Posted by Alan in Houston on January 25, 2002 at 02:29:04:
During that debate, I loved how Steve Cook slammed the phone down on Ed during a role play. Not what Ed expected Steve to do. That night I went to bed at 6am.
Ah the memories…
Favorite Post - Posted by Michael Strickland (MD)
Posted by Michael Strickland (MD) on January 24, 2002 at 19:29:11:
Just for fun…
What is your favorite CRE post?
Post the link if you know it.
Re: Favorite Post - Posted by Ronald * Starr(in No CA)
Posted by Ronald * Starr(in No CA) on January 24, 2002 at 23:53:08:
Michael Strickland(MD)-------------
Thank you for the question. I had not really thought about it before. I like a lot of what I read on CREONLINE.COM forum. And I like the help people give each other. I’ve learned a lot by reading here.
I think my favorite was one where I and Ray Alcorn discussed the question of loan principal reduction as a “financial benefit” of real estate investing. I didn’t change my position, but I deepened my understanding of the issue of leverage, and financing in real estate investing.
The thread started at message # 3148 of the commercial board, in June of last year. I found it by putting “principal paydown” into the search function of the board5.
I like trying to have a deeper understanding of what we are doing. Anybody who challenges my thinking allows me to get a new perspective and offers me an opportunity to understand things better. So, I like opposing opinions even more than I like those who agree with me. As long as they are based on real thinking and are not aimed at personal attack.
Good Investing*Ron Starr
Re: Favorite Post - Posted by TRandle
Posted by TRandle on January 24, 2002 at 20:22:51:
Michael,
That’s an easy one for me. I couldn’t find Alcorn’s specific post, but here’s a copy within a Garcia post.
http://www.creonline.com/wwwboard/messages/arc_2001/arc_16/16804.html
A related enjoyable thread is…
http://www.creonline.com/wwwboard/messages/arc_1999//sep99/41588.html
And I’m not sure this is the correct thread, but if anyone has the right link to “Woodchuck” thread, that may have been the best thread of all time…
http://www.creonline.com/wwwboard/messages/arc_1999//apr99/21106.html
There are certain people whose - Posted by Ben (NJ)
Posted by Ben (NJ) on January 24, 2002 at 20:12:59:
posts I always read: Ron Starr, Ron Guy, JT-IN, JPiper,
David Krulac, Ray Alcorn, Ed Garcia, but one of my favorites is Ron Guy’s at creonline.com/www.board/messages/arc_2001/arc_12/12970.html. I was a law review editor at law school and published an article as well, so I appreciate a good writing style as well as content and this was an excellent and informative post. Good question, by the way.
Re: Favorite Post - Posted by Ronald * Starr(in no CA)
Posted by Ronald * Starr(in no CA) on January 24, 2002 at 23:40:47:
T Randle-------
Ok, that woodchucking thread was fine. And before I started up here at CREONLINE.COM, so I hadn’t seen it before.
But, I am always bothered by things which are not correct.
Nowhere in the thread did I see the accurate quote, so I supply it herewith:
How much wood would a woodchuck chuck if a woodchuck would chuck wood?
Call me compulsive. Call me anal. Fine. I always just try for accuracy.
Good Investing and Good WoodchuckingRon Starr********
Re: Favorite Post - Posted by JohnBoy
Posted by JohnBoy on January 24, 2002 at 21:00:09:
Here is another great one posted by Ray with a twist of comedy:
http://www.creonline.com/wwwboard/messages/arc_1999//dec99/50174.html
Re: Favorite Post - Posted by TRandle
Posted by TRandle on January 24, 2002 at 23:49:24:
Ron,
As I mentioned, I don’t think that’s even one-half of the actual thread. I wish I could find the beginning post that kicked it off.
And I thought it was…
“How much wood would a woodchuck chuck if a woodchuck could chuck wood?”
And no, I won’t call you any names…yet. Besides, Kennedy is the reigning champion (in my opinion) at righting “wrongs” on the NG. No, Jim, I’m not calling you any names, either. See you soon…
"
Agreed… - Posted by TRandle
Posted by TRandle on January 24, 2002 at 21:37:11:
JC,
I almost posted that one as well - it definitely ranks up there…
Re: Favorite Post - Posted by Ronald * Starr(in No CA)
Posted by Ronald * Starr(in No CA) on January 25, 2002 at 24:14:09:
T Randle----------
I apologize to you and all. My Mother was wrong.
The correct version, at least as found on multiple internet sites is: “How much wood would a woodchuck chuck if a woodchuck could chuck wood?”
However, please note this variation, found at The International Joke
How much wood could a woodchuck chuck if a woodchuck could chuck wood?"
‘A woodchuck could chuck no amount of wood, since a woodchuck can’t chuck wood.’
“But if a woodchuck could chuck and would chuck some amount of wood, what amount of wood would a woodchuck chuck?”
‘Even if a woodchuck could chuck wood, and even if a woodchuck would chuck wood, should a woodchuck chuck wood?’
“A woodchuck should chuck if a woodchuck could chuck wood, as long as a woodchuck would chuck wood.”
The world gets more complicated daily.
Now here are the good references to woodchucking. I’m sorry I don’t know how to put hyperlinks here.
all start with http://www.
straightdope.com/classics/a2_083a.html
lib.washington.edu/ougl/fun/qboard/wood.html
The last is the most scholarly. The earlier two have purported figures from supposed scientific sources. I am dubious.
Good Investing and Good WoodchuckingRon Starr********
The big L/O Debate - Posted by JohnBoy
Posted by JohnBoy on January 24, 2002 at 22:04:30:
Lets not forget this classic! I don’t have the url off hand, but here is the thread between Garcia and Piper debate.
The Great Debate Between Ed Garcia and Jim Piper
Lease Option vs Financing, and the easy way out???
I notice that most folks on this site endorse Lease Options over
Financing, when selling a property.
Since my being aquatinted with the Creonline, I have tried to
educate investors to the point where I even did a couple of
workshops on,
( How To Have Lenders Fighting To Give You Money).
I try to teach you folks about working a credit line, which is not easy
to obtain. But is a killer financial tool. It allows you to make cash
offers, season your own deals, and do flips with out costly financing.
The reason I screened my students so thoroughly, was because I wanted
experienced investors. Investors who were real players, not just part
time investors. Unfortunately, my workshop had people with different
experience levels, and so I had to adjust my workshop accordingly to
accommodate everyone. Allowing them to leave it with something of
value.
My workshop was designed to do much more than just teach about
a working credit line. It was designed to teach you about all facets
of financing, lenders, techniques, marketing, sales techniques,
negotiations, and more.
What I?m talking about here is EDUCATION.
The reason I bring all of this up, is because I feel that much of the
information being taught today is out dated. Some of the people
teaching you people are not with the times. Their out dated,
their Dinosaurs.
Did I leave something out, or do you catch my drift.
Now the reason I coming on so strong, is because I have been
watching questions being asked on this board, being answered by
people who just a few month ago, were asking the same questions.
And now a few month later their experts, and answering these
questions like they really know what their talking about.
When I watch someone pushing lease options. I know two things.
There either a newbie who has learned about it for the first time, and
think that they have just struck oil, or a Pro who is locked in gear,
and has been successful with this technique, and therefore has not
learned to develop their sales skills, and are using it as a crutch.
I found this to be a common practice where an experienced investor
uses a lease option as a niche closing tool, and don?t properly
develop their sales skills. Instead they sell themselves on the fact that
they have sold the house and now have income as a lender, rather
than being a landlord.
Don?t fool yourself, your a landlord.
OK, the mind is a powerful tool. We can think about it, or justify it,
any way we want to. But bottom line is, that house isn?t sold until the
buyer exercises their option.
Now lets talk about this buyer. With financing so available as it is
today, why do we have to do a lease option ? Usually it?s because the
borrower has had credit problems. (Oh and buy the way, I realize,
that some folks want to do a lease option, who have good credit), but
that?s the exception to the rule, Not the rule.
Now don?t get me wrong, everybody deserves a second chance and
I?m not saying that this buyer can?t do well with their second chance,
but for the benefit of my point, I want to make you aware of the fact
that the buyers are usually high risk.
So I?m going to lease option my property to this high risk buyer with
the underlying financing being in my name.
If this buyer pays me slow, it could effect me paying the mortgage
on the property on time. Yes I know, I could get rid of the buyer and
get another one. But then I will have down time, and maybe some fix
up cost, and what will my next buyer look like, if I use this same
technique ? Do you get the picture.
Don?t get me wrong, LEASE OPTIONS, are definitely a way to sell
your house. There strong point is, if the market place is slow, then
Lease Options can be King… They are a fast sale, and you can get full
price. But just keep in mind that there is a reason for that.
Also, if you know how to do 100% financing on a good borrower,
you still will get full price.
Now believe me when I tell you, if I want to defend Lease Options.
I Ed Garcia, could give you indisputable reasons, that lease options
are the way to go. And give you live examples, as defending reasons.
Remember folks, lease options, are just another way of financing
your deal. And that?s exactly how I view it, as a source of financing.
But the truth of the matter is, the deal speaks for it?s self.
And if we start to think about doing lease options as a way of doing
our deal, than that?s exactly what we will end up with.
The MAIN reasons I like FINANCING over LEASE OPTION.
-
The obvious, I have my cash in my hand.
-
I don?t have the financing in my name.
(Now that?s a biggie. The reason is, because I don?t want the
liability of the loan. It reduces my borrowing power.
It also reduces exposing my credit.
- Asset with no Liability.
Even if the borrower has bad credit, in today?s market there is a
loan for that guy. Not all companies are credit score driven, and
at 70 to 75% LTV you can finance the dead.
So wouldn?t you be better off carrying a second, behind a first that is in
the buyers name. And have an asset being the second, with no liability.
Also if the buyer gets behind on their first. It won?t effect your credit.
In CONCLUSION,
I don?t want to turn anybody off as far as lease options are concerned.
I think they are a powerful way to do a deal. But not a preferable way.
The point I?m trying to get across is, that the knowledge of
financing in general. Is more powerful, than any one technique.
So take the time to learn an understand what financing is all about.
As I said before, a lease options is just one way to finance a property.
If the time I have taken to write this posting, helps 1 person.
Then I have accomplished my goal.
Ed Garcia
Hi Ed:
I couldn’t help but respond to your post?..if for no other reason than to show one possible reason why someone might want to sell via lease/option rather than for cash.
Let’s assume for a moment that we bought a house and fixed it up?.our cost basis is $70K. Let’s further assume that we can sell the house one of two way for $100K. The first way is to sell with a lease/option?.and let’s assume that we sell for $5K in option consideration. The second way is to sell with institutional financing?..and for the purpose of this let’s assume that we sell with $5K down, $85K first, and a $10K second. Further, for the purpose of this comparison let’s completely disregard the cashflow from the lease/option?and let’s disregard the income from the second mortgage. I’m disregarding these by the way not because they should be?but because they detract from the central point I’m going to make.
Proceeds from the sale with institutional financing will be $90K. However, gross sales price is $100K?and therefore your profit for tax purposes is $30K?.eventhough you only got $20K in cash. I’m assuming by the way that if you’ve taken Ed’s suggestion and sold for cash?.and you’ve done more than a few of these?.you’re now a dealer and subject to dealer rules in terms of taxes. Therefore you’re taxed on $30K. For the fun of it let’s assume for a moment that taxes amount to 30%?.or $9K. Therefore the after-tax profit is $21K?.but wait?..$10K of that is a second mortgage?..so you put $11K in your pocket?cash.
Now let’s look at the lease/option example. You sell for $100K?.except that you only get $5K cash in the form of option consideration. Interesting though?.this cash is not taxable at this time?.not until the option is exercised or expires. Let’s assume that you did a 2 year lease/option?.and that over the course of this period you are busy building the tenant/buyer’s credit. Let’s further assume that you took Ed’s good advice?and that you have a credit line which you bought the property with originally?and that you refi the property after you have it seasoned in 12 months?thereby taking it off the line?.and putting cash in your pocket. Let’s say you do an $80K refi?.which for arguments sake puts $10K in your pocket?.which is not taxed since it’s loan proceeds. Let’s assume that at the end of 2 years?.you get this tenant refinanced with an 80% loan?.which covers the original purchase price less your option consideration. So now we have $15K to go do another deal with?.except in this case we’re going to do a 1031 exchange?.thereby deferring taxes.
So here’s how that looks?..$10K in your pocket from loan proceeds (NO TAX). $15K in cash serving as your down payment on your upleg property in a 1031 exchange (NO TAX)?..and $5K in option consideration that may have been received as boot and therefore was taxed. So in this example you have tax of $1500?.the rest of it is deferred.
Therefore, with the lease/option using my example, the after-tax profit is $28,500. We have $$13,500 of it in our pocket?.and the other $15K in a new property. Compare this with the institutional finance way?.$11K in your pocket?.and a $10K note.
So here’s a little summary. Using Ed’s financing method?.we put $11K in our pocket. We only put $5K in our pocket with the lease/option?..but after 12 months we put another $10K in our pocket from our refinance. Further, assuming Ed collects on his note?.he’ll make $21K. Disregarding the lease/option cashflow?.the lease/option method will give you profits of $28,500. That’s a $7,500 difference. Now let’s multiply that by 10 deals?.and we’re looking at a $75,000 difference.
Here’s the question Ed. Is the lease/option method sufficiently more lucrative to warrant taking the risk of financing yourself?
JPiper
Jim:
I was thinking of you when I made the posting and knew you wouldn?t
be able to resist taking the stand that you took.
There is an old saying that says,
(FIGURES don?t lie, but liars can FIGURE.)
Your hypothetical example was designed to prove your point.
And as usual, you did. (That is you did with your example.)
I loved the way you took your figures and decided that if you did that
with 10 houses your difference would be $75,000.
Boy talk about pulling numbers out of a hat.
Jim what I was thinking of doing, is taking your hypothetical example,
and create hypothetical vacancies, so then I could show hypothetical
losses. Then you would be glad to take your money and run and do
another deal.
You also left out the fact, what if the seller destroyed the property ?
What if the property value instead of going up went down ?
What could I have done with that extra cash as far a future purchases ?
After all lets not forget the TIME VALUE OF MONEY.
In carry a second, I can walk and not look back, after all, I?ve got most
of my money.
Another thing lets not forget, 9 out of 10 times the property is a hard to
move property. It?s not usually on a HOT PROPERTY list.
So it?s almost a given that I?m not going to experience any real
appreciation.
Believe me, you don?t lease option HOT PROPERTIES.
Jim, tonight I?m taking Sandra to dinner and a PLAY. So I don?t have
much time, and I knew if I answered you tomorrow. This posting would
be at the bottom of the board.
Other wise, we might of had some fun.
Your Friend,
Ed Garcia
Hi Ed:
Thought I’d take each of your points and answer it. By the way, be sure to add any questions you may have missed.
“Jim what I was thinking of doing, is taking your hypothetical example, and create hypothetical vacancies, so then I could show hypothetical losses.”
Actually in my experience vacancies arising out of lease/options when properly done are few and far between. And when they do occur, they’re easy to market. Two weeks and you’ve got a new buyer. And keep in mind that the $5K option consideration is a powerful incentive for the buyer NOT to leave, and is more than ample to compensate for a vacancy factor if it arises. But Ed, here you missed the whole point. If you’ll recall in the example I gave I did NOT count any cashflow from the lease/option. The whole thrust here is simply to get the property to the point where it can be exchanged. Even if you had a couple of vacancies?.they’re easy to replace?.and the property CAN be sold for cash after sufficient time has gone by to legally justify an exchange.
“You also left out the fact, what if the seller destroyed the property ?”
Let’s assume the property has been damaged in the amount of $10K. What this means is that YOU lose $10K in your note. I have to fix?.but I can recover my $10K by selling the property for cash and doing an exchange. So in reality this does not change the numbers at all.
“What if the property value instead of going up went down ?”
Let’s assume the property goes down 10%. You lose your $10K note?.and I lose $10K in equity. Maybe my buyer doesn’t exercise?.but now I sell the property and do an exchange for 10% less. Looks like it washes to me Ed.
“What could I have done with that extra cash as far a future purchases ?”
Here’s what you HAVE to do Ed, in order to stay even. You HAVE to do 1/3 more deals?.because after-tax your profit is skinnier. And keep in mind that I do have some cash?.cash for the option consideration, cash from the refi, and cash from ongoing cashflow. You’re going to have to run mighty fast just to stay even.
Now here’s a few points that you left out. Chances are I can sell the property for more money?.let’s say $5K more. Chances are it’s going to take you longer to close?thereby increasing your holding costs. Let’s say that’s another $1K per property. Over the 2 year period there’s an additional $5400 roughly in cash flow. Then there’s the issue of closing costs?.it’s going to be easier for me to save money in terms of closing because my buyer may be better able to afford his own closing 2 years down the road when he doesn’t have to also put up a down payment. Let’s give that another $1K. So the total here is $12,400 per property that I didn’t count?.let’s call that a slush fund to handle some of the problems you’re worried about.
But let’s step aside from the issue of whether cash is better than lease/option. Between you and me, I’d rather have cash IF everything else were equal. The problem is?.it isn’t. Taxes are a huge consideration. They account for 1/3 of your profits EVERYTIME you settle for cash. Your statement “figures don’t lie…” is correct. They don’t. Taxes are a real cost in EVERY deal. And an exchange is one way to defer them.
Now why did I pick 10 properties? Easy?I plucked it out of thin air. I could just as easily have picked 50 properties?or estimated the number of properties that might be bought and sold over the course of a lifetime of investing. Pick any number you would like.?.it doesn’t change one fact. The central point is that you can’t spend pre-tax profits?.you have to pay tax before you spend a dime. Selling for cash is THE most tax intensive method of doing business.
JPiper
Hi Jim:
First of all, Sandra came in my office and noticed the expression I used,
( Figures don?t lie, but liars can Figure). She said why would you call
Jim Piper a liar. After she said that, I realized that if your not familiar
with that expression, it could be misinterpreted.
So for starters, I?m sure you know I would never call you a liar. The only
word I could ever use for you is, FRIEND.
The expression ( Figures don?t lie, but liars can Figure) is meant to
mean that the person who uses their figures, can make those figures work
in their favor, to prove their point.
Piper, your masterful in using examples to your benefit. When you put
together a posting, it is well thought out and articulate.
Rather than go over point by point and address what you have presented,
as you have done to me.
There was only one valid argument that I will acknowledge, TAXES.
What I was going to ask you to do, is to rebuttal yourself. I know you are
capable of taking either side of this issue, and present it convincingly.
It would have been fun to see PIPER vs PIPER.
I think it was healthy for you to defend Lease Options the way you have.
After all, there are probably few who have done as many as you.
However Jim, you and I have been over this issue before. That?s why I hate
hypothetical examples, because they are designed to prove your point, as
you have just done. Believe me when I tell you Jim, I also can create a
hypothetical example that could prove you wrong, and you know that.
In fact, I?ll tell you what I?m going to do. I?m going to take your first
point and show you how easy it is for me to prove my point.
JIM PIPERS POST:
“Jim what I was thinking of doing, is taking your hypothetical example, and
create hypothetical vacancies, so then I could show hypothetical losses.”
Actually in my experience vacancies arising out of lease/options when
properly done are few and far between. And when they do occur, they’re
easy to market. Two weeks and you’ve got a new buyer. And keep in mind
that the $5K option consideration is a powerful incentive for the buyer NOT
to leave, and is more than ample to compensate for a vacancy factor if it
arises. But Ed, here you missed the whole point. If you’ll recall in the
example I gave I did NOT count any cashflow from the lease/option. The
whole thrust here is simply to get the property to the point where it can be
exchanged. Even if you had a couple of vacancies?.they’re easy to
replace?.and the property CAN be sold for cash after sufficient time has
gone by to legally justify an exchange.
First part of your answer:
Actually in my experience vacancies arising out of lease/options when
properly done are few and far between. And when they do occur, they’re
easy to market. Two weeks and you’ve got a new buyer.
STOP: (Two weeks and you?ve got a buyer.) Jim in two weeks you
can?t even get your contractor to finish up the clean up, and now your
going to find a buyer and close a deal in two weeks. I DON?T
THINK SO. Also when someone leaves the property, they don?t leave it
ready for the next buyer. Usually it will take TIME to get them out
which will COST YOU, plus LEGAL FEEs.
Two weeks, I think you better think about that statement Jim.
NEXT:
(Even if you had a couple of vacancies?.they’re easy to
replace?.and the property CAN be sold for cash after sufficient time has
gone by to legally justify an exchange.)
I really love the part where you say (( and the property CAN be sold for
cash after sufficient time has gone by to legally justify as exchange.))
Now let me see if I understand this. If I SCREW UP IN MY LEASE
OPTION, I can always sell it for cash the way I should have done it to
begin with. I could have done a 1031 from day one, so what was this
whole thing all about.
Piper, your a thing of beauty.
Bottom line, your only argument is Taxes. But like you said, I can do a
1031 exchange to solve that problem. I could also have excessive
receipts for work done to off set the profit, as most rehabbers do.
By the way Jim, have you ever had excessive receipts for repairs on
your property ?
Never mind Jim, I really don?t want you to answer that question.
I just want you to see how investors have the ability to make
adjustments in their deal. As I am sure you are aware of.
As I said in my original posting, the deal speaks for it?s self.
I think I have presented some valid arguments that needed to be
addressed. And so I addressed them.
Ed Garcia
Ed:
Just to clear up this exchange thing.
You can’t do a rehab or buy a property and exchange immediately. That’s the whole point. You’re going to have to hold it a while. That’s one reason for the lease/option?..to buy you the time so that you can get to the point where you can actually sell for cash and do an exchange. It doesn’t particularly matter who you sell to?.it could be the optionee, or it could be a new buyer after you evicted the optionee. The key issue is getting to the point in terms of time where an exchange can be done. Remember again, in my initial example I did not include cash flow to arrive at my numbers. As far as time goes, you get different answers, but certainly the minimum I’ve heard is one year holding?..but most advisors tell me that it would be better to hold for 2 years. In other words, if your goal is to defer your taxes through an exchange, you can’t sell for cash until you hold long enough. When you say you could have done an exchange from day one?.that isn’t true.
I would also say that whatever problems I have with the lease/option are going to be similar problems to holding a second. See my post to Troy above. I think the costs and problems are going to wash. The main distinction?.and I think an important one?.is that with the second you don’t HAVE to deal with the problems if you don’t want to. With a lease/option you do.
Finally, are there ways to moderate the tax? Sure there are?..but at least in my mind one of those isn’t to get some phony receipts. That isn’t going to stand up on an audit. Probably the best way is to do the rehabs in a corporation. If your income in the corporation is under $50K, then the tax will be 15%. Further, you may be able to structure expenditures within the corporate setting that are tax advantages in and of themselves. So depending on exactly what you do, the tax bite may be better than I indicated.
Again, my initial post was just to indicate one reason why it might be possible that someone would consider a lease/option?.that being the tax cost of selling immediately. It appears that you have acknowledged that. Whether the tax advantage offsets the disadvantages is something that each person will have to answer depending on their individual circumstances.
JPiper
Jim:
I used extensive repair bills as an example of what I know investors do
to offset profit. It wasn?t something I recommend , but knew most
people do. (Real World.) But as you indicated, there are other vehicles
for tax deferment that can be used , and that was my point.
Now this time frame of holding a property for two years.
Jim if you got to http://www.1031X.com/.
you will find that an exchange has to be identified in 45 days. This
web site is a good site for learning about exchanges, and will do one
for you if need be. Here is some of the information I pulled off of that
site.
11.) How long do I have to identify, how do I identify, what constitutes sufficient
identification, is there any leeway?
The replacement properties must be identified within 45 days after the sale of the
relinquished property. This requirement is strictly enforced, even if the 45th day
falls on a holiday. Identification must be in writing, signed and dated by the
exchanger and received by the QI no later than 45 days after the sale of the
relinquished property. Replacement property must be identified unambiguously.
Usually either a legal description or a mailing address is sufficient. Beware of an
exchange where a exchanger identifies a property in whole and then closes on
only a part of the whole. If challenged, this may not be sufficiently unambiguous
identification for a successful exchange.
12.) How long do I have to purchase my replacement?
The replacement property must be purchased within 180 days after the sale of the
relinquished property.
Jim, I appreciate your input, and I?m satisfied that I did what my
original post was intended to do, and that was to make people open their
eyes.
Thank you Jim,
Ed Garcia
Just for fun and clarification I thought I’d apply both methods to a rehab I am completing this week. You all can have fun picking apart my example, ok?
Some of the numbers are rounded just for simplification:
$12,500 purchase cost (closing costs included)
$17,500 rehab costs
$30,000 total basis
FMV = $50,000
IF everything goes right and I sell w/ financing, me holding a 10% second lien, assume sales price of 50k and 2k closing costs, I get:
$45,000 from first lien
$ 5,000 note from buyer (5yrs @10%, mo. pymt= $106.25)
less-
2k closing cost
After 1 yr. I have 13k (at closing) plus 12 pymts=$1275 for a total of $14,275 (most of which is collected at time of sale).
If I sell on a L/O and everything goes right (buyer gets new financing after 1 yr. term), I get:
$3,000 Nonrefundable option consideration, buyer pays $700/mo. rent w/ $200/mo credit. After a year, I have collected :
$3,000 nonrefundable option consideration
$8,400 in monthly pymts, only $2,400 of which goes toward purchase price, so:
$14,600 from new loan
$26,000 total received from buyer, MINUS
$3,000 1 year’s interest on underlying financing
$1,200 property taxes and insurance
$2,000 closing costs
$19,800 cash to me after 1 yr.
Now, let’s assume everything goes WRONG, after 1 year, buyer has stopped paying, and has done 5k damage to the house. If I’m holding the second, unless the buyer will play ball it is not IMHO worth pursuing, so I have collected the $14,275 and I’m done with it.
If I have sold on L/O, I have collected:
$11,400 (option consideration + 1 yr. pymts)
$ 4,200 holding costs (interest, taxes, and insurance)
$ 7,200 profit, but I still own the property, and can evict my tenant/buyer.
Then, I have a 50k house for which I still owe 30k (less the amount paid down over a year)and needs 5k in repair.
In conclusion, best case scenarios, I like the extra $5,520 I get from the L/O in one year (not a long term IMHO). NOTE: I realize I left out the second lien note for 4 more years which will net you $5,100 more.
Worst case scenario, obviously you get more cash with the finance sale, but IMHO $5k is a terrible thing to waste, could be even more if your house is pricier, or if you have to hold a larger second (i.e. 15-25%). I like the fact that the profit will still be there if the “buyer” stops paying.
I realize there are a hundred variables we can throw in there, such as apreciation or depreciation in the area, buyer claiming an equitable interest, and greater damages to the house, just to name a few. These are all risks, but isn’t that what it’s all about? Risk management, and maximizing profit? Once again, I don’t claim to be an expert here, but this topic is near and dear to my livelihood, so go ahead, tear it up.
Regards,
Troy M
Troy:
OK Troy, it?s just you and me kid.
Pipers sleeping, it?s his nap time. Rick Vesole, Landlord Extrodenair,
is trying to get a new computer to count his money.
But I will tell you, that I?m happy that you brought me at least a real deal.
Now before we start to play, keep in mind that I?m at a disadvantage.
I don?t know your market place, or if the subject property is in Beverly
Hills or an area that you have to carry a gun to collect your payments.
I?m going to have to think, that?s it?s not in a bright and shiny area, or
you wouldn?t have to do a lease option to begin with. Especially after
you just figured to spend $17000 for rehab cost. That alone should be
a sign that something?s not right in river city. We can see you had to
do more than just cosmetic repairs and now you want to spend that type
of money, and turn it over to someone who already has a track record of
not paying , or they would be able to finance the deal to begin with.
So I want you to know that I?m with you. LET THE GAMES BEGIN.
Oh, and one more thing ,I want you to know that( I?ll Be Your Huckleberry)
Troy, Doc Holliday said that in the movie (Tombstone) and I?ve always
thought it was a cool saying.
Troy, let me do this. I?ll put your posting, on this posting, and then destroy
it, making you mad. You will then go make up a Voodoo doll of me, and
stick pins into it. It?s OK Troy, I?m Voodoo doll proof, I?m a Catholic.
Here Go?s??.
Posted by Troy M on September 05, 1999 at 15:21:33:
In Reply to: Lease Option vs Financing, and the easy way out???
posted by Ed Garcia on September 04, 1999 at 16:39:40:
Just for fun and clarification I thought I’d apply both methods to a rehab I
am completing this week. You all can have fun picking apart my example,
ok?
Some of the numbers are rounded just for simplification:
$12,500 purchase cost (closing costs included)
$17,500 rehab costs
$30,000 total basis
FMV = $50,000
IF everything goes right and I sell w/ financing, me holding a 10% second
lien, assume sales price of 50k and 2k closing costs, I get:
$45,000 from first lien
$ 5,000 note from buyer (5yrs @10%, mo. pymt= $106.25)
less 2k closing cost
After 1 yr. I have 13k (at closing) plus 12 pymts=$1275 for a total of
$14,275 (most of which is collected at time of sale).
ED GARCIA SAYS*****
**((@ Now Troy, lets Stop right there. Why did you decide that, you had
to carry back 10% ? Why couldn?t you have gotten 100%
financing ? .Also, Why if you can sell with a lease option and get
$3000 down, couldn?t you sell with financing and get $3000 down.
It makes a difference Troy. I think to be fair to our deal, I?m going
to give us $3000 down, just like your lease option deal. Or do the
Lease Option with no money down, just like my deal. You don?t
like the sound of that do you Troy ? You pick the poison, but it?s
got to be the same. For now I?m going to use your $3000 down.
In doing so I now have a 90% loan =$45,000 minus $2000 closing ,
STOP. I?m going to add $3000 to my price to cover the $2000 closing
cost. I?m doing this as a favor to the buyer, because I don?t want them
to come up with any more money than they have to.
(Remember, it?s the buyers loan, not ours. That?s their cost, not ours)
Now this deal, is already starting to shape up. I now have $15,000
from my loan, and $3000 down in cash. I?ve got $18000. Up front.
And now I?m only carrying a $2000 second for 3 years at 10%=
rounded off, $66.63 per month. ( chump change) But I have no
exposure. And I?ll have another $2399. **((@
Troy CONTINUES
If I sell on a L/O and everything goes right (buyer gets new financing after
1 yr. term), I get:
$3,000 Nonrefundable option consideration, buyer pays $700/mo. rent w/
$200/mo credit. After a year, I have collected :
$3,000 nonrefundable option consideration
$8,400 in monthly pymts, only $2,400 of which goes toward purchase price,
so:
$14,600 from new loan
=$26,000 total received from buyer, MINUS
$3,000 1 year’s interest on underlying financing
$1,200 property taxes and insurance
$2,000 closing costs
=$19,800 cash to me after 1 yr.
ED GARCIA SAYS
**((@ STOP. We now have for the first year $19,800 from the
Lease Option, and $18,200 from the sale being financed.
$19,800 take away $18,200= $1,600 difference for the
first year. I still have as much control in the deal as you
do, and no exposure. At this point were at,
( 1 bird in hand, 2 in the bush). I?d like to bring up the fact.
that I?ve got my money, your hoping that your lease option
can be financed to get yours. Yes, you will be $3000 a head
if it?s not. But while your dealing with this problem, I?ve
already bought another house with the money I made off of
this deal and made $20,000 again. You still have your money
tied up in the first deal and hoping to still sell it. **((@
Troy CONTINUES
Now, let’s assume everything goes WRONG, after 1 year, buyer has
stopped paying, and has done 5k damage to the house. If I’m holding the
second, unless the buyer will play ball it is not IMHO worth pursuing, so I
have collected the $14,275 and I’m done with it.
If I have sold on L/O, I have collected:
$11,400 (option consideration + 1 yr. pymts)
$ 4,200 holding costs (interest, taxes, and insurance)
=$ 7,200 profit, but I still own the property, and can evict my tenant/buyer.
Then, I have a 50k house for which I still owe 30k (less the amount paid
down over a year)and needs 5k in repair.
In conclusion, best case scenarios, I like the extra $5,520 I get from the
L/O in one year (not a long term IMHO). NOTE: I realize I left out the
second lien note for 4 more years which will net you $5,100 more.
Worst case scenario, obviously you get more cash with the finance sale, but
IMHO $5k is a terrible thing to waste, could be even more if your house is
pricier, or if you have to hold a larger second (i.e. 15-25%). I like the fact
that the profit will still be there if the “buyer” stops paying.
ED GARCIA SAYS
**((@ STOP, at this point Troy, your already talking about how much
money your going to make (IF) the deal don?t go down so you can
sell it again. Also I?m wearing out with the largest word in the
dictionary, (IF). When I do my deal, I don?t have to worry about
that word (IF). I?m done, and on to my next deal. (IF) the guy don?t
pay me. I would most likely have walked from the deal, I?ve got
my money in my pocket, and I don?t need the aggravation for a $2000
second. **((@
Troy CONTINUES
I realize there are a hundred variables we can throw in there, such as
apreciation or depreciation in the area, buyer claiming an equitable interest,
and greater damages to the house, just to name a few. These are all risks,
but isn’t that what it’s all about? Risk management, and maximizing profit ?
ED GARCIA??..
In CONCLUSION :
First of all Troy, I want to think you for being such a good sport.
As you said when you started, that I could have some fun picking apart
your deal. Well I hope it was as much fun for you as it was for me.
I hope that you noticed something that I found interesting.
You structured your Lease Option deal with $3000 down, but when you
did your Financed deal, you structured it with no money down.
So that proves what I?ve been saying all along. And that is, A DEAL
STARTS IN OUR MIND. We actually program ourselves. When we do
this, we find ourselves looking for what we think we should be finding.
You have been taught to do Lease Options with money down, and that?s
why you did it.
I also feel that it?s only fair to remember if I did pull my money out of
a deal, it gives me CASH to go into another DEAL.
As I saw you like to make $20,000 a deal, that was the figure I would
use. So the way I see it. Is if my money is tied up in a deal, then it?s
costing me $20,000, because it prevents me from doing another deal.
Like I said before, deals are made in our mind??.But the mechanics
of these deals Financing vs Lease Option can make a difference.
Ed Garcia
Hi Huckleberry:
It’s been a while since I read the book?.but as I recall Huck was a practical joker, who at the beginning of the book is being taught the basics of reading, writing, and arithmetic?.which he doesn’t care for at all. How interesting that you would pick this character! Anyway, I’ll honor your request to think of you as Huckleberry for the remainder of this exercise. Well Huckleberry, let’s see if we can teach you some arithmetic and some reality, no matter how much you resist it.
CASH DEAL:
I’m going to use Troy’s numbers?.I mean I don’t know how you or I can “imagine” what something can sell for. Troy tells us in his response to you that the house isn’t worth more than $50K?.so $50K it is no matter how much you might like to “fluff” up the price. As we all know, it does need to appraise. Also in his response, Troy states the reason for no down payment is so the buyer can pay his own closing costs?.and as we all know, that’s reality sometimes. Buyer’s sometimes don’t have BOTH down payment AND closing costs. So the numbers are:
$50,000 sales price
$45,000 new first mortgage
$5,000 seller carried second
Seller pays $3000 in his own closing costs
Buyer pays $2000 in closing costs
Gross Proceeds To Seller $13000 ($45000 minus existing financing minus buyer closing costs)
Taxable Gain $18,000 (The note is taxed immediately since this is dealer property)
Taxes at 30% $5,400
After tax proceeds $13000 minus $5,400 or $7,600
So Huckleberry, this cash deal is going to give you $7,600 at closing in after-tax profits?..plus a $5,000 note. Now just to make this a little more real, I’m going to subtract another $600 to pay for the extra advertising and carrying costs to find this buyer relative to the lease/option buyer, because this buyer does need good credit for this type of loan?.and because it’s going to be more difficult to find him?and because it’s going to take the lender a while to do the deal. Therefore $7,000 goes in your pocket?plus the $5,000 note.
At the conclusion of the first year you’ve received another $1,272 in payments on the note?.the interest of which is taxed?.so let’s say you put $1000 in your pocket?..So at the end of year one you have $8,000. Year 2 you have $9,000.
LEASE/OPTION METHOD:
Now Huckleberry, with the lease/option method I don’t need to pay as close attention to the appraised value as I do with a cash deal. Therefore, I’m going to sell this house for $55,000. Further, I’m going to do a 2 year lease/option, instead of a one-year?.and I’m only going to give him $100 per month as rent credit instead of $200?.it still compares favorably with an amortization schedule.
Here’s how it looks. In the first year I receive:
Option Consideration $3,000
Rent $8,400
Taxes- none on the option consideration, on the rent I pay on rent less interest, taxes and insurance, so approximately $1,260. Keep in mind that I could also depreciate, and I might not have to pay on the rent credit?.but these are too complicated to calculate here?and only serve to make my number better anyway.
So I have $11,400 minus mortgage payment, taxes, and insurance of $4200 minus income taxes of $1,260 for a total of $5,940.
Now at the end of year one?..Troy is going to refi this property because he now has 12 months seasoning, for $40000 (80% of appraised value)?..putting an additional $10,000 in his pocket.
So at the end of year one?.with the non-taxable loan proceeds, Troy now has $15,940 in his pocket. That compares with $8,000 with the cash sale.
Now here’s year 2. Let’s assume that when Troy refinanced, he did a 9% loan. Therefore principal and interest costs increase to $3,862. Therefore after reflecting income tax, taxes and insurance, Troy puts another $2,338 in his pocket, not counting the benefit of depreciation.
So at the end of year 2 Troy now has $18,278 in his pocket?.versus $9,000.
Ouch Huck?.I haven’t even sold the house yet! Let’s assume the buyer doesn’t get a loan?..something you keep stressing. OK?I renew my deal for another year. That gives me another $2,338 or a total of $20,616?..about twice what you have in the cash sale.
But let’s assume I get “lucky” and I get the buyer refinanced in 2 years. My balance is $55,000 minus option consider of $3K, minus rent credits of $2,400 or $49,600?.let’s assume some closing costs of $1,600?.so I have another $8K let’s say?which I 1031 exchange into a new property?..thereby deferring the tax.
Therefore I have now made $18,272 plus $8,000?.or $26,272. This compares with $9000 with the cash method.
Now Huckleberry?.I know you have $7000 right out of the chute to go do another deal with. I only have $3,000. But I thought that was what this newsgroup was all about?.learning how to buy deals cheap enough that you can put financing on them. Are you trying to say that Troy can’t do another deal where combined purchase price and rehab costs are 60% of market value without having some cash??? Huck, I know you know better than that.
So those are the REAL numbers Huckleberry, or as close as I can make them or have the time to.
JPiper
I typed a few things wrong?..doesn’t change the numbers but here’s the corrections.
Seller pays $2000 in his own closing costs.
Buyer pays $3000 in his own closing costs.
Gross proceeds to seller should read “?.. existing financing minus seller closing costs”?.not buyer.
Sorry for the confusion?..however I used the correct numbers?.so the numbers remain the same.
JPiper
Jim:
Your at it again. And out of control as ever.
Well I guess I’ve got to meet up again with your (MAGIC PENCIL).
You come in and let me sell my house for $50,000 and then sell yours
for $55,000. (Piper, your a thing of beauty).
Let me give you an EDUCATION.
I’ve got a magic pencil of my own.
For starters, I can sell the house for what ever I want. It’s just the lender
won’t finance more than what the property will appraise for. SO WHAT,
I can carry the difference in my second just like you would.
As a matter of fact since were talking hypothetically, ( and your a master
with hypothetical examples) I’ll sell my house for $60,000.
Since you’ve changed the rules, so will I.
I sold my house for $63,000 got a tax deferred 1031 exchange, bought
another house that had a $20,000 profit in it, sold it the same way,
and picked up another house with $20,000 profit it, sold it the same way,
and now I have a NEW problem. I’ve got to find another exchange because
I have a buyer for that one. Mean while I’m looking at two other houses but
a year ending is now starting to approach and I have to get ready to do my
taxes.
But that’s OK. Lets see, this year I’ve bought and sold 3 houses with the
same money in the last year and made approximately $60,000.
Oh that’s right, your still making a fortune on the same old house you
bought a year ago if you can get it refinanced.
But don’t worry, I know that if you can’t you can always re-sell it.
Ed Garcia
Ed:
I was more than a little surprised to see your new hypothetical example?.but it was interesting and eye-opening to put my “magic pencil” to it.
To summarize, you’re now selling the property for $63,000. However since the property appraises for $50,000?..the lender will only loan $45,000. Therefore you’re going to carry an $18,000 second. The buyer is paying his own $3000 closing costs, and the seller is paying $2000 in closing costs. Cost basis of the property is $30,000.
So here’s how this all pencils out. You have $15,000 in cash at closing less the $2,000 closing costs, which is $13,000. Your taxable gain however is $33,000, assuming you’re doing these as a business which you’re indicating you are. Therefore your tax liability in the first year is $9,900?.assuming a 30% rate.
This means that after tax?.you put $3,100 in your pocket. Of course you do have an $18,000 note which you can collect on. In other words, raising the price may not help you if your goal is to put cash in your pocket to go do another deal. Your cash in hand went DOWN by raising the price, NOT up. Sometimes less is more. I’ll leave it to you to compare this to the lease/option method.
Further, in your example you say you’re going to exchange these properties for new properties. Just thought I’d point out again, that according to IRS rules a 1031 exchange must be an investment property. The term “investment property” does NOT include rehabs, properties that you’re flipping, etc. That was my whole point from the beginning, that in order to do a 1031 exchange and thus defer what is a LARGE tax bite, you would need to HOLD the property for a period of time, to establish the fact that it’s an “investment property”. Selling the property shortly after purchase does NOT accomplish this.
Ed, what my original intent was here, and the thrust of my original post, was to illustrate the effect of what is a very large COST associated with selling a property?..ie income taxes. I’m not saying that anyone should or shouldn’t sell for cash. As you know, I do that myself at times. There are obviously other considerations that should be taken into account other than just taxes?.as you have capably brought out. But in real estate one of the SIGNIFICANT advantages provided through the tax code is the ability to DEFER taxes through the 1031 exchange, assuming you can qualify for the exchange to begin with. Through the illustrations I think you can see the effect of taxes?..and the cost that an investor is required to PAY to receive cash. Anytime you change your method of sale, you also change the risk characteristics of the investment?.which is your point?..and a point well-taken.
JPiper
Re: Favorite Post - Posted by Alan in Houston
Posted by Alan in Houston on January 25, 2002 at 02:34:23:
Now I might have to call you names. LOL. Where do you find the time to do all of the useful post you do, and look up woodchuck rhymes?
Stay the way you are Ron, we love the debates and insights.
wow… - Posted by Shawn MM
Posted by Shawn MM on January 26, 2002 at 09:45:46:
I will have to read and re-read that a few times to completely absorb everyhting, but all I can say is “WOW”. Ed and Jim are jedi-masters. After I read Ed’s posts, I start to question lease/options, then I read Jim’s posts, and say to myself,…“yeah.”
The whole thing has given me an eye ache similar to the kind you get when you eat ice cream.
I thank you guys, but my printer’s about ready to stroke-out. 
okay, okay… - Posted by TRandle
Posted by TRandle on January 24, 2002 at 23:35:59:
JC,
Yes, it’s a good one, but it pales in comparison to the face to face in Atlanta. I don’t recall if you were around to witness this or not. Within minutes of David proving that Tequila shots remove all inhibitions, with his courageous, albeit not so graceful, exhibition of martial arts days gone by, the Ed and Jim show began.
Ed practically pushed us out of the way (and wobbled a bit as he did so - I think it was 2 a.m.) as he “called Piper out” at the top of his lungs. As Jim walked out of the closing bar, Ed drew both his imaginary six shooters from both his imaginary holsters and drew down on Jim.
Ed then proceeded to scream (Jim was at the opposite end of the hallway) “Bang! Bang!, You’re Mine! I Own You! Cash is King!” or something to that effect. And that was followed up by a sit-down in the lobby where they tried to argue the other’s viewpoints. It was very humorous and much more memorable than a dry post.
Re: The big L/O Debate - Posted by Mark wv
Posted by Mark wv on January 24, 2002 at 22:45:18:
Johnboy,
I could’nt help my self ,I had read the post when it first was up but had to reread it again, You guys amaze me , yall can think quicker than I can walk.
Thanks for the repost
Mark
Re: Favorite Post - Posted by Ronald * Starr(in No CA)
Posted by Ronald * Starr(in No CA) on January 25, 2002 at 11:20:39:
Alan–(TX)----------
I neglect my work and have a lousy social life. I sleep less than I should and I type very fast.
Good Investing***********Ron Starr*************