Neophyte Investor - Posted by Richard Jackson


#1

Posted by JPiper on October 22, 1998 at 13:08:20:

Tom:

I think the point you’re missing here is that when the lease and option are written on the same document, you may well have equitable title issues IF the tenant buyer goes to court over this issue.

Your documents may say anything that you put in them, and the tenant may well accept them. But when you get to court the documents will be interpreted not just based on what they say, but based on established legal doctrines and case law. One of those doctrines has to do with equitable title. If it is determined that based on your document that equitable title exists, the judge could rule that you need to foreclose under the document rather than evict. If this is the case the foreclosure would need to be a judicial foreclosure, which would necessitate time varying on the existing court system, and cost. Obviously these would exceed the time and cost of an eviction.

The question is not whether the tenant has a leg to stand on. If he is in default he is in default. The question is how you legally remove the tenant once he’s in default. Having one document rather than two with your tenant heightens the risk that a court might determine your situation to be an equitable title situation. That’s a risk that I personally would not want to take.

One other point, there is some legal precedence for the idea that the separate lease and option MAY not violate a due on sale clause…whereas an agreement on one document might. Again, a court would determine this.

One of the areas that we’ve seen this in the past is the contract for deed. Many of the contracts state that if the buyer defaults, a quit claim will be filed, and the buyer becomes a renter, and thus subject to an eviction. Courts in some states have ruled that despite this agreement, that the buyer has equitable title, that he can’t sign away his right to a foreclosure, and therefore the contract must be foreclosed on judicially.

As for your thought that by separating the documents that you tranfer the option, this is a valid point. I don’t transfer options, so this is a moot point to me. But certainly it’s an idea worth considering prior to entering into the agreement, and structuring this way if that is your goal.

JPiper


#2

Neophyte Investor - Posted by Richard Jackson

Posted by Richard Jackson on October 21, 1998 at 09:03:18:

I’ve just recently completed a Carlton Sheets home-study course and am ready to embark on that long road to financial freedom.
I am working on a deal to lse opt a house, however, the lease option forms in the course, I think, are more for selling a property on a lse opt than buying a property with one.
Has anyone out there modified his “Buyers Contract” to purchase with a lse opt? If so, what changes did you make?
I’m presenting the deal on Friday and what I did was write up the contract like I was buying it today but added an addendum to incorporate the lease option conditions.
If there is any one out there in the Sacramento, CA. area send me an e-mail and lets talk about starting an investment club. I need all the help I can get!!!


#3

Re: Neophyte Investor - Posted by paul(OK)

Posted by paul(OK) on October 21, 1998 at 12:51:41:

Not that it is my information. I am recycling what I have read here previously. You might consider having a competent lawyer examine your form before using it in your state. Thats my 2/100th of a dollar. good success.


#4

Re: Neophyte Investor - Posted by Mike Flewelling

Posted by Mike Flewelling on October 21, 1998 at 12:16:29:

Normally a contract with typed terms favorable for the buyer should be used to obtain property. When you lease/option your property a contract with typed terms favorable for the seller should be used. Any course on this site that deals specifically with lease/options has two distinctly different contracts. If you plan on doing lease/options, I highly recommend obtaining information targeted at lease/options instead of relying on more general information that you have obtained from CS. It will be money well spent.


#5

Re: Neophyte Investor - Posted by Brad Crouch

Posted by Brad Crouch on October 21, 1998 at 12:15:28:

Richard,

Sounds to me like you want a “sandwich lease option” type senario. If so, you might want to consider Bill Bronchick’s method.

Use a single document for the “master lease” with the seller. The single document contains both the lease and the option to purchase.

When sub-leasing to your tenant buyer, you’ll want to use two separate documents, with no reference to the option, in the lease agreement.

There are different contracts for buying, than for selling. You want the contracts you use to be slightly “skewed” in your favor, whichever side you happen to be on at the moment.

All the forms you need for this are in Bronchick’s courses, “How to be Your Own Real Estate Lawyer” and “Lease Option Workshop”. I recommend both of these courses.

If you don’t have the time to wait for delivery (a few days), try going to http://www.legalwiz.com. When you get there, click on “Forms” for some samples.

Luck,

Brad


#6

Re: Neophyte Investor - Posted by Tom Brown

Posted by Tom Brown on October 21, 1998 at 16:40:47:

I think the exact opposite is true in a lease option situation. You should generally use a separate lease and option with the seller and a combined lease option with the tenant for the following reasons:

A separate lease and option with the seller gives you two separate commodities that can be sold, traded, etc. Also the breaking of the lease does not void the option or vice versa.

With the tenant, you want to use a combined lease and option. That way if the tenant breaks the lease terms, the option is null and void. It helps keep the tenant in line, especially if they have put up a considerable amount of option consideration.

If Bronchick is teaching the method that you described, to me it flies in the face of the common sense approach although his specific contracts may accomplish the same thing that my approach does.


#7

Re: Neophyte Investor - Posted by JohnBoy

Posted by JohnBoy on October 22, 1998 at 12:42:11:

Ok, lets see if I understand this correctly.

You as the buyer approach the seller. The property has a FMV of say $95k. Rents are going for $800 in the area. On a lease option you could get maybe a $1000 from your sub-tenants.

You agree on terms with the seller to l/o their property for $700 per month with an option to buy for $80k. You draw up separate contracts.

Now you find your sub-tenant that you lease option to at $1000 per month with the option to buy at $100k which you recieved $5k down as option consideration. You tie this end up by using one contract with the lease and option tied together between you and your sub-tenant.

Now you say you could sell your underlying contracts off between you and the seller to different parties. What do you have here to sell? You have a lease that you are paying out $700 per month to the sellers. What’s in this liability that I as an investor would want to buy? Nothing. You couldn’t give that to me. Now you have an option to sell that is for $80k on a $95k property and is tied up for a year to someone else that has an option to buy at $100k with a balance due of $95K. $15k equity IF the sub-tenant exercises their option or I have to buy the property myself to protect my investment. How much would that be worth to sit back and hold for one year? Not much if anything at all. So what do you really have to sell by using two contracts? Not much or nothing. Who would buy that? Would you? How much would you pay for it?

I think you have this entire thing backwards.

Now if you had one contract tied to gether between you and the seller and then used separate contracts between you and your sub-tenant, you have something more valuable. Now you can sell your underlying contract with your tenants contracts to someone else that has a good cash flow ($300 a month) and $15k equity in the property tied up with an option to buy from a the same party paying you the $300 a month cash flow. You recieved the $5k down as option consideration from your sub-tenant and a small assignment fee from someone else by assigning your contracts over to a third party.

By using separate contracts between you and your seller you have an underlying lease with no cash flow with a $700 a month liability. Who would consider wanting that? The option has a potential $15k value IF the subtenant exercises their option. IF they don’t exercise the option, then I would have to come up with $80k to exercise my option just to protect the fee I paid you to take over your option. Why would I want to do this? I’d be betting on the come here with an $80k liability if the sub-tenant doesn’t exercise the option. No Thanks! Would you buy that?

Please clarify what you mean here?


#8

Re: Neophyte Investor - Posted by Brad Crouch

Posted by Brad Crouch on October 22, 1998 at 03:46:19:

Tom,

> A separate lease and option with the seller gives you
> two separate commodities that can be sold, traded,
> etc. Also the breaking of the lease does not void the
> option or vice versa.

Why would you want to do this? If the lease is broken, for any reason, that will automatically void the option. Then you can find a new tenant buyer, and do it all over again . . . with MORE initial option consideration and a higher strike price than before (after all, the property has now appreciated, right?)

Sounds kinda like a “money pump” doesn’t it?

If you wanted to do this, why call it a “sandwich” lease? You could master lease with an option to buy, and then just rent the place out. Then you could sell to a new buyer with a tenant already in place. It seems to me that the tenant would be the logical choice as “buyer”, but you could find someone else.

The option would have no value if the lease were in default. And the “option” . . . how valuable would that be if a person had to wait for the lease to expire (of the present tenant) or evict, if the tenant ever defaulted?

> With the tenant, you want to use a combined lease and
> option. That way if the tenant breaks the lease
> terms, the option is null and void. It helps keep the
> tenant in line, especially if they have put up a
> considerable amount of option consideration.

If the tenant buyer has put up a sizeable amount of cash for the initial option consideration, the thought of loosing all that cash, should be enough to keep the tenant “in line”. But there is also the “rent credit”. It doesn’t get applied towards the purchase price if the monthly payment is late. That’s a pretty big “ouch” for the tenant buyer. Also, if the payment is as much as 15 days late (or whatever time limit you decide upon), the whole option to purchase, can be revoked. Not to mention the upkeep of the place . . . if this is not kept “up to snuff”, that’s ANOTHER reason to revoke the option or lease.

It’s mostly about “equitable interest” as Rob put it so well. But here’s another possible senario: suppose you find a tenant buyer who puts up a lot of cash for the initial option consideration (as you said). Lets say his year or 18 months go by and the tenant buyer cannot get the financing he needs to exercise his option. The logical thing to do would be to renew his option and start working with him to clean up his credit so he could later qualify (or hook him up with a mortgage broker who will do this). But the renewal of his option is not free! So maybe you charge him half the original amount of his option consideration. But guess what? He no longer has an appetite for this and no wants his money back, even though the agreement clearly stated that this money was “non-refundable”.

So he goes to court claiming he has an “equitable interest” in the property.

Do you want the judge looking at a lease agreement, or a lease agreement WITH an option to purchase?

> If Bronchick is teaching the method that you
> described, to me it flies in the face of the common
> sense approach although his specific contracts may
> accomplish the same thing that my approach does.

Bronchick has a strong lease agreement (pro landlord) that makes no mention of an option to purchase.

In paragraph 3 of Bronchick’s option contract, it points out that if there is a default of ANY term of the “attached lease”, the option will be void.

In paragraph 4 it says that any recording of the option contract (or memorandum) will also void the option and it makes the tenant buyer responsible for all costs involved in clearing up the title if that should be necessary.

Tom, I know I’m not always right, But I sure would appreciate it if you would show me where I’m wrong on this.

Brad


#9

Re: Neophyte Investor - Posted by Rob FL

Posted by Rob FL on October 21, 1998 at 19:15:54:

The reason why you need 1 document when you buy with a l/o is the same reason why you need 2 documents when you sell on a l/o.

When you buy you want to obtain an equitable interest in the property. If you are the buyer and for some reason you miss a payment or default on the lease, you still have an equitable interest. If the seller wants to evict you, he may have to actually foreclose because you have an equitable interest; you are not just a tenant anymore. Kind of like a contract for deed. Also, most l/o agreements even if they are 2 separate documents, specify in the option that if you default on the lease payments that you default on the option as well. Most people would refuse to buy your option from you if they found out you were in default, simply because there is a huge risk that all of your equity may be in jeopardy.

As for selling on a l/o, the reason why you want 2 documents is specifically to separate the lease from the option to purchase. If the tenant defaults on the lease you evict them. Their equity is only dependant on whether or not they execute the option agreement. If the judge said lets look at the lease you are evicting on, he would not see a reference to the option. If they were combined he might say the tenant is a part-owner and therefore cannot be evicted but must be foreclosed or partitioned. The option references the lease, but the lease does not reference the option.


#10

Re: Neophyte Investor - Posted by JPiper

Posted by JPiper on October 21, 1998 at 17:04:22:

Tom:

I see your point. Certainly as the buyer via l/o having the lease and option on separate forms does give you a tradeable item. I think that’s an important consideration.

Selling with the lease and option on the SAME contract to me creates a risk…that risk being that you MAY have inadvertently created an equitable title situation. My preference would be to sell on separate documents as well. Your option agreement may be worded to make it invalid it invalid if there is not an existing lease.

Finally I would say that what your intent with the property is would determine which direction you wanted to go in terms of forms if you are the buyer. I would rather have one agreement and create the possibility of equitable title if I were the buyer, and if I had no intent to sell or trade my option. Sometimes common sense and the law are entirely different subjects.

JPiper


#11

Re: Neophyte Investor - Posted by JPiper

Posted by JPiper on October 22, 1998 at 13:44:06:

John:

I have to disagree with you here.

Under your scenario the lease portion creates a cashflow of $300 per month. Tom doesn’t say how long the lease is but if we assume 1 year, there’s a potential cashflow of $3600. This would appear to me to have some value, although speculative, if you believe that the tenant will pay.

Likewise, under your scenario you have the property tied up at $80K with your option, and have given your tenant/buyer an option for $100K (on a property worth $95K). Your scenario doesn’t give a time period, but let’s assume 1 year. Again, you have a potential $20K profit over the course of the year. This might have value to someone. If the tenant/buyer doesn’t exercise you would have to exercise at $80K, but could resell immediately for $95K. Looks like value to me.

I think Tom’s idea of having your purchase on two separate forms has merit if the goal is to try to sell these documents separately to another party. Obviously at the time you wrote the initial deal up this would be a consideration.

Where I personally would bog down a little would be with the idea of having the tenant/buyer sign one document.

JPiper


#12

Re: Neophyte Investor - Posted by Tom Brown

Posted by Tom Brown on October 22, 1998 at 09:38:06:

A separate lease and option with a seller when YOU are the buyer is what I was talking about. The lease is a separate legal document and the option is a separate legal document. Breaking the lease does NOT void the option. The option expiring does NOT void the lease.

Who says you have to give your tenant a rent credit?

The option is attached to the lease like an addendum. It is specifically spelled out in the option that the option is contingent upon the satisfactory performance of the lease. That is PART of the option consideration.

I have no trouble with a judge looking at my lease with attached option, the tenant doesn’t have a legal leg to stand on.

As far as the majority of the other points you brought up, there is nothing to preclude you from doing those things with a separate lease and option. But there are things you can’t do with a combined lease/option that you can do with separate documents.

Whether you would ever want to, well, that would depend on the situation, but at least you would have the flexibility if you needed it.

Tom


#13

Re: Neophyte Investor - Posted by Tom Brown

Posted by Tom Brown on October 22, 1998 at 10:19:56:

>>>>When you buy you want to obtain an equitable interest in the property. If you are the buyer and for some reason you miss a payment or default on the lease, you still have an equitable interest. If the seller wants to evict you, he may have to actually foreclose because you have an equitable interest; you are not just a tenant anymore. Kind of like a contract for deed. Also, most l/o agreements even if they are 2 separate documents, specify in the option that if you default on the lease payments that you default on the option as well. Most people would refuse to buy your option from you if they found out you were in default, simply because there is a huge risk that all of your equity may be in jeopardy.

Using two documents works like this. The lease is a separate legal document and the option is a separate legal document. If the lease is broken, it DOES NOT void the option. It all depends on how you write the documents.

>>>As for selling on a l/o, the reason why you want 2 documents is specifically to separate the lease from the option to purchase. If the tenant defaults on the lease you evict them. Their equity is only dependant on whether or not they execute the option agreement. If the judge said lets look at the lease you are evicting on, he would not see a reference to the option. If they were combined he might say the tenant is a part-owner and therefore cannot be evicted but must be foreclosed or partitioned. The option references the lease, but the lease does not reference the option.

Part of the option consideration is the satisfactory performance of the lease. If the lease is broken, the option is void. The tenant has no equitable interest in the property. The option is attached to the lease like an addendum.

The tenant has no legal leg to stand on.


#14

Re: Neophyte Investor - Posted by Tom Brown

Posted by Tom Brown on October 22, 1998 at 15:10:35:

Option Contract

In consideration of the Resident’s faithful compliance with the terms of the attached rental contract…

The faithful compliance with the lease is the option consideration. Not complying with the lease nullifies the option consideration, so there is no option by definition since there was no consideration. It would be the same as if I promised to pay you $1000 in 30 days if you signed an option for me. If I didn’t pay the money, the option is not a valid contract by definition. You are not voiding a valid option because there never was one.


#15

Re: Neophyte Investor - Posted by JohnBoy

Posted by JohnBoy on October 22, 1998 at 18:34:27:

Let me clarify what I was referring to here.

Yes, I was assuming a 1 year lease. Yes, the cash flow between the sub-tenant and buyer would be $300 per month and $15k equity with the option.

But my point is about the two separate documents between the buyer and owner. Not the one l/o document between the buyer and sub-tenant.

The buyer has a lease to pay at $700 per month to the owner and a separate option to buy at $80k. The purpose behind separating the two documents was so you could sell off the lease to one party and sell off the option to another party. In this case the option does have some value. ($15k) The lease has no value at all. Here’s what I mean by this:

The buyer has one l/o agreement with the sub-tenant which would have the $300 a month cash flow. But the underlying lease for $700 per month has no cash flow. Only the obligation to pay $700 rent. The buyer still holds the sub-lease which is paying $1000 per month. He’s separated the underlying lease option to sell off those two documents separately. If you sell off the underlying lease, I still hold the secondary lease in which the payments of $1000 are coming to me, not the person that would have bought the underlying lease. He didn’t buy the sub-lease, only the underlying lease which has no value to a 3rd party without assigning the sub-lease along with the underlying lease.

After I posted on this I keep thinking about how you could split the two underlying documents to sell off separately with only one document as the sub-lease. Which one gets the sub-lease? The party that buys the underlying lease or the one that buys the underlying option? This is when I figured out there is only one way to work this by having the one document sub-lease above the two underlying lease and option.

The party that buys the underlying lease of $700 per month would HAVE to have the sub-lease assigned along with the underlying lease in order to recieve the $300 cash flow. The option could be sold off by itself without assigning the sub-lease along with the option.

Before when I first read the post my thoughts were who in the world would want to just buy an underlying lease with $700 rent payments by itself? This alone would have no value to me. Only an obligation to pay $700 rent on a property someone else is living in. This is what I was referring too.

As long as your going to create separate documents between the buyer and seller, then why not create separate documents between the sub-tenant and buyer also? For one, you would limit your liability between you and the sub-tenant if the tenants were to ever default or couldn’t get financing and start claiming they have an equitable interest in the property. The second reason would be so you could sell off the underlying lease and assign the sub-lease along with the underlying lease. Then sell off the option and assign your interest in the secondary option along with the underlying option.

I would assume the underlying lease and option would be for a minimum term of three years. The sub-lease and option would be for a period of one year. The party that buys the lease would be buying three years of cash flow. He could also have the potential of increasing that cash flow by raising the rent in the second and third year. The party buying the underlying option could sell another option in the second year for a higher option price and a higher option price again in the third year providing no one exercises the option in the first or second year.

Ooops! I just thought of something else. Assuming the underlying lease and option were for three years or longer, the party buying the lease would have something else to consider. What happens if the sub-tenant exercises the option? The sub-tenant would have a new mortgage to pay and would also have a valid lease thats good for three years being controled by someone else. Will the tenant have to honor that underlying lease until it expire’s? That lease allows the party holding it the right to sub-lease and only pay the new owner $700 per month. This would leave the new owner with a negative cash flow since their new mortgage on a $100k property would more than likely be more than $700 per month PITI. Would the new owners have to move out and allow the party controling the lease rent to someone else? I only see two ways to possibly avoid this from happening. One is to have the underlying lease for the same term as the sub-lease. The other way would be to put some kind of a clause in the lease that states the lease would become void should the optionee ever exercise the option. So how much of a value would you place on that underlying lease now? On the first choice by having the terms of the underlying lease and option the same as the sub-lease and option, you would have to have a clause in the second option that states the option can only be exercised at the end of the term and not at anytime before or during. Otherwise you would need the clause in the lease that voids out the lease early should the option get exercised early.

Although the idea of all this sounds good to have the documents separated for the purpose of selling them off separately, it sounds like a lot more liability and risk by having different underlying parties holding separate documents while the sub-tenant has a right to exercise the option at anytime.

At first the idea sounded pretty good. But now I don’t think its all the good anymore without putting restrictions in the lease and the option to protect the sub-tenant from ending up with a problem. I think I’ll stick to one document with my seller and the two separate documents with my tenant/buyer.

What do you think?


#16

Re: Neophyte Investor - Posted by Tom Brown

Posted by Tom Brown on October 22, 1998 at 15:16:38:

I should probably point out that I recently moved cross country and even though I was a landlord in OK, I don’t really intend to be one in a major way in GA. My focus is primarily going to be getting chunks of cash or payments instead of being a landlord.