases with end buyers can be risky, as the only recourse is to sue for specific performance. If the buyer can’t get a mortgage or doesn’t have money before the end of their time frame, then what will you win in court anyway? You can’t squeeze blood from a turnip, so what will you do even if you win? You will only be throwing away good money after bad. Consider this when you feel you have a solid buyer. How solid are they? Can they get a mortgage? How sure are you on this? For instance, I am a good candidate on a lease purchase. A seller would be able to get me to perform. I can qualify, I do have the means, but not everyone can or will. Make sure the investment is good enough if they don’t or that you will be willing to close if your buyer does not.

As a final negotiation technique on a solid investment:

There are times when you might be negotiating with a seller for a lease with an option to buy and the seller is concerned that you will not perform or purchase the home. They don’t want the house back and are hesitant. This is when you can throw the lease purchase in as a way to secure the deal. Only do this if the deal is solid enough as a lease purchase. Don’t guarantee something you don’t want to or can’t fulfill.

When investing in real estate using a lease purchase always know ethics play a big part. If you say you will purchase the home from the seller, then you should do what you say you will do. If for instance you can’t close on the home due to personal circumstances then consider several other options: partner with someone who can, sell it outright, get a private loan, wholesale it, etc. Always make sure you do what you say you will do as a real estate investor or you will affect the real estate investing entire industry.

Lease Purchases are a great way to buy real estate when the terms or market are right. Always get a Lease Option if the seller is willing to do one over a lease purchase. It is a safer technique. Lease options are great as well, but there are those times when nothing will work better than a Lease Purchase.

Investing in Real Estate: Why Soft Markets are GREAT Markets.

Investing in Real Estate:
Why Soft Markets are GREAT Markets

© 2009 by Wendy Patton

Investing in real estate has changed in many markets in our country. If you are like me, you live in a real estate market that has gone soft.  There are still some areas in the country where homes are appreciating nicely, but nothing like it was just a year or two ago.  There were a lot of self-proclaimed real estate gurus that popped up during the boom times telling you how to make HUGE PROFITS in real estate.  Back then, during the up cycle, investing in real estate was so easy.  You could throw money at almost any piece of real estate and be practically guaranteed to make a profit.  It seemed like anyone who had flipped a couple of houses and made a profit was an “expert” investor.

Times are different now.  Investing in real estate takes a little more effort.  Investors that haven’t weathered down cycles before are struggling because all they know are massively appreciating markets.  All too many of those self-proclaimed gurus lost their shirts when the markets changed.  Those ads that go “I made $256 Million in real estate in 4 weeks with no money down” are a whole lot less believable.  Okay, $256 Million is an exaggeration, but you know what I mean.

So the question is, “How do we still go about investing in real estate and make profits?”  Can it be done in these soft markets?

The answer to that question is quite simple.  I can say without question, without hesitation, the answer is:  YES!  ABSOLUTELY!

I have been investing in real estate for more than 20 years.  I have seen up cycles and I have seen down cycles.  I have made money and been successful in both.  I can tell you several things about down markets that may surprise you.  First, experienced real estate investors will tell you that more money is made in down markets than in up markets.  It’s true, MORE MONEY is made in DOWN markets than in up markets!  Second, experienced investors PREFER to do the bulk of their investing in DOWN markets.  There are a number of reasons for this but the big ones are that there are more motivated sellers in down markets and the competition (other investors) pursuing these motivated sellers is LOWER.  It’s a double bonus. 

Down markets produce more deals and less competition to get those deals.

One of the investing techniques I specialize in is Lease Options.  Lease Options are one of the absolute best techniques for investing in real estate in down markets.  I’ll say it again, because if you are looking for ways to get involved with real estate investing you need to know this, Lease Options are one of the absolute best techniques for investing in real estate in down markets.

Let’s take a look at why.

I’ve already said that down markets produce high numbers of motivated sellers.  Right now in Michigan, it’s very common to see a house listed on the market in two ways, both for sale and for rent.  They are listed this way because the sellers KNOW how bad it is and they want someone, anyone, to cover their mortgage payment.  These double listings SCREAM “Motivated Seller!”  Now, not every single one of these is going to be an excellent Lease Option deal.  But you know what?  That’s okay, there are plenty to choose from!

The critical part in selecting your Lease Option candidates, in an up market or a down market, is creating WIN-WIN-WIN situations.  The seller must be satisfied with the deal, you must be satisfied and the end buyer must be satisfied.  When investing in real estate, this is what makes us successful.  How does this work? 

To create a WIN for someone we must meet their core need.  A motivated seller’s goal is to sell their house.  Eventually they need their mortgage paid off and the deed transferred out of their name.  If they are willing to rent the house as well as sell it, they are telling you that having their mortgage paid each month is more important right now than actually getting the house sold.  If we can find a tenant buyer for them we are satisfying their core need of paying the mortgage each month and eventually selling the home.  This is a WIN for the seller.

Our end buyer is looking for a home to own. Their current situation prevents them from getting a mortgage immediately but they plan on being able to get a mortgage soon. They want a home now. They don’t want to wait to get their house.  By allowing them to lease and then purchase the house we are meeting their core need. This gives our buyer a WIN.

Before we talk about what makes a WIN for us as an investor let’s talk a little more about mortgages for our end buyer. There has been a lot of news lately about sub-prime lending woes and how lenders with riskier loans are facing high rates of foreclosure and may be going bankrupt.  As a result it is getting much harder for people with poor credit to obtain a mortgage.  It is also getting harder for ANYONE to obtain a mortgage with 100% financing (i.e. no money out of the buyer’s pocket). This may sound crazy, but this is actually a good thing for us when investing in real estate.

When investing in real estate by doing Lease Options it is harder for us to find quality tenant buyers when almost anyone who can fog a mirror can get a mortgage. Not only that but because it was so easy to get 100% financing most buyers save nothing and are unable or unwilling to pay much for an option fee.  With the lending companies tightening their belts I expect we will see a growing population of QUALITY tenant buyers who are able to pay HIGHER option fees.

The flip side of this is that because lenders are tightening their belts your tenant buyers will need to work harder to restore their credit.  It may take as much as 2 to 3 years for some tenant buyers to be able to qualify for mortgages instead of just 1 year as we had seen before.

The bottom line is when investing in real estate by using Lease Options the difficulties of the mortgage lenders are just another reason why this down market is a GREAT time for us investors.

Now let’s look at the last part of our WIN-WIN-WIN equation -- the WIN for us, the investor. For us to WIN we need to make a profit. The profit comes both from the equity spread between your option price to the seller and the buyer’s option price to you as well as any monthly cash flow in the rental payments.  With Lease Options it pays to be creative. You’ll find a lot more deals and be a lot more successful investing in real estate if you practice creativity in your structuring.

The most common motivated seller we encounter is the one who has little to no equity in his home.  Too many real estate investors get calls from sellers that only care about “What’s it worth?” and “What do you owe?”  If the numbers are too close together, they say, “Sorry I can’t help you.”  Click.

What if you pursue it a little further with a creative mind?  A good question to always ask is “What are your monthly payments?”  If the payments are lower than rental rates you may be able to make some monthly cash flow. 

Another good question to ask is, “How soon do you need to sell the house?”  You may want to ask this question a couple of times while you are talking to them.  You could be surprised to find that the number grows longer each time you ask.  There aren’t too many markets I can think of that stay down forever.  Eventually the house should start appreciating again.  If your option period to the seller is long enough you can capture appreciation to make your profit.

What about this – “Are you willing to bring money to closing to sell your house?” And if their monthly payment is higher than what you can rent the house for, “Are you willing to pay the difference between the rental amount and your monthly payment?”  These two questions may seem brazen, but ask yourself, what have you got to lose?  If the seller is fully leveraged on the house or their payment is higher than the rental rate you have nothing to lose, because if they aren’t willing to make concessions then you can’t help them!  Certainly some of us feel awkward in asking these questions, but trust me, if you ask this question 30 times, no matter how embarrassed you might feel at the beginning, you will start to feel much more comfortable by the end.

These are just a few creative questions you might come up with to try to find terms that will allow you, as the investor, to make a profit, a WIN for you.  When you add all of three of these together, meeting the seller’s need, meeting the buyer’s need and you making a profit, you have created a WIN-WIN-WIN.  This is what you MUST do to be successful when investing in real estate with Lease Options.

Do you see how much BETTER it can be to find deals in down markets?  Motivated Sellers are EVERYWHERE and there are FEWER investors competing with you.  Combining these two factors allows you to choose your deals with greater care. Always “Cherry Pick” your deals in a soft market.  This is why experienced investors, who have been in both up markets and down markets, prefer the down markets.  Soft markets can provide some of the best deals when investing in real estate.