Advanced Strategies for Lease Option and Subject-To Properties
Jack Sternberg
If you're an experienced investor, sooner or later you'll want to seek extra protection for your hard-won investments. This article will cover key strategies for getting that protection. Of course, not every strategy I describe will apply to every situation. In other words, you may not have a use for all of them, but I'm willing to be they'll come in handy at some time during your investment career.
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 purpose of the memorandum is to prevent an unethical seller from refinancing and selling the property to someone else. It also provides you protection from bad faith sellers who try to squirm out of their obligations. With lease options, always record a memorandum of option!
Advanced Strategy 1-the Deed in Escrow You may think that the term escrow refers only to the deposit of funds by one party for delivery to another party upon completion of a specific event or condition.
But, the definition also refers to the deposit of deeds and other written financial/legal instruments. Here's my suggestion--place the deed in escrow at the same time the memorandum of option is filed. When this happens, the seller signs the deed along with the other contracts. The deed isn't recorded on the title at this point however; it's held in escrow by an attorney or title company, and they're provided with instructions for its release.
Now, this action doesn't protect against the filing of liens against the property. But, its effect is to reinforce to sellers that they've actually sold the property. This, in turn, creates reluctance on their part to try to back out on a lease option agreement.
It also has another advantage: It allows you to close on the property without the seller being present! With the deed in escrow, you should specify how and when the deed is to be released and recorded. The instructions can be simple, such as this example: "When Sam Smith pays $200,000 in certified funds to John Jones, the deed will be released to him. By (date), these funds must be paid."
Advanced Strategy 2: The Performance Mortgage With this technique, the seller pledges the property as collateral for the lease option agreement, and, thus, 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.
I'm sure it's no secret to you that many sellers dislike the idea of a performance mortgage and won't agree to such an arrangement! However, if you do find a customer who agrees, your attorney should review the terminology of the mortgage to make sure the appropriate clauses are included.
Advanced Strategy 3: The Land Trust Land trusts are formed by organizations established to hold land and to administer use of that land. You'll find that this technique is very useful with subject-to's because a land trust minimizes your exposure to litigation.
It does this by hiding true ownership. The actual owner or beneficiary is not recorded in the public records, just the name of the trust. This means potential litigants find it difficult to identify someone to sue.
Land trust contracts tend to be complicated and long so investors will definitely need an expert lawyer to draw them up.
Advanced Strategy 4: Get a Partner In some cases, you may want to consider subject-to high-end properties (in terms of rapidly appreciating value). With these properties, there's more risk. Since there is more risk, you can spread that risk by taking on the seller as a partner. In this case, the buyer 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.
Ironclad rule: If you use this method, insist 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, and it's not a taxable event. That means this investor can use that money to reinvest in other properties while still holding on to the original property.
Check with lenders and brokers in your area to find out what refinancing programs are available.
Tax Concerns The methods I've just described have to meet IRS regulations. So, you and your tax person should be on top of those regulations. They do change from time to time, and those changes 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. Currently, a person can sell his or her 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 Never stop learning! Keep advanced strategies in mind as you grow your investment portfolio. It's not likely you'll 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 investment situation arises.
Key Point: Make certain you get the lenders permission! Study advanced strategies in depth, so you can make use of them at the appropriate time for maximum protection of your investments.
Jack Sternberg is the creator of the renowned "Buyers First Program". As the "gurus' guru", he is well known by the professional creative real estate community as "Obi-Won Kenobi". Having been a full time investor since 1977, Mr. Sternberg has been "at" the closing table more than 1,500 times. Mr. Sternberg has the depth of experience that lend value to his associations. Contact Mr. Sternberg at www.askjacksternberg.com
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