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Why I Don’t Buy on Lease/Option or Land Contract | By: Multiple Speaker(s)

Why I Don’t Buy on Lease/Option or Land Contract
By Vena Jones-Cox

If you’ve paid attention at all, you’ve probably noticed that I’m a big advocate of certain types of creative buying strategies, including owner-held mortgages, subject to, and private borrowing. You might wonder, then, why I don’t talk a lot about the other 2 common creative buying strategies—lease/options and land contracts.

Although both of these strategies, when used by investors to BUY (as opposed to sell, which I am greatly in favor of) have proponents that will defend them to the death as great techniques, I am not an advocate of using them except in very specialized situations.

My preference for the strategies here comes down to one key concept: ownership vs. control.

When you own a property, you have certain rights in the property. For instance, you have the right to use the property, to occupy it, to possess it, and to dispose of all or part of the property. These rights represent the fullest “interest” in a property that you can have.

True “ownership” in real estate comes with title. Title is the legal term for the “bundle of rights” you get when you own a piece of real estate. When you have title to a piece of property—conveyed by a deed or deed of trust—you have all of the rights of ownership.

However, it’s possible to have some of the rights of ownership without actually having title. For instance, a tenant has two of these rights: the right to possess and occupy the property and the right to enjoy it undisturbed by others. By virtue of his lease, he can live in the property just like an owner, but he does NOT have the other rights of ownership, such as the right to sell the property.

Lease/Options and land contracts take advantage of the concept that it’s possible to have “control” of a property without having title. When you buy on a lease/option, for instance, you are legally a tenant with a right to buy the property. Your profit comes from your ability to assign or “wrap” these two rights, renting the property to a third party at a higher monthly payment and ultimately selling the property at a higher price.

The problem with control without title, in my mind, is that it’s limited by the laws of the land and the realities of everyday life.

When you “buy” a property using one of the non-ownership control methods (lease/option or land contract), you are in some ways at the mercy of the actual owner, your seller. Because he remains the titleholder, his actions can, without your knowledge or consent, cloud the title in a way that makes it difficult for you to fulfill your obligations to YOUR tenants or tenant/buyers, or to profit from the deal at all.

Here’s an example:

Let’s say that you lease a home with an option to buy it for $100,000. The owner has a mortgage on the property of $70,000, but your payment to the owner more than covers his payments to the bank.

You lease/option the property to a tenant buyer for $110,000. All is well until the tenant/buyer attempts to get a loan 3 years later. The title search for that loan turns up the minor problem that the owner, unbeknownst to you, was in a traffic accident the year before, and the judgment exceeded the limits of his insurance. As a result, a $50,000 lien has attached to the property, meaning that he now has to come up with $120,000 to clear the title to sell it to you.

Is he still legally obligated to sell the property to you for $110,000? Yes.

CAN he? No.

What are your legal remedies? You can sue him for “specific performance,” in an attempt to get the court to order him to come up with the difference. You’d probably win that case—eventually—but if he doesn’t have the $10K difference, what have you accomplished? Probably driving him into bankruptcy, at which point the bankruptcy court will void your option and leave you with nothing.

In the meantime, what about your poor tenant/buyer? Unless you disclosed to him in advance that his right to buy the property was subject to your ABILITY to buy it—and perhaps even if this was the case—he’s going to be mad. Lawsuit mad. Accusations of fraud mad. Mad.

There are a number of complex, difficult-to-explain-to-sellers ways to overcome these and other problems with someone else holding title to “your” property. But my question is, “Why would you bother?” The long and short of it is, there are lots of ways—described in this lesson—to have both control AND title. With these methods, only YOU can screw up your deal…and isn’t that a great feeling?

There’s one exception to my personal rule about buying with lease/option or land contract, and that’s when you plan to—very carefully—step out of the deal.

This strategy has been variously called “option assignment” or “flipping lease/options”, and it works like this:

With the full knowledge of the seller, you negotiate a lease/option or land contract price and terms, and then look for a buyer to which to assign your contract. What you get from the deal is the down payment or option fee from the buyer. What the seller gets is his payments taken care of; the buyer gets financing on a property he wants to live in without going to the bank.

I’ve seen this strategy pitched at seminars for several years. It’s a great way for you to make money from houses that are overleveraged, and that you wouldn’t want to stay involved with long term because the payments are too high for you to profit from on an ongoing basis. It’s also safer for your seller, because in general a non-paying lease/option tenant can be EVICTED rather than foreclosed on, as is often the case with land contracts, or begged for the deed back, as is the case with “subject to” assignments.

However, the people who are telling you to do it RIGHT (like Ron Legrand, guest speaker at the OREIA National Real Estate Strategies Summit), will tell you this:

Fully disclose to the seller, up front, that you will not be the person ultimately making the payments
Screen the buyer or tenant/buyer thoroughly, just as if it were YOU that needed to collect payments for the next umpteen years
Fully disclose to the seller what will happen if the buyer doesn’t make payments, and that the buyer might damage the property, and all the other things that “could” happen in a relationship like this
Fully disclose to the BUYER that you are not the owner, and that if the owner doesn’t make payments on the underlying mortgage, that the buyer could lose possession of the property and his option fee or downpayment
Do not put balloons into these deals—let them fully amortize over the life of the underlying loan. Buyers often can’t meet balloon dates, leaving everyone in a mess
Let the buyer, even in a lease/option, have all the advantages of the paydown on the underlying mortgage. In other words, if the mortgage has 23 years left to run, the option price at any given time is the payoff on the mortgage, and in 23 years, the buyer owes nothing and gets the deed free and clear
If you’re staying involved, get the deed. If you’re assigning, use a lease/option or land contract.


Reprinted with permission of Vena Jones-Cox. To get more free articles and tips, subscribe at www.TheRealEstateGoddess.com

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