brian-gibbons
01-11-2005, 10:52 AM
Strategies of Today - Foundation of Tomorrow
Some of you who are proficient in these current techniques may want to skip ahead to more enlightening material. For those of you who need to begin understanding and using these strategies to get started, this section will provide a good working primer from which to begin.
There are a wide variety of techniques that can be successfully used in today's marketplace. But in the none-too-distant future a perpetual and fierce seller's market will make nearly all of them obsolete. Of those not made obsolete, a metamorphosis will need to take place to adapt them to the change.
Straight Purchase Agreement:
A traditional approach of simply buying a property, either as a personal residence or to add to your portfolio. Simple enough to do now, but in the future scenario proposed earlier, only the wealthiest of families will be able to pay the price for real estate which will be in such high demand. It might very well be that any real estate (including land) will be sold at auction to the highest bidder. If this happens, trust me when I say that anyone not in the top 5-10% socially and financially would fare better to just sit home and enjoy the artificial turf on the patio rather than attend such an auction in the hope of buying property. It just ain't gonna happen!
Yet the purchase agreement will, indeed, play a very important role, albeit with a few adaptations. Let's take a closer look at how the purchase agreement works in today's marketplace. Later we will discuss how this form of purchase can be better used (with minor alterations) to begin working toward the future, then gradually mutate to what it must eventually become.
Using a purchase agreement, ordinarily you offer to purchase real estate (the land with all appurtenances - buildings) at a certain price and under terms you can live with. Normally, you would make a down payment of at least 5% (although this can be avoided), and get a mortgage from a lender to cover the balance of the purchase. You would close on the deal (settlement/escrow) and the Title Agent does the magic paperwork shuffle, and miraculously end up possessing the property, the seller has a pocketful of cash and the lender makes a fortune off you in interest. That's the gist of it - pretty straight-forward. As an investor, however (as opposed to a homebuyer) you must try to negotiate a lower price, better terms and try your level best to buy in such a fashion as to create that elusive thing called profit, or positive cash flow. Doing so is as much an art as a science, and you should become proficient in both. Remember - everything in the agreement is negotiable - even your name! As investor, your task is to negotiate well, and to choose only those properties where an obvious profit can be made. If you do not know where and how your profit will come, and approximately how much it will be even before you offer to buy, then don't buy. Real Estate investing is similar to a game of chess in which you need to have the next few moves already figured out in advance, based on expected moves by your opponent.
Lease Option:
While the lease with option to buy is not falling out of favor with investors, it is much less desirable to sellers and lenders alike. It is becoming increasingly difficult to effect a good lease option - a sign of things to come?
The typical lease option involves an ordinary lease on the property that also provides you with the exclusive option of buying that property at a predetermined price during a predetermined time period. Normally, a portion of the lease payment(10-50%) is applied to the purchase price if you exercise your option to buy. Then, when you buy the property, hopefully the amount being applied is great enough to be accepted as your down payment.
For the investor, it is important to include a clause that permits subletting to a third party. In this way, the tenant is actually paying the lease along with the amount being applied to your purchase price. You virtually get the property for free.
A big problem with a lease option arises from the fact that mortgages written after 1976 have a nasty little item called the "due-on-sale" clause. In effect, this prevents any seller who has such a mortgage from entering into any transaction that transfers rights to the property to any other person. A lease option does, in fact, transfer such rights to the lessee - the exclusive right to buy the property, and an equitable interest inherent in the portion of the lease payment that is applied to the purchase price. The only legitimate method of getting around this is to get approval in writing from the mortgagor. If the lender has no problem with the seller transferring rights to a particular individual (based on his/her ability to qualify with adequate income and low debt), then the seller may lease option.
It is important to note that many self-proclaimed real estate gurus will say you can avopid a due-on-sale clause by using a "performance mortgage" or any one of a number of other deceitful strategies. Don't believe any of it! The only method of getting past such a clause is with the written permission of the lender. Period!
At any rate, the lease option is dying a slow and horrible death. It's too bad, really, as it has been instrumental in providing otherwise unattainable homes for buyers, and otherwise unobtainable wealth for investors.
Real estate investors of the future will not likely have many opportunities to enter into a lease option agreement - at least, not in its present form. Like the purchase agreement, it will have to be adapted to the new age of real estate. This will be discussed in detail later. For now, if you have the opportunity to get into a lease option, take it! Such a deal can help you build your current net worth which you may very well need before long if you are to stay in the game for the long haul.
Contract for Deed (land contract):
This resembles the lease option, but with greater potential for profit. It also falls prey to the same problems as the lease option - it triggers a due-on-sale clause, and it is a dying breed.
The primary differences between a Contract for Deed and the Lease Option include:
a) Under a Contract for Deed, 100% of your payment is applied to the purchase price
b) A contract for deed can be written to allow complete pay-off of the property - "x" dollars per month for "y" number of years until the entire purchase price has been paid. Or, it can be for as little as a few months, after which you are required to finance the balance through a lender, paying the seller off in full.
c) Under a contract for deed, the seller holds the deed until you have met your full obligation under the agreement.
d) Under a contract for deed, the buyer becomes responsible for taxes and insurance. These expenses are not applied to the purchase price.
e) Under a contract for deed, you are more or less obligated to eventually purchase the property - it is not an option. However, your agreement could include a clause that, in the event of default, you become a tenant under a tenancy at will, and all monies paid to date shall be as rent. You will no longer have any equitable interest in the property. You are just a tenant paying rent on a month-to-month basis.
As an investor, you also need a clause that permits you to sublet. Your tenant would then be paying for the place for you. Again, like the lease option, you can get the property virtually at no cost to you. Gravy, if you will. And like the lease option, the contract for deed is also a fading blossom, mostly because it is too profitable for the investor, and because it does fall victim to the due-on-sale clause. Another great strategy soon to be extinct in its present form. Its future form, however, may become just as bright a flame as ever.
Options:
Usually used in land speculation, the option can also be successfully used in residential and commercial real estate that includes buildings. To use an option, the investor normally will pay a small amount of consideration to the owner in exchange for the exclusive option to buy a property during a specific time period at a predetermined price. The optioner is not obligated to buy - he simply has the right to, and the seller cannot sell that property to anyone else during the life of the option. Ordinarily, the agreed upon purchase price will be slightly higher than market value simply because appreciation is expected to raise the value during the option period.
Years ago an enterprising individual used $5000 from his pension fund to purchase an option on a large tract of swampland in Florida. The purchase price if he exercised his option was only around $150,000. Before the option expired, he found a buyer for the land, exercised his option and sold the property at a profit of over $4,000,000. You can visit this property (or maybe you already have), but it will cost you - it is now known as DisneyWorld.
Such is the power of options. In the future, options will still have great power, but not in the same circles as today. As you will see, options may very well become much-used instruments in ways that were never before imagined. For now, however, they can still be used to help create the groundwork for your future in real estate. Later, I will show you how.
Equity Participation:
Also known as equity sharing, this method of investing has sadly declined over the years. A great idea with potential to provide nice homes to people who otherwise could not afford to own, while providing good profits to investors, equity sharing is quickly becoming a dinosaur.
In a typical equity share purchase, the investor will put up the down payment and closing costs, while his equity share partners take on the payment of the mortgage, taxes, insurance and upkeep. The tenant partner lives in the home while the invest simply sits back and waits. The E.Q. agreement usually has a lifespan of 5 years, after which the tenant either refinances the property and pays off the investor, or they can sell the place and each takes their appointed share of any profits.
For the homeowner, the benefits are obvious: no down payment, no closing costs. It's a lot easier to own your own home. For the investor, however, the rewards are quite different. During the term of the E.Q., the investor gets all the tax benefits of the property - depreciation, interest deductions etc. At the end of the term, the tenant repays the investor for his original investment PLUS the investor gets 50% of all appreciation, including mortgage paydown. Further profits for the investor may come from his not having to actually pay a down payment from his own pocket. If the property he is "E.Q.ing" is already owned by him, he can simply "leave" enough of his equity in the place to cover the necessary down payment. In other words, he just defers collecting on that portion of his equity until the life of the E.Q. has ended. Not a bad deal, really. Everyone wins.
So, if the equity share is such a great win/win strategy, why is it becoming extinct?
It seems that many banks simply do not like complicating mortgages. They also prefer mortgages designed to earn them interest for many years (not just 5). But the real reasons for the unpopularity of the E.Q. is summed up in two words: investors and homebuyers.
Investors have never been sold on E.Q.'s because they tie up cash and the good returns simply are not good enough. Most investors can do better, while tying up less money and less time. Homebuyers, on the other hand, seem to be somewhat leery. They do not want a stranger owning ½ of their home. They generally are not interested in having to deal with paying off the investor in 5 years. They are unsure that it will even be possible to do so - interests rates may have gone through the roof; deflation could devalue their property. So many uncertainties. Homebuyers, in general, avoided the E.Q.
What does the future hold for the E.Q.? If the scenario painted earlier does, indeed, take place, there will no longer be any need nor use for equity sharing. Its day is nearly done.
Life Estate:
This is a much lesser known technique that can be used in real estate transactions. It involves providing someone with full rights of possession in a property. Like tenants, the occupant(s) are merely using someone else's property. Unlike tenants, however, they have recorded, equitable interest in the property. They can never be evicted or forced out. They may stay for life, unencumbered by rent payments. If they choose to move elsewhere, they retain the right to rent out the property and collect the rents - for life.
Today, this strategy is most often used by parents who want to insure their children own the property after the parents pass away, without having the property pass through probate, and without having to pay inheritance taxes. They turn ownership over to their adult child, usually for its fair market value so as not to raise questions with the IRS. But the child does not have to actually pay that price. Since the parents will be inhabiting the property, it can be assumed that the child can charge fair rent. Let's assume that the property is worth $100,000, and that the life expectancy of the parents is 30 more years. If the child were to finance that $100,000 for 30 years, that property mortgage would cost him around $10,000/year, or roughly $840/month. Further assuming fair rental value is $750/month, the child would merely have to pay his parents the difference - about $90/month. What has happened is simple - the parents sell the house to the child for $100,000 at 8% interest for 30 years (which comes to around $300,000), then pay that child about $270,000 in rents for 30 years. Therefore, the child only has to pay the $30,000 difference for the property, payable in small monthly installments over 30 years. Of course, the child is also responsible for property taxes and insurance, as well as major repairs over $100.
For the seasoned investor, the life estate can also be lucrative, using the same principles. By taking the place of the child, he can purchase a $100,000 property for about $30,000. When the tenants pass away, the investor owns the property free and clear, and it will be worth much, much more by then. In the meantime, he can mortgage the property to pull out working capital for buying other properties.
What, then, does the future hold for the life estate transaction? Surely parents may still want to help their children and bypass probate. In that sense the life estate may continue on much as it is today. But for the investor, using the life estate for profit will likely become nothing more than a memory.
Compiled from creiu2.com :SM039:
Some of you who are proficient in these current techniques may want to skip ahead to more enlightening material. For those of you who need to begin understanding and using these strategies to get started, this section will provide a good working primer from which to begin.
There are a wide variety of techniques that can be successfully used in today's marketplace. But in the none-too-distant future a perpetual and fierce seller's market will make nearly all of them obsolete. Of those not made obsolete, a metamorphosis will need to take place to adapt them to the change.
Straight Purchase Agreement:
A traditional approach of simply buying a property, either as a personal residence or to add to your portfolio. Simple enough to do now, but in the future scenario proposed earlier, only the wealthiest of families will be able to pay the price for real estate which will be in such high demand. It might very well be that any real estate (including land) will be sold at auction to the highest bidder. If this happens, trust me when I say that anyone not in the top 5-10% socially and financially would fare better to just sit home and enjoy the artificial turf on the patio rather than attend such an auction in the hope of buying property. It just ain't gonna happen!
Yet the purchase agreement will, indeed, play a very important role, albeit with a few adaptations. Let's take a closer look at how the purchase agreement works in today's marketplace. Later we will discuss how this form of purchase can be better used (with minor alterations) to begin working toward the future, then gradually mutate to what it must eventually become.
Using a purchase agreement, ordinarily you offer to purchase real estate (the land with all appurtenances - buildings) at a certain price and under terms you can live with. Normally, you would make a down payment of at least 5% (although this can be avoided), and get a mortgage from a lender to cover the balance of the purchase. You would close on the deal (settlement/escrow) and the Title Agent does the magic paperwork shuffle, and miraculously end up possessing the property, the seller has a pocketful of cash and the lender makes a fortune off you in interest. That's the gist of it - pretty straight-forward. As an investor, however (as opposed to a homebuyer) you must try to negotiate a lower price, better terms and try your level best to buy in such a fashion as to create that elusive thing called profit, or positive cash flow. Doing so is as much an art as a science, and you should become proficient in both. Remember - everything in the agreement is negotiable - even your name! As investor, your task is to negotiate well, and to choose only those properties where an obvious profit can be made. If you do not know where and how your profit will come, and approximately how much it will be even before you offer to buy, then don't buy. Real Estate investing is similar to a game of chess in which you need to have the next few moves already figured out in advance, based on expected moves by your opponent.
Lease Option:
While the lease with option to buy is not falling out of favor with investors, it is much less desirable to sellers and lenders alike. It is becoming increasingly difficult to effect a good lease option - a sign of things to come?
The typical lease option involves an ordinary lease on the property that also provides you with the exclusive option of buying that property at a predetermined price during a predetermined time period. Normally, a portion of the lease payment(10-50%) is applied to the purchase price if you exercise your option to buy. Then, when you buy the property, hopefully the amount being applied is great enough to be accepted as your down payment.
For the investor, it is important to include a clause that permits subletting to a third party. In this way, the tenant is actually paying the lease along with the amount being applied to your purchase price. You virtually get the property for free.
A big problem with a lease option arises from the fact that mortgages written after 1976 have a nasty little item called the "due-on-sale" clause. In effect, this prevents any seller who has such a mortgage from entering into any transaction that transfers rights to the property to any other person. A lease option does, in fact, transfer such rights to the lessee - the exclusive right to buy the property, and an equitable interest inherent in the portion of the lease payment that is applied to the purchase price. The only legitimate method of getting around this is to get approval in writing from the mortgagor. If the lender has no problem with the seller transferring rights to a particular individual (based on his/her ability to qualify with adequate income and low debt), then the seller may lease option.
It is important to note that many self-proclaimed real estate gurus will say you can avopid a due-on-sale clause by using a "performance mortgage" or any one of a number of other deceitful strategies. Don't believe any of it! The only method of getting past such a clause is with the written permission of the lender. Period!
At any rate, the lease option is dying a slow and horrible death. It's too bad, really, as it has been instrumental in providing otherwise unattainable homes for buyers, and otherwise unobtainable wealth for investors.
Real estate investors of the future will not likely have many opportunities to enter into a lease option agreement - at least, not in its present form. Like the purchase agreement, it will have to be adapted to the new age of real estate. This will be discussed in detail later. For now, if you have the opportunity to get into a lease option, take it! Such a deal can help you build your current net worth which you may very well need before long if you are to stay in the game for the long haul.
Contract for Deed (land contract):
This resembles the lease option, but with greater potential for profit. It also falls prey to the same problems as the lease option - it triggers a due-on-sale clause, and it is a dying breed.
The primary differences between a Contract for Deed and the Lease Option include:
a) Under a Contract for Deed, 100% of your payment is applied to the purchase price
b) A contract for deed can be written to allow complete pay-off of the property - "x" dollars per month for "y" number of years until the entire purchase price has been paid. Or, it can be for as little as a few months, after which you are required to finance the balance through a lender, paying the seller off in full.
c) Under a contract for deed, the seller holds the deed until you have met your full obligation under the agreement.
d) Under a contract for deed, the buyer becomes responsible for taxes and insurance. These expenses are not applied to the purchase price.
e) Under a contract for deed, you are more or less obligated to eventually purchase the property - it is not an option. However, your agreement could include a clause that, in the event of default, you become a tenant under a tenancy at will, and all monies paid to date shall be as rent. You will no longer have any equitable interest in the property. You are just a tenant paying rent on a month-to-month basis.
As an investor, you also need a clause that permits you to sublet. Your tenant would then be paying for the place for you. Again, like the lease option, you can get the property virtually at no cost to you. Gravy, if you will. And like the lease option, the contract for deed is also a fading blossom, mostly because it is too profitable for the investor, and because it does fall victim to the due-on-sale clause. Another great strategy soon to be extinct in its present form. Its future form, however, may become just as bright a flame as ever.
Options:
Usually used in land speculation, the option can also be successfully used in residential and commercial real estate that includes buildings. To use an option, the investor normally will pay a small amount of consideration to the owner in exchange for the exclusive option to buy a property during a specific time period at a predetermined price. The optioner is not obligated to buy - he simply has the right to, and the seller cannot sell that property to anyone else during the life of the option. Ordinarily, the agreed upon purchase price will be slightly higher than market value simply because appreciation is expected to raise the value during the option period.
Years ago an enterprising individual used $5000 from his pension fund to purchase an option on a large tract of swampland in Florida. The purchase price if he exercised his option was only around $150,000. Before the option expired, he found a buyer for the land, exercised his option and sold the property at a profit of over $4,000,000. You can visit this property (or maybe you already have), but it will cost you - it is now known as DisneyWorld.
Such is the power of options. In the future, options will still have great power, but not in the same circles as today. As you will see, options may very well become much-used instruments in ways that were never before imagined. For now, however, they can still be used to help create the groundwork for your future in real estate. Later, I will show you how.
Equity Participation:
Also known as equity sharing, this method of investing has sadly declined over the years. A great idea with potential to provide nice homes to people who otherwise could not afford to own, while providing good profits to investors, equity sharing is quickly becoming a dinosaur.
In a typical equity share purchase, the investor will put up the down payment and closing costs, while his equity share partners take on the payment of the mortgage, taxes, insurance and upkeep. The tenant partner lives in the home while the invest simply sits back and waits. The E.Q. agreement usually has a lifespan of 5 years, after which the tenant either refinances the property and pays off the investor, or they can sell the place and each takes their appointed share of any profits.
For the homeowner, the benefits are obvious: no down payment, no closing costs. It's a lot easier to own your own home. For the investor, however, the rewards are quite different. During the term of the E.Q., the investor gets all the tax benefits of the property - depreciation, interest deductions etc. At the end of the term, the tenant repays the investor for his original investment PLUS the investor gets 50% of all appreciation, including mortgage paydown. Further profits for the investor may come from his not having to actually pay a down payment from his own pocket. If the property he is "E.Q.ing" is already owned by him, he can simply "leave" enough of his equity in the place to cover the necessary down payment. In other words, he just defers collecting on that portion of his equity until the life of the E.Q. has ended. Not a bad deal, really. Everyone wins.
So, if the equity share is such a great win/win strategy, why is it becoming extinct?
It seems that many banks simply do not like complicating mortgages. They also prefer mortgages designed to earn them interest for many years (not just 5). But the real reasons for the unpopularity of the E.Q. is summed up in two words: investors and homebuyers.
Investors have never been sold on E.Q.'s because they tie up cash and the good returns simply are not good enough. Most investors can do better, while tying up less money and less time. Homebuyers, on the other hand, seem to be somewhat leery. They do not want a stranger owning ½ of their home. They generally are not interested in having to deal with paying off the investor in 5 years. They are unsure that it will even be possible to do so - interests rates may have gone through the roof; deflation could devalue their property. So many uncertainties. Homebuyers, in general, avoided the E.Q.
What does the future hold for the E.Q.? If the scenario painted earlier does, indeed, take place, there will no longer be any need nor use for equity sharing. Its day is nearly done.
Life Estate:
This is a much lesser known technique that can be used in real estate transactions. It involves providing someone with full rights of possession in a property. Like tenants, the occupant(s) are merely using someone else's property. Unlike tenants, however, they have recorded, equitable interest in the property. They can never be evicted or forced out. They may stay for life, unencumbered by rent payments. If they choose to move elsewhere, they retain the right to rent out the property and collect the rents - for life.
Today, this strategy is most often used by parents who want to insure their children own the property after the parents pass away, without having the property pass through probate, and without having to pay inheritance taxes. They turn ownership over to their adult child, usually for its fair market value so as not to raise questions with the IRS. But the child does not have to actually pay that price. Since the parents will be inhabiting the property, it can be assumed that the child can charge fair rent. Let's assume that the property is worth $100,000, and that the life expectancy of the parents is 30 more years. If the child were to finance that $100,000 for 30 years, that property mortgage would cost him around $10,000/year, or roughly $840/month. Further assuming fair rental value is $750/month, the child would merely have to pay his parents the difference - about $90/month. What has happened is simple - the parents sell the house to the child for $100,000 at 8% interest for 30 years (which comes to around $300,000), then pay that child about $270,000 in rents for 30 years. Therefore, the child only has to pay the $30,000 difference for the property, payable in small monthly installments over 30 years. Of course, the child is also responsible for property taxes and insurance, as well as major repairs over $100.
For the seasoned investor, the life estate can also be lucrative, using the same principles. By taking the place of the child, he can purchase a $100,000 property for about $30,000. When the tenants pass away, the investor owns the property free and clear, and it will be worth much, much more by then. In the meantime, he can mortgage the property to pull out working capital for buying other properties.
What, then, does the future hold for the life estate transaction? Surely parents may still want to help their children and bypass probate. In that sense the life estate may continue on much as it is today. But for the investor, using the life estate for profit will likely become nothing more than a memory.
Compiled from creiu2.com :SM039: