Lease Option & Subject-To - Strategies for Experienced Investors
The focus of this article is advanced strategies for experienced real estate investors who want extra protection for your investments. The use of the strategies I’ll cover will depend upon your investment strategy. Also, they may not be solutions you’ll commonly use, but you’ll have the knowledge you need should you decide to employ them. It’s always good to have more weapons in your investment arsenal!
The Fundamental Protection of the Memorandum of Option A primary negative of lease options concerns financial difficulties of sellers. These problems can result in liens, delinquent property taxes and other similar hassles. For the investor, this can result in a considerable amount of time and money spent on resolving these issues before the property can be sold.
The Memorandum of Option is a basic protection for the investor. The memorandum is a document is a record against the title of the property and should always be recorded. It informs the public that you have an interest in the property.
The memorandum has an important purpose–to prevent an unethical seller from selling the property out from under the investor’s nose to someone else. It also provides protection from bad faith sellers trying to squirm out of their obligations. My advice–always record a memorandum of option!
Advanced Strategy 1-the Deed in Escrow Most often, escrow refers simply to the deposit of funds by one party for the delivery to another party upon completion of a particular condition or event.
However, the definition also includes the deposit of deeds and other written financial/legal instruments. I recommend placing the deed in escrow at the time the memorandum of option is filed. In this case, the seller signs the deed along with the other contracts, but the deed is not recorded on the title at this point. Instead, it’s held in escrow by a title company or attorney, and they’re provided with instructions for its release.
You should know that this action doesn’t protect against the filing of liens against the property. However, its effect is to impress upon sellers the fact that they’ve actually sold the property. The result-it creates reluctance on the sellers’ part to attempt to back out on lease option agreements.
This action another benefit for you; it allows you to close on the property without the seller being present! With the deed in escrow, you can then specify how and when the deed is to be released and recorded. The instructions can be simple, such as this example: “When Joanie Jay pays $200,000 in certified funds to Stan Wild, the deed will be released to him. By (date), these funds must be paid.”
Advanced Strategy 2: The Performance Mortgage With this method, the seller pledges the property as collateral for the lease option agreement, and, therefore, ensures good faith performance by that seller. Once the mortgage is assigned to the buyer, it prevents the seller from selling the mortgage to other people. (It replaces the memorandum of option filing.)
The performance mortgage permits the seller’s insurance company to put the buyer’s name on the owner’s policy as another insured. It shows as well that the buyer is a lien holder and requires that he or she be notified if any type of foreclosure action is taken.
Naturally, some sellers dislike the idea of a performance mortgage and won’t agree to this deal! In the event that a performance mortgage is agreed to, an attorney should review the terminology of the mortgage to make sure the appropriate, specific clauses are included.
Advanced Strategy 3: The Land Trust A land trust is defined as an organization established to hold land and to administer use of that land. This technique is very useful with subject-to’s. The purpose of a land trust is to minimize possible exposure to litigation.
It achieves this by hiding true ownership. The actual owner or beneficiary is not recorded in the public records, only the trust’s name. In other words, it’s difficult to get sued because litigants find it hard to identify anyone to sue.
Keep in mind that land trust contracts tend to be complicated and long so you’ll definitely need an expert lawyer to draw them up.
Advanced Strategy 4: Get Yourself a Seller-Partner There may come a time when you want to consider subject-to high-end properties (in terms of quickly appreciating value). Since there’s more risk involved, it’s a smart idea to spread that risk. You can do this by taking on the seller as a partner. With this arrangement, you and the seller share the profits.
Here’s an example: Assume a property is worth $800,000 and the monthly rental is $3,500. Under normal circumstances, an investor would usually back away from this deal. However, let’s assume that the investor finds that this home might be sold for $200,000+ in profits. This deal makes good financial sense for the investor and the seller. So, they agree on a 50-50 partnership (or another percentage arrangement), and they’re both happy.
My recommendation: If you take this course, require that the seller cover all the risks.
Advanced Strategy 5: Refinancing Refinancing is a tax-deferment strategy. Here’s an example: Assume an investor has a house worth $300,000, and $230,000 is owed on it. Through a new mortgage, that investor can take out some or all of the $70,000 in equity
It’s a good idea to check with lenders and brokers in your area to find out what refinancing programs are available.
Tax Concerns Remember that with any of the methods I’ve just described they have to meet IRS regulations. So, make sure that you and/or your tax person are on top of them; the regulations do change from time to time and can affect the legality and profitability of deals. One area to really stay on top of is capital gains.
Capital gains are the profit on the sale of a property. At the present time, you can sell your primary residence (the one actually lived in, not investment properties) every two years.
If a person is single, he or she can keep the profits up to $250,000; if a person is married, he or she can keep up to $500,000. In both instances, the profits are tax free. If the seller of a property lives in his or her home for two out of five years, then that property qualifies for a tax-free gain. The seller can rent the home out for three years - and not a single day more.
My Advice Study advanced strategies and keep them in mind as you grow your investment portfolio. More than likely, you won’t need them for the majority of investments (especially early in a career), but, as is often said, knowledge is power. With that knowledge, you’ll be able to apply it quickly and easily when the right situation arises.
Key Point: Always get the lenders written permission. Study advanced strategies in depth, so you can make use of them at the appropriate time for maximum protection of your investments.
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