L/O Consideration... Where does it go? - Posted by Steve Heller

Real Estate Investing
1

Posted by Brad Crouch on June 14, 1999 at 17:26:49:

Steve,

I don’t know what happened to my reply, but it seems now to be gone. I don’t have the time to retype it, so I’ll be brief.

> What I am suggesting is the TB pays me the option
> consideration. If they move or can not qualify for
> the loan after their lease period expires then I keep
> their option consideration.

So what if they can’t exercise? The option consideration is yours to keep, anyway.

> But what I do tell them is that I will use part if
> not all of their option consideration to make their
> down payment, provided they qualify with the lending
> institution for the loan.

Are you crazy? Don’t tell them that!

> Now with that said, at the closing I bring a check
> for their down payment and I get a check for the
> diffence in what I agreed to pay the seller and
> what I sign the purchaser up for, less any rent
> credits.

Closings are for picking up checks . . . not writing them.

> So I get the option consideration back at the time of
> closing and I am out the down payment money from the
> time it takes me to get it and close on the deal.

You will end up paying someone elses downpayment, no matter how you figure it. You WANT to give away money?

> What do you think?

I think you need to buy some courses on lease options so you can learn exactly how they work. I am worried that you’ll get killed in this business if you don’t learn what you’re doing.

Plenty of excellent courses are available here (Joe Kaiser, Bill Bronchick, Ron LeGrand, Bill Gatten to name a few).

Good luck,

2

L/O Consideration… Where does it go? - Posted by Steve Heller

Posted by Steve Heller on June 08, 1999 at 20:03:56:

With L/O Consideration, is it subtracted from the purchase price to the tenant/buyer? Little confused about this.

Thanks for your reply.

3

Re: L/O Consideration… Where does it go? - Posted by Brad Crouch

Posted by Brad Crouch on June 09, 1999 at 11:29:08:

Steve,

If there WAS a “rule of thumb”, it would be that all option consideration is generally applied towards the purchase price, if and when the tenant buyer exercises his option to purchase.

The initial option consideration (3% to 5% of purchase price . . . or as much as you can get) generally counts towards a down payment, sort of like paying a down payment in two “installments”, the second installment happening when the tenant buyer obtains the necessary financing to exercise his option.

The cash goes into your pocket and is non-refundable. But you keep a photocopy of the check and the deposit slip where the money was deposited so it can be shown later that this money was actually transferred to you. Then it will be easy to prove that the money was real and that it should count as “down payment money” when the tenant buyer is trying to get financing to exercise his option.

Rent credits are a different story. These monthly amounts are generally credited towards the purchase price, but not the down payment. Most lenders will allow a certain portion of these monthly amounts to be considered as part of the down payment. The amount allowed would be whatever amount was in “excess” of the Fair Market Rents in your area. Of course, it would be better if your tenant buyer paid his monthly payments by using two checks, the first one being somewhere near the amount of FMR.

Some folks don’t give rent credits at all. Some folks give 50% of the monthly payments as rent credit, while others give 100% of the monthly payments as rent credit. One of the beautiful aspects of this business is that you can do it any way you want, and can negotiate. It’s YOUR business!

There really is no “right” or “wrong” in this. Right and wrong is only defined by what is agreed upon.

Good luck,

Brad

4

Re: L/O Consideration… Where does it go? - Posted by Stacy (AZ)

Posted by Stacy (AZ) on June 08, 1999 at 20:45:14:

Bill Bronchick had the same question asked recently on his site, and his reply was that normally it is applied to the purchase price (if the T/B ends up buying), but everything is negotiable.

Stacy

5

Re: L/O Consideration… Where does it go? - Posted by Steve Heller

Posted by Steve Heller on June 13, 1999 at 20:23:08:

Brad,

Thanks for your post. Would you please look at the post I just made to JPiper in this thread and tell us if you agree with the logic. Thanks a million!

Steve Heller

6

Re: L/O Consideration… Where does it go? - Posted by JPiper

Posted by JPiper on June 10, 1999 at 09:32:00:

Hi LW:

I’m gathering you’re referred to Brad’s post on option consideration and rent credits.

I thought Brad made an excellent point?..that option consideration is treated as defined in the contract. Just a few additional comments.

No where in my contract do I refer to “downpayment”. I only refer to option consideration, and it applies to the purchase price in my contract. Similarly, I apply rent credits to the purchase price.

Understand that how you or I treat option consideration has absolutely NO bearing on what a lender may decide to do when the option is exercised. TODAY there are some lenders who will treat a lease/option as a refinance. Note the emphasis on today. This could change tomorrow as lending conditions and programs change?it’s not engraved in stone. But in the case of a refinance, the lenders concern will be the appraised value of the property. Downpayment will NOT be a consideration. What will be a consideration is the appraised value, and the size of the loan relative to that value. In this case, option consideration and rent credits all serve to reduce the size of the loan needed for exercise?.because they are all applied to the purchase price.

Other lenders today will treat the exercise of a lease/option as a new loan. Therefore they will expect a downpayment. In this case the initial option consideration can be used as downpayment as long as it is documented and can be proven. It was a payment made from buyer to seller. What gets a little murkier is that ONLY the rent in excess of fair market rent may be used as a downpayment. In other words if the rent is $500, and you have give $200 rent credit, and the FMR is $400?.the lender will only consider $100 per month as part of the downpayment?not $200. However the $100 that is NOT counted by the lender still serves to reduce the size of the loan needed by the optionee.

In other words, your contract can specify how much rent credit?.but it can’t dictate the lender’s loan program. Lender’s decide whether a lease/option is a refinance or a new loan. Lender’s decide on how much downpayment, if any, is necessary. In my mind your lease/option contract should not concern itself with lender issues?.because these are all changeable at any time.

Again, I apply all option consideration and rent credit toward the purchase price. I carefully document payment of option consideration AND monthly rental payments. When the time for exercise arrives the optionee and I will figure out what type of loan program best works for him, and can adjust our numbers accordingly depending on how that loan program views the lease/option.

JPiper

7

J.Piper, Is this correct??? - Posted by L.W. Block

Posted by L.W. Block on June 10, 1999 at 01:03:25:

Steve, I’m sorry for questioning your information. I would just like to make sure your most excellent post is correct. J.Piper, I thank you for all of your time and effort spent on this site.

L.W.Block

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Re: L/O Consideration… Where does it go? - Posted by Brad Crouch

Posted by Brad Crouch on June 13, 1999 at 21:28:39:

Steve,

> It sounds like you are suggesting that if the TB does
> not have the required down payment neccessary for the
> loan that you will come out of pocket with the TB’s
> option consideration and use it as part or all of
> their down payment. Sounds like a workable concept.
> You provide the down payment from their option
> consideration

(in other words, you reach into your pocket and come up with the downpayment FOR them? Not “workable” at all!)

> and pick up a check for the difference at the closing
> table (i.e. purchase price, less no option
> consideration, less rent credits).

No, Steve . . . this is not something I would do. If the tenant buyer had difficulty in exercising his option, why should I make that MY problem? Or make less money because of HIS shortcomings?

I want as much initial option consideration as I can possibly get! And its got to be NON-REFUNDABLE! And if the tenant buyer cannot “perform” by the end of his option period, he has to either re-negotiate a longer term or move out. If he moves out, I can make the SAME OFFER to the next guy and receive initial option consideration, AGAIN! Please explain why you would be willing to loose money due to the non-qualifying charactistics of a tenant buyer?

I will do my “part” by only selecting a prospective tenant buyer to occupy the property who “appears to possess” the ability to exercise an option to purchase the property within the time frame we have agreed upon. I will even send the tenant buyer (or his paperwork) to a mortgage broker (like Ed Garcia, who is located in my local area . . . more or less) to determine whether or not this person COULD qualify for a purchase loan within the time frame before us. This action would take place as part of the acceptance process, and well before the tenant buyer actually moved in.

If there was a screw-up somewhere by whomever, or the tenant buyer just needed some more time, I would be willing to extend the option period . . . for a fee (more non-refundable option consideration . . . to also be applied to the purchase price, in my case. Though it doesn’t necessarily HAVE to be).

> This would probably be looked on favorably by the
> sellers since you are basically ‘guaranteeing the
> monthly payment and the TB’s down payment’.

Absolutely, the tenant buyers would LOVE you. Do you really think they care whether or not you financially damaged yourself in the process of helping them by paying THEIR downpayment? Noooooo! They just want in!

Even if they found somebody to put up their down payment for them, what would be the tenant buyers financial committment to the property? If money gets a little tight . . . “Oh well . . . we’ve got nothing in this property anyway, we might as well stop making ANY payments. It’ll take them several months to get us out. And by then, maybe we can find another place and who knows, maybe even another sucker”.

Sorry to rain on your parade, Steve.

Brad

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Re: L/O Consideration… Where does it go? - Posted by Steve Heller

Posted by Steve Heller on June 13, 1999 at 20:17:48:

Jim,

It sounds like you are suggesting that if the TB does not have the required down payment neccessary for the loan that you will come out of pocket with the TB’s option consideration and use it as part or all of their down payment. Sounds like a workable concept. You provide the down payment from their option consideration and pick up a check for the difference at the closing table (i.e. purchase price, less no option consideration, less rent credits). This would probably be looked on favorably by the sellers since you are basically ‘guaranteeing the monthly payment and the TB’s down payment’. Is this correct? Sounds great to me!

Steve Heller

10

Re: J.Piper, Is this correct??? - Posted by JPiper

Posted by JPiper on June 10, 1999 at 10:45:30:

Oops. Posted under Brad’s name. Sorry about that.

JPiper

11

Re: L/O Consideration… Where does it go? - Posted by Steve Heller

Posted by Steve Heller on June 10, 1999 at 03:02:42:

Brad,

Thanks for your post. I don’t think we’re on the same wave length. What I am suggesting is the TB pays me the option consideration. If they move or can not qualify for the loan after their lease period expires then I keep their option consideration. In other words , they understand upfront that the option consideration is ‘non-refundable’. But what I do tell them is that I will use part if not all of their option consideration to make their down payment, provided they qualify with the lending institution for the loan. Now with that said, at the closing I bring a check for their down payment and I get a check for the diffence in what I agreed to pay the seller and what I sign the purchaser up for, less any rent credits.

So I get the option consideration back at the time of closing and I am out the down payment money from the time it takes me to get it and close on the deal. It sounds like this could work and the sellers would be more motivated to do the deal if they knew I was guaranteeing the TB down payment provided they qualify for the loan. What do you think?

Steve Heller

12

Re: L/O Consideration… Where does it go? - Posted by JPiper

Posted by JPiper on June 10, 1999 at 05:41:50:

Steve:

Sounds like there’s some confusion here.

Option consideration, as long as it is properly documented and proven, IS considered to be a downpayment by the lender. This money was given TO you by the tenant/buyer?..it’s not given to the lender. It doesn’t have to be re-materialized at the closing between you and the T/B. You don’t have to come “out of pocket”. The lender doesn’t receive the downpayment.

Keep in mind that SOME lenders DON’T require a downpayment at all. SOME lenders view the financing of an exercise as a refinance?..NOT a new loan. Refinancing DOES NOT require a downpayment.

There are some types of lenders who have loan programs who will view the transaction as a new purchase and therefore will require a downpayment. THEY establish what the amount of the downpayment is. The amount of this downpayment will vary depending on the type of loan, and the qualifications of the tenant/buyer. BUT, while the lender may require a downpayment, THEY don’t receive it.

I haven’t been one to do sandwich leases, but if I did I WOULDN’T guarantee the seller ANYTHING, other than I will make the monthly rent payment, and take care of the repairs?..in other words, the things specified in the contract. I WOULDN’T guarantee that I will make the downpayment, if one is required, for the tenant/buyer. I wouldn’t discuss in detail anything regarding a tenant/buyer with the seller. As far as the seller is concerned, he has a contract with me.

Would I help the tenant/buyer if it were necessary? Depends on the situation. If I were in the middle of a sandwich lease, and had a $15K equity to pick up if the t/b exercised, and he needed some help with closing costs, or perhaps a small second?..I probably would. But this is not something I guarantee in advance?..it’s something I decide at the time based on all the facts.

JPiper