This seems too easy ... what am I missing? - Posted by Ed Eaton

Real Estate Investing
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Posted by Houserookie on August 27, 2003 at 22:01:30:

or department of commerce. When in doubt go to the people that issued the license.

Contact the local board of Realtors as well.

Several years ago I turned in a Realtor and appraiser. They tried to inflate an appraisal with false comps and lied about repairs being done.

Not only did I decline to fund the deal, I turned them into the California Association Of Realtor and licensing board.

It has been awhile and I’ve forgotten the details.
I can only recall that they weren’t very happy.

Cheerz,

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This seems too easy … what am I missing? - Posted by Ed Eaton

Posted by Ed Eaton on August 26, 2003 at 01:51:29:

I’ve been trying to pick one or two good strategies and really focus on them, because right now I’m running around like a chicken without a head trying to learn a million different things at once and it’s a little stressful. I have somewhat motivated sellers calling on my bandit signs etc. but obviously most either aren’t quite motivated enough and/or they don’t have enough equity, etc. Then I read an old post made by JohnBoy and it made a lot of sense to me. The post is at:

http://www.creonline.com/wwwboard/messages/arc_2002/arc_05/5344.html

The first 3 pages talk about a strategy involving paying close to full price for houses by buying them subject to, and then turning around and selling it to a tenant/buyer on a lease option. The whole thing just sounds like a no brainer. Finding people with little or no equity in their properties that you can take subject to seems easy enough. Then selling it to a tenant/buyer for 5-10k down, slightly higher than market rent, and an option to buy for a price that basically just includes standard appreciation 1-2 years later seems like a no brainer as well. And after you ran that first ad or otherwise advertised that first property, you’d have a whole list of people looking for properties and so from then on it sounds like you could unload the properties pretty quick.

I understand some of the risks of remaining in the middle of a deal like this. But we have cash reserves in an amount that is more than enough to cover any “problems” that may arise. This whole strategy just seems perfect … no talking to 100 “motivated sellers” just to find 1 that will accept your “lowball” offer, no banks to deal with, no closing costs (aside from title insurance and misc fees), no significant holding costs, and no realtor commissions or other selling costs at the end of the deal. It just seems almost too good to be true. What am I missing??

I just put out about 25 bandit signs over the past 2 weeks. I’ve received about 10 calls so far, and out of those 10 calls I’m pretty sure I could buy at least 2-3 properties subject to with at least 10% built in equity. Can’t imagine they are too hard to sell on L/O … because I see other investors’ “house for lease” or “rent to own” etc. signs all the time, and they are usually gone a week later. Plus this type of strategy is just so straighforward and laser focused. My enthusiasm and anxiousness to really get started could be affecting my judgement, so I just wanted to see if I’m missing anything really important here.

What are YOUR thoughts about this strategy, as JohnBoy describes it in the first 3 pages at the post mentioned above?

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Re: This seems too easy … what am I missing? - Posted by Jeff TX

Posted by Jeff TX on August 27, 2003 at 11:48:06:

I want to respond to your original question as to whether this is too good to be true. (By the way: I didn’t take the time to read JohnBoy’s post you referred to. Although I have read many of his posts over the last couple of years.) I am somewhat of a newbie myself. I have purchased 4 houses subject-to over the last year and sold 3 of them to tenant/buyers on rent-to-own. (The fourth is a rehab in progress)

My experience so far is that there will be some motivated sellers who will easily give you deed, but others who seem like they would benefit the most just won’t do it. Just move on to the next one and don’t try figure sellers out.

In theory buying subject-to and selling on L/O is fairly easy. However, you will run into problems along the way, such as unexpected repairs or a great house in great neighborhood sitting on the market for 2 months for no good reason. I have had problems finding good contractors, handymen, and maids. All very frustrating problems at the time.

On the other hand my most recent deal I bought from the seller and sold to a tenant buyer within 10 days.

This stuff takes alot of work. You will make mistakes and you will probably lose money at some point. That’s business. Keep going and learning, and you will make money in the long run.

As for buying properties with no equity… Avoid it unless you can produce some killer cashflow. Try to find properties with a little bit of equity. I have to make $20,000 on every deal, and I look for properties priced from $80 to $120k. The median price in my area is $139k.

As for the ethics discussion, you can probably guess where I stand. Sellers thank me on their way out the door, and tenant buyers thank me on the way in. I am also trying to get my T/B’s to refi because at my point in the game I need that $20k that I talked about before.

Learn your market conditions and talk to an experienced investor that you trust before you sign up any deals at the begining.

Best of Luck,
Jeff TX

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Re: This seems too easy … what am I missing? - Posted by Ronald * Starr(in No CA)

Posted by Ronald * Starr(in No CA) on August 26, 2003 at 05:20:48:

Ed Eaton-----------

Since it seems to be working for other people in your area, it likely will work for you. At least until the housing market changes, if it does. Some people are reporting that is not working well in their areas these days because the low interest rates allow the renters with better financial situations to buy houses outright. Thus they are having to chose renter from the “bottom of the barrel” applicants. Result: higher default rate, more damage to properties, more expenses, less profit.

This approach is not new, it has been around for years. But it was rarely used until the past half-dozen years or so. Now it is very popular among newer real estate investors. But it has been popular only when we have had an “up” market–increasing house prices pretty much everywhere in the USA.

I predict that should your housing market experience declining prices that the selling or “exit” end of things will be a nightmare. Which potential homeowner is going to want to pay even the current market value for a property–let along a higher one–for a property when they expect it to decline in value over the next few years? And what is their motivation to pay more than market rents?

There are also some ethical issues, which Johnboy does not like to talk about. And most of the other practioners of this approach avoid discussing. I’m not going to tell you what your ethics should be. However, I do suggest that you read Jack Reed’s discussion about the topic on his www.johntreed.com website.

Understand that many practitioners of this lease/option selling approach do not like Jack Reed. But their arguments about the ethical issues are generally not well articulated, with the possible exception of Johnboy. I don’t know if his arguments are still around or not. But you might do an archive search here in the main board of this CREONLINE.COM website to see if you can find them. Unfortunately, some people have emotional, nonlogical reactions to what Jack Reed says, Johnboy included. It is impossible to communicate intelligently with them on the subject of Jack. I know, as I have tried.

Jack also has some concerns that the lease-option programs might be recharacterized by the IRS as being contract for deed sales (also known as contract of sale and other names in some states). Even he admits that he does not know that it happens. However, he suggests that a lease with option really is a contract for deed. Just study the major aspects of the two. I agree with him on this one.

If the IRS were to recharacterize the lease option as a contract for deed, the sale of the property for income tax purposes would be set at the time that the lease option was effective, at the initiation. So, the tax liability would be for the tax year that includes that date. So, if you have not declared it as a taxable sale on your income taxes, you would have to pay late fees, penalties, and so on.

Also, many people who hold for a couple of years and then sell who would claim that this is a long-term holding and thus eligible for capital gains treatment. They would lose this argument if their deal were recharacterized as a contract for deed. All of the gain would be taxable at ordinary income tax rates, not long-term capital gains rate.

I don’t know that the IRS will start massively recharacterizing lease-options as contract for sales. However, I think you should at least consider the possibility. As I said, the lease-option phenomenon has increased greatly in recent years. It may be that it has gotten big enough to interest the IRS. I have no evidence that this has occurred. Do you have any evidence it has not?

I am not planning on using this investment technique myself. So, I will not be hurt if the IRS cracks down. I hope you will not be hurt either.

Good InvestingRon Starr***

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My comments… - Posted by Ed Eaton

Posted by Ed Eaton on August 26, 2003 at 11:17:47:

Hi Ron, thanks for your detailed reply. Since you made several points I wanted to address them separately …

“I predict that should your housing market experience declining prices that the selling or “exit” end of things will be a nightmare. Which potential homeowner is going to want to pay even the current market value for a property–let along a higher one–for a property when they expect it to decline in value over the next few years?”

It seems logical to me that if the prospective tenant/buyer thinks the property is going to decline in value that they wouldn’t enter into the agreement in the first place.

“And what is their motivation to pay more than market rents?”

Generally speaking, whether as part of a L/O or not, it seems that many people who can’t qualify for traditional bank financing would be more than happy to pay a slight premium above current market rents. Especially if they were receiving rent credits. No?

You make a good point but it seems like it wouldn’t be a problem unless the market really went south and everyone thought that prices were going to decline. Basically the opposite of where we’re at right now, and I don’t assume too many people would be buying houses at all if they thought prices were going to decline, whether it was via my L/O deal or a house they found in the MLS. It just doesn’t seem likely that it would get that “bad”. Worst case scenario I would just rent the properties out and bank the cash flow, like you do. After all, I would be buying the houses at least 10% below FMV and you and I both know that low end “starter houses” generally cashflow very well.

If anything it seems like now is the perfect time to start using this type of strategy … because the people you’ll be buying properties from subject to their existing mortgage, people who have generally only owned the house for a year or two, will probably have an interest rate that is relatively low…

"There are also some ethical issues, which Johnboy does not like to talk about. And most of the other practioners of this approach avoid discussing. I’m not going to tell you what your ethics should be. However, I do suggest that you read Jack Reed’s discussion about the topic on his www.johntreed.com website. "

I just searched the site and can’t find any page or article where he states his opinions on subject to deals. I searched through the articles, guru pages, etc. and couldn’t find it. Perhaps you could share the URL? Or briefly describe what the “ethical issues” are? I’m not saying I would target people who I thought had no chance of excercising the option if that’s what you mean. Other than that I can’t think of anything even close to being unethical.

Finally, regarding the IRS issue … I’m reading some material now that supposedly eliminates the chance of this happening as long as you have all your ducks in a row, use the correct paperwork and procedure, etc. I’m still researching this though …

Thanks for the discussion!

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Re: This seems too easy … what am I missing? - Posted by Dolf

Posted by Dolf on August 26, 2003 at 09:29:53:

Shame on you! How dare you hold up an unethical sleazeball like john t. reed as some paragon of virtue! Sleazy reed has never done a lease-option deal! And he wasn’t done any type of real estate transaction in twenty years!!!

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Re: This seems too easy … what am I missing? - Posted by Dfree

Posted by Dfree on August 26, 2003 at 07:26:41:

RON STARR
I’ve seen your response to Lease/Opt as well as SUB2 investing strategies and they seem to be on the “caution side”. If you don’t mind me asking what strategy do you primarily use and why?

Just wanted to know, chances are you’ve moved on to Million Dollar Multi-Unit Properties which I hear is the eventual graduation of most long-term investors.

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Re: My comments… - Posted by Ronald * Starr(in No CA)

Posted by Ronald * Starr(in No CA) on August 26, 2003 at 11:41:21:

Ed Eaton---------

You are right, the problem would be that the prospect buyers would not sign up for the lease option agreement. That is what I mean by the ??selling or “exit” end of things?? When you sign up the leasee/optionee you are doing your exit.

Yes, if prices slide, the number of people buying regularly will decline also. Thus those who can buy will gain market clout, I would think. Those who can buy will have their choice of ordinary purchases to choice from. Thus, they will be less inclined to mess around with a strange?to them?thing like a ?lease with option to buy.? Better to just buy and not deal with the possibility that it is a scam, or that the seller?you?will not deliver on his/her promise, or that there will be problems with loans in the future. Or, to just hold off buying until it looks like the housing prices have hit a bottom.

Jack Reed has a discussion of lease-option. He also has some discussion of the due on sale clause. In his view taking the property over due on sale is also an ethical no-no. Plus the possibility of the loan being called. As well as the possibility that you are preying on young people who are vulnerable to to promises that will not come true. I think that he puts all of the burden on the seller, and does not acknowledge that the leasee/optionees have some responsibility for what is going to happen also.

However, it is interesting to me how little discussion there is of possible problems with ethics in doing lease-option deals. I think that many people are not very aware of being ethical. I was involved, many years, ago in research on college graduate students, including those in business and law school. We asked a couple of questions about what problems or harm the student thought that she/he might cause people in the future. It seemed that virtually none of the students had even thought about the possibility that they might do harm. It was a surprising question to them.

Good InvestingRon Starr*******

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Re: This seems too easy … what am I missing? - Posted by Ronald * Starr(in No CA)

Posted by Ronald * Starr(in No CA) on August 26, 2003 at 10:46:01:

Dolf---------------

What is going on? You have been maligning Jack Reed every chance you get. Are you jealous? Are you still going through your adolescent rebellion against authority figures? Are you just so emotionally immature that you cannot think logically? All of these seem like very real possibilities to me.

So what if Jack has not owned real estate recently? What is the point of pointing this out? Is this supposed to be a criterion for determining whether you listen to somebody’s advice or not? The length of time when the invest or do not invest? Makes no sense to me.

And your false comments that Jack is “Sleaze” or “sleazeball” makes no sense at all. Jack is a very ethical and moral person. Perhaps a bit conservative for some people’s taste, but an honest gentleman. Where do you get off with this lie?

Of course, that is what you have done all along: lie, lie, lie.

You disgust me.

Good InvestingRon Starr****

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Re: This seems too easy … what am I missing? - Posted by Ronald * Starr(in No CA)

Posted by Ronald * Starr(in No CA) on August 26, 2003 at 10:33:41:

DFree---------------

I buy properties at steep discounts from market value by buying at county tax sales and, in Oklahoma, county tax resales.

I think many investors never “graduate” to multimillion dollar apartment complexes. Some are single family investors. I am comtemplating, however, moving into apartment complexes, consolidating my holdings into a few properties, rather than the many I have now. A main reason is to get more cash flow, rather than appreciation.

Good InvestingRon Starr*******

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Ethics - Posted by Jim (NY)

Posted by Jim (NY) on August 27, 2003 at 09:43:03:

I don’t see how doing lease option deals or trying to avoid the DOSC is unethical. I think that I could argue that the DOSC in of itself is unethical, and buy using them banks try to use their leverage to prevent would-be buyers from assuming an old mortgage that has a low interest rate in lieu of getting a new, higher rate loan (of course, this isn’t the case in today’s low-rate market). Don’t you think that the theory of threatening to call due a loan, knowing that the buyer would never be able to pay it, just to force them to get a new, higher interest rate mortgage is unethical?

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Re: My comments… - Posted by Bryan-SactoCA

Posted by Bryan-SactoCA on August 26, 2003 at 14:33:22:

Sandwich lease options sound good on paper, but if the market goes down in value you have t/b’s locked in to buy a house at above FMV and paying above average rent. OTOH, if the market is appreciating quickly you can end up with a seller who is locked in to selling at a price far below FMV. Either way, you’ll get sued. I never really could convince myself that these problems (along with the DoS clause) didn’t matter and would work themselves out. I’m thinking of doing Steve Cook’s flipping ugly houses to rehabbers technique, but the problem I see with it is that it only works if there’s a lot of equity in the house. What do I do if I find a house with no equity?

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I’m still not following you… - Posted by Ed Eaton

Posted by Ed Eaton on August 26, 2003 at 12:01:50:

You re-iterated 3 points …

As far as home prices declining temporarily, one could just continue to rent out the property as a “normal” rental until the market become more favorable for doing the lease options again. I don’t see the big deal. I would be in the same position that you or anyone else with rental properties would be in, because I paid below FMV for properties that cashflow. What am I missing?

Secondly, regarding the due on sale clause, I think that’s a little like discussing religiton or politics. It seems that people feel one way or another about the issue and won’t budge. Personally my feeling is that unless something is illegal, if no one gets hurt and it is a win-win-win situation, then there is nothing wrong with it. If the lender happens to call the loan due, then oh well, I’ll refinance.

Finally, you mention the ethics again. Since I can’t find Reeds article or discussion on this, I’m not sure what the issues are. I honestly can’t think of any. I’ll keep searching …

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Re: Ethics - Posted by Ronald * Starr(in No CA)

Posted by Ronald * Starr(in No CA) on August 27, 2003 at 10:56:49:

Jim–(NY)------------

We can decide for ourselves what is ethical behavior on our parts.

What the banks do is legal. Ethics is irrelevant, it seems to me. You may not like it. If so, try to get the laws changed. There for a while we had loans readily assumable legally until the Garn-StJermain law got passed. I don’t think it makes much difference to a lot of people.

Jack Reed argues something to the effect that it is an interference with the contract between the lender and the borrower, if I recall correctly. I don’t know if that is right or not. I do know that Jack is sensible and reads a lot of law stuff to understand what is going on. Whether he is right or not, I’m not judging. I recommend that, if you plan to use a certain investing technique, that you understand it well. That includes reading and understanding objections or criticisms of the technique.

Good InvestingRon Starr*****

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Re: My comments… - Posted by Ronald * Starr(in No CA)

Posted by Ronald * Starr(in No CA) on August 26, 2003 at 22:13:06:

Bryan–(CA)-------------------

I would agree with JP’s analysis. There is not much suing in the real world. The cost of attorneys and the uncertain outcome lean against it. I wonder if you might have a tendency to dramatize things? I remember this being a characteristic of some of your early posts. Thus, it may be that you overstate potential problems. You might want to meditate on that idea.

If you are not going to do the no-equity lease-option technique the only other way to go, it seems to me is to determine if there will be a positive cash flow as a rental property. I would suggest that this might be so at the lowest priced properties in the Sacramento area, but not in the middling or higher-priced ones.

And of course, many people advise only buying when there is equity. I lean toward that direction.

Good Investing*Ron Starr

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No offense but… - Posted by JP

Posted by JP on August 26, 2003 at 16:05:55:

Are you actually out there doing any deals or are you just getting started? As far as you saying “Either way, you’ll get sued” I think that is ridiculous. I’ve talked to people who have done 50+ lease option deals and have never been sued. They have to evict every now and then, but have never had any real problems.

You say …

"…but if the market goes down in value you have t/b’s locked in to buy a house at above FMV and paying above average rent. OTOH, if the market is appreciating quickly you can end up with a seller who is locked in to selling at a price far below FMV. Either way, you’ll get sued. "

That is simply not correct. Do you know what an option is? The tenant/buyer would not be “locked in to buy a house above FMV” - that is what an option is. They have the OPTION of buying the property according to the option agreement, but they don’t have to. They could walk away and lose their option fee if they chose to do so.

Your other scenario doesn’t really apply either because for one this thread is not about a “sandwich lease option” as you put it. The strategy involves buying a property subject to, not on a lease option. You sell on a L/O. Even in the scenario you describe, there is no big “problem”. If you did the option paperwork correctly, the seller is obligated to sell you the property. YOU won’t get sued … but there is a small chance he may refuse to sell you the property in which case you might have to sue him. Remind him that when he loses he will have to pay your attorneys fees and other reasonable costs. If he still doesn’t want to sell, sue him and get the property. A small hiccup … especially considering it’s not going to happen THAT often…

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Ron, anything bad about JT Reed - Posted by Houserookie

Posted by Houserookie on August 27, 2003 at 11:50:55:

that you know of? I find pros and cons in every author but I’ve yet to read anything not positive out of you about Reed.

This is not to offend you in anyway. I’m just curious if someone with your experience in the business has anything negative to say about him.

Cheerz,

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I think you summed it up nicely… - Posted by JP

Posted by JP on August 27, 2003 at 11:28:55:

“What the banks do is legal. Ethics is irrelevant, it seems to me.”

There is nothing illegal about trying to get around the due on sale clause, so according to you, ethics shouldn’t apply to that discussion either. Right? It’s pretty cut and dry if you ask me. If the lender finds out and calls the loan due, you better be prepared to deal with it, simple as that. Get a new loan and pay them off. No big deal. No ethics involved here …

I read Reed’s review of Joe Kaiser’s L/O course, and his objections where in regards to the fact that Joe described a deal where he paid like $1 option consideration, less than market rent, with a then-current (or lower) FMV as the strike price (as opposed to paying a “fair” price that included appreciation during the option period, etc.) Reed says that in a case like this Joe is getting an awesome deal and he is ripping off the seller. It’s unethical he says.

I say Reed is wrong. It’s no different than the way a lot of people think “stealing” someone’s house in foreclosure is unethical. The truth of the matter is, if someone has no other options, and what you offer does indeed solve their problem, you are truly helping them and there is nothing unethical about it. Quite the opposite really…

People aren’t going to accept your offer if they have a better option, simple as that.

In my mind, Reed’s statements only serve to remind those who pay attention about his lack of real-world experience.

A wise preforclosure investor once said …

“As the family finished loading their belongings into the U-Haul, they gave me the keys to the house and I gave them the agreed upon $5,000 to help them get back on their feet. With tears in her eyes, she said ‘Thank you so much for what you have done to help save our credit, and our family.’ The first time that happens to you, you will understand.”

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Re: Ethics - I agree - Posted by Jim (NY)

Posted by Jim (NY) on August 27, 2003 at 11:26:33:

Ron, thanks for your comments. Part of my struggle (and hopefully a lot of us) is to find ways to make money in this profession in a manner that is ethical. Sometimes it’s disheartening - I just got off the phone with a realtor who told me that he could get me 103% financing if I put on my application that the property that I was looking to buy would be owner-occupied (even though we both knew it wouldn’t be). I can’t believe, especially over the phone, that he would encourage me to openly commit fraud… Bad stuff…

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Re: No offense but… - Posted by ScottS

Posted by ScottS on August 27, 2003 at 12:57:10:

The best way I can see is to use the Performance Mortgage (DOT) and be sure the seller knows a foreclosure is possible should he not perform as promised.

Escrowing the Deed is good, in the longer ones we worry about it getting stale. we don’t get real excited about recording our option, but the power of that Performance mortgage makes me happy.

ScottS