House Lease-Purchase for Fun and Profit

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I have an acquaintance of 10+ years who is a handyman and does great work on my house.  He wants to purchase a home, but tells me that his variable income doesn't allow him to qualify for a loan.  He does have the down payment and his total income doesn't seem to be a problem.

Separately, I have wanted to be a landlord for the extra income, but I hesitated in the past due to the issues of 1) finding tenants and 2) inconvenient maintenance calls.

So I have an idea of purchasing a house that he picks out (a fixer), and doing a lease-purchase agreement with him along the lines of a 30-year term and a dollar buyout.  He would supply the down payment for the property.  I would profit from an interest rate spread of 1-2%, but would not participate in the increased rent from appreciated real estate values in the future as would a conventional landlord.  House repair/upgrades would be his responsibility, which I hope will reduce my risk in the event that he leaves the property in a down market (his choice of property, not mine).  He, on the other hand, locks in his monthly payment and will own a home in 30 years that he would not otherwise qualify to purchase.

Unlike with a wrap, the title would stay in my name so the loan balance wouldn't get called.  Otherwise, I believe the idea is pretty much the same.

Financially, I have the ability to make payments if he defaults on his payments to me.

Is this a good idea, or am I missing something that can make this plan go terribly wrong?  Does anyone have any suggestions for how to structure this to reduce risk and/or increase fairness to both parties?  Are there other risks to me that I'm not seeing?

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if a guy can't get a subsidized, fed-backed, ultra-low interest loan meant to be obtainable for almost any Wor... (more)

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Wasn't there a website about a guy who bought a moneypit because the 'flipper' made improvements like removing a load be... (more)

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I am in the same boat as you are. Thanks for putting this together

What happens when the property loses its value?  Tax implications ?  How are you planning to insure it, as a rental?

ach1199 said:   What happens when the property loses its value?  Tax implications ?  How are you planning to insure it, as a rental?
If the property loses value and he stops paying, then I am at some risk.  However, he will have paid the down payment and probably have done some fixing on the house, which should mitigate much of the loss.  Beyond that, I guess I have the same risk that I would take if I purchased the house as a straight rental investment property.

As for tax implications, I have been thinking of this as a standard landlord/tenant situation because I will purchase the property and collect monthly payments from him.  The difference only comes at the end, when he will own the property.

Yes, I assume it would be insured as a rental.  Property taxes and HO insurance would be paid by me, reimbursed by him as part of the monthly payments.

1-2% spread is insane. Needs to be 5%+ to do this. You are shouldering all the risk, including the risk that he screws up the place "fixing it up".

How would you structure the deal? ARe you thinking of a 30 year lease? Or a rent to own contract which has annual renewal?

What happens if he wants to back out of the deal in X years? Will he get his down payment back or is he forfeiting it?

Owner financing is much less liability for you (although it is harder to kick them out). I charge 10% on my owner financed house and in retrospect I think that's too low. I didn't jack up the price of the house like most people do to get the extra spread. Won't make that mistake again.

Personally the 1 or 2% spread wouldn't be worth the added tax forms needed. Years ago I did some owner financing at 10%. I made more $ on the interest than profit from the initial investment. FYI many of us are self employed contractors with yo yo incomes yet are able to get bank loans so be sure to check everything out and get paid for your risk. Good luck!

I know multiple people (including the handyman who did a lot of work on my house recently - great guy!) with variable income who purchased their own house with bank loans.

what makes this acquaintance of yours so "special" that banks won't touch him?

jerosen said:   How would you structure the deal? ARe you thinking of a 30 year lease? Or a rent to own contract which has annual renewal?

What happens if he wants to back out of the deal in X years? Will he get his down payment back or is he forfeiting it?

I was thinking a 30 year lease and no down payment refund, but I am open to suggestions.  In the end, though, he needs to feel like a buyer, not a renter.
bbr said: Owner financing is much less liability for you (although it is harder to kick them out). I charge 10% on my owner financed house and in retrospect I think that's too low. I didn't jack up the price of the house like most people do to get the extra spread. Won't make that mistake again.
When you say that owner financing is less liability for me, are you referring to items typically covered by liability insurance, or something else?

I began with the idea of doing this as a wrap (basically owner financing), but that means that my mortgage on the house is callable due to ownership transfer, which would be bad for both parties.  That's why I have steered more towards a lease-purchase which keeps the title in my name.  I don't want to be faced with coming up with a huge lump-sum out of pocket payoff or forced sale situation due to the mortgage company calling the loan.

You are correct that this situation will be less and less in my favor (financially) as time goes on.  Because the spread is low, the free-market rent on the same house will become much higher than what I will receive.  On the other hand, my risk goes down tremendously (since I profit if he walks away) and it should be as close to a truly passive income as landlording can be.

Remember that my situation may be unique in that I am not trying to sell my house, nor do I have the option of waiting for the next buyer.  I want to make this work with one particular person, and jacking rates too high will likely just blow up the deal and cause him to feel that I am ripping him off.

In the end, my goal is to do this as a low-risk, (somewhat) low-reward investment.   Of course I want to maximize my profit, but I consider this person a friend and I really do want this to be fair to both parties.

What state? Some states limit length of lease contracts.

Also I don't know why someoen would want to commit to a 30 year lease and no way to get his ddown payment or equity out before.

I realize that his variable income (alone) should not disqualify him from loans, and I am only reporting what he said to me.  I would have to look further to see what is going on, but I wanted to structure this deal so that even if he has bad credit and stops paying monthly payments, I would be protected (because he paid the down payment, the title is in my name, he fixed up the fixer, etc).

I am grateful for the suggestions on interest rates.  I did not want to charge something too high, and later have him feel resentment towards me for "gouging" him.  However, if something closer to 10% is standard practice in a situation like this, then I am certainly willing to increase this rate.  BBR and Cajundavid, when you did your owner financing, did the buyer give you a sizeable down payment (20%?), and was the term around 30 years?

jerosen said:   What state? Some states limit length of lease contracts.

Also I don't know why someoen would want to commit to a 30 year lease and no way to get his ddown payment or equity out before.

California.

Remember that he is not able to purchase a house on his own so that isn't an option.  Thus, a long lease might be preferable to escalating rent costs, as I'm guessing that half way through the term his monthly payments to me would probably be cheaper than free-market rent.  Then there is the benefit of ownership at the end.

If you will be charging a higher rate to compensate for the risk and want to be fair, it might be better to make 15 year deal as payments won't be much more, will save your friend a lot of money and mostly reduce your risk after a few years. If your friend puts 20% down with 8% rate would get you to ~55% ltv after 5 years.

accfw said:   I realize that his variable income (alone) should not disqualify him from loans, and I am only reporting what he said to me.  I would have to look further to see what is going on, but I wanted to structure this deal so that even if he has bad credit and stops paying monthly payments, I would be protected (because he paid the down payment, the title is in my name, he fixed up the fixer, etc).

I am grateful for the suggestions on interest rates.  I did not want to charge something too high, and later have him feel resentment towards me for "gouging" him.  However, if something closer to 10% is standard practice in a situation like this, then I am certainly willing to increase this rate.  BBR
and Cajundavid, when you did your owner financing, did the buyer give you a sizeable down payment (20%?), and was the term around 30 years?

  
I think I got around 10% down and a 10 year payout. It was a goldmine for me as they paid like clockwork. They paid it off early. I also had a sizable profit in the property itself after holding it 3 years.

accfw said:   
jerosen said:   What state? Some states limit length of lease contracts.

Also I don't know why someoen would want to commit to a 30 year lease and no way to get his ddown payment or equity out before.

California.

Remember that he is not able to purchase a house on his own so that isn't an option.  Thus, a long lease might be preferable to escalating rent costs, as I'm guessing that half way through the term his monthly payments to me would probably be cheaper than free-market rent.  Then there is the benefit of ownership at the end.

  

Yeah but its a 30 year commitment on his part.   
Who wants a 30 year commitment with no way out without losing their investment?
What if he changes his mind in 3 years?    Has to move out of state for work?    Dies?   What happens to his down payment and equity investment?

Who's paying the property taxes?    
 

accfw said:   I realize that his variable income (alone) should not disqualify him from loans, and I am only reporting what he said to me.  I would have to look further to see what is going on, but I wanted to structure this deal so that even if he has bad credit and stops paying monthly payments, I would be protected (because he paid the down payment, the title is in my name, he fixed up the fixer, etc).

I am grateful for the suggestions on interest rates.  I did not want to charge something too high, and later have him feel resentment towards me for "gouging" him.  However, if something closer to 10% is standard practice in a situation like this, then I am certainly willing to increase this rate.  BBR and Cajundavid, when you did your owner financing, did the buyer give you a sizeable down payment (20%?), and was the term around 30 years?

  I got 10% down + they paid the closing costs. This was a house that the current renter bought. It also didn't have a mortgage so I didn't have to worry about the bank calling the note. The term is for 35 months (avoided the intangible tax) and amortized for 15 years. My lawyer recommended to short term so that I could evict them easier if things went south (although we told them it was to avoid the intangible tax to save them money). The intention is to renew the note with the same terms at the end of 35 months.

As a side note, make sure you add a hefty fee if the buyer is late (double whatever you think is hefty). My buyer has been late on 5 of their 10 payments they have made. These types of buyers expect fees like that and while the interest rate (10%) seems high to us, it's actually not for them. Maybe ask him what he would propose and that can give you an idea of where his head is at. It might surprise you what he offers. 



In the end, my goal is to do this as a low-risk, (somewhat) low-reward investment. 

  No matter how much you tell yourself this, it's not a low risk investment. Nowhere close to low risk. Price the reward accordingly.

Maybe "variable" income means "paid in cash to evade taxes"? That would pose a problem, tax returns are how lenders would verify income. They don't care how seasonal it may be.

I think if you are borrowing the money to buy a house and then selling it to the guy for 1-2% (or more) interest than what you are paying, then that is a bad deal for you. If you have to keep the deed in your name in order to not have the loan called, and you expect the guy to give you a down payment, do a bunch of work on it, and trust you to deed it over to him in the distant future, then that is a bad deal for him.

If you already owned a house free and clear and wanted to sell it to the guy with him giving a down payment and you carrying the note at a higher than market rate, then that would be good for both of you.

If you buy a house with a mortgage in your name, then a lease-purchase agreement with the guy could also be good. But he would have to pay enough above market rent in order for it to be worth your while.  You can just buy a property and rent it to someone and still keep all the appreciation for yourself, if you just want to get market rent.

I understand you like the quality of his work, (everything must be up to code and permits pulled) but beyond minor fixing, get a clause allowing outside inspections and YOUR prior approval to any house modifications What if he recarpets affecting value of the house depending on his choices? Most are likely to be agreeable to you, but be protected.
Some possible Murphy events that could bite you:
A neighbor tore out a wall to expand a kitchen reducing the number of bedrooms. Another neighbor built an addition that was not suitable for the neighborhood. Guy across the street put a front deck on - did a great job - put in permit application and plans which were approved. Lo and behold, City came up behind the finished project and makes him cut the deck back a few feet.

Given his profession, what if he has an accident or business slows, he gets a lowball competitor, Get a FULL background check and credit reports from multiple sources including business credit check. Include a clause that allows you to do so at anytime or at least annually. Find a REAL ESTATE ATTORNEY who has done several such deals. That said, take the contract to a second attorney for a second opinion. I recently did a deal handled by a very competent well established attorney who does real estate deals weekly. The problem was he has gotten to the point, he uses a lot of boiler plate that was not what the buyer and I agreed. From what you have written, you do not have enough experience to do this without professional help (NOT a Realtor). Whatever insurance is in place, make sure you are covered like a mortgage company would be and listed on the insurance as a lienholder.
My Dad did this once and was lucky, despite the poor people (financially) involved, there were a few Murphy events along the way, but they worked it out. When Murphy's Laws bite, how are you able to respond?

bbr said:   


In the end, my goal is to do this as a low-risk, (somewhat) low-reward investment. 

  No matter how much you tell yourself this, it's not a low risk investment. Nowhere close to low risk. Price the reward accordingly.

You mentioned the risk of him screwing up the place by fixing it up.  Besides that, can you explain how I am at any more risk than with an ordinary landlord/tenant month-to-month arrangement?  If he leaves, I still own the place and have his down payment as well right?

To address other concerns, as a result of this thread I will ask for a higher interest rate spread than I originally planned (5%?) and a 15-year lease sounds good as well.  Also, thank you JW10 for all the suggestions.  I absolutely have been planning on working with a real estate attorney through this process, as I am new to these types of transactions.  However, since this is a lease-purchase (not a wrap / owner-finance), I think I would just be listed with the insurance company as an owner, not a lienholder, right?   

Ask a good insurance agent. In that boat, I want to be in line for any insurance settlement before he decided the place is untenable and runs off with the check. I had an event that because of the lienholder clause, I had to get them to endorse the check before I could cash it. Lender was friendly, so it worked out for all.

Plan for the worst .. Pray for the best.

accfw said:   
bbr said:   


In the end, my goal is to do this as a low-risk, (somewhat) low-reward investment. 

  No matter how much you tell yourself this, it's not a low risk investment. Nowhere close to low risk. Price the reward accordingly.

You mentioned the risk of him screwing up the place by fixing it up.  Besides that, can you explain how I am at any more risk than with an ordinary landlord/tenant month-to-month arrangement?  If he leaves, I still own the place and have his down payment as well right?

To address other concerns, as a result of this thread I will ask for a higher interest rate spread than I originally planned (5%?) and a 15-year lease sounds good as well.  Also, thank you JW10 for all the suggestions.  I absolutely have been planning on working with a real estate attorney through this process, as I am new to these types of transactions.  However, since this is a lease-purchase (not a wrap / owner-finance), I think I would just be listed with the insurance company as an owner, not a lienholder, right?   

  First, let me state that I'm not trying to talk you out of doing this deal. Structured properly, it could benefit both parties. I'm just saying that the reward should match the risk and this is not low risk. Here are a few of the risks that I can think of (I'm sure there are many more).......

1. Liability - this can mostly be mitigated with good insurance, but if you are a high net worth individual make sure you have a good umbrella policy ($3 million+) that covers this property
2. Home Value Drops - "buyer" walks away and leaves you with the bill - remember that 10 years ago the banks thought they were covered too and a lot of them went bust
3. Un-permitted Improvements - Meaning the state makes you redo a bunch of stuff before you can sell it (and fixing stuff isn't cheap!)
4. House has problems not discovered until after closing - "buyer" only has his deposit on the line and I'm sure he is judgement proof
5. Buyer becomes injured/unemployed - Can you kick out an injured friend if he doesn't pay rent?
6. Buyer trashes the place - leaves you with the mess (and the bill!) to clean up, if you think his deposit will cover this know that people can cause a lot of damage in a short period of time!!
7. Legal issues - Buyer sues you because they thought something different than you

There are many other potential pitfalls but these should be enough to get you thinking. Again, if it were me, I'd let the potential buyer make a proposal to you. If he is not interested enough to make an offer you should just walk away. I recently made a hard money loan where the borrower offered double what I expected to make. It doesn't hurt to let them throw out a number.

Thank you BBR, that was a great post!  #3 is an especially good point that I had not previously considered.  I will take your suggestions, including letting him give me a proposal instead of just giving him mine.

easiest to just rent to him with a buy option that you can both agree on. don't do anything long-term, don't structure it like a loan.

anything else is a lot harder to unwrap if it goes south. i know, i've been there.

JW10 said:   Ask a good insurance agent. In that boat, I want to be in line for any insurance settlement before he decided the place is untenable and runs off with the check. I had an event that because of the lienholder clause, I had to get them to endorse the check before I could cash it. Lender was friendly, so it worked out for all.

Plan for the worst .. Pray for the best.

Sorry, I'm not trying to be difficult as I don't quite understand... how can he run off with a check when I am the owner / title holder and he is just a tenant?  Since this isn't owner-financed, the title will not change hands until after the lease is up in 15 or 30 years.  So any insurance payments would go to the lender, and then to the title holder (me), right?

solarUS said:   easiest to just rent to him with a buy option that you can both agree on. don't do anything long-term, don't structure it like a loan.

anything else is a lot harder to unwrap if it goes south. i know, i've been there.

  Yes, but if he can't get a loan on his own, how will he ever exercise the buy option?

accfw said:   
solarUS said:   easiest to just rent to him with a buy option that you can both agree on. don't do anything long-term, don't structure it like a loan.

anything else is a lot harder to unwrap if it goes south. i know, i've been there.

  Yes, but if he can't get a loan on his own, how will he ever exercise the buy option?

um...save?

if a guy can't get a subsidized, fed-backed, ultra-low interest loan meant to be obtainable for almost any Working Person, then he probably shouldnt be privately financed.

"variable income"? sounds like he doesnt claim much on his taxes, otherwise he'd probably qualify. not a person i want to enter into a financial contract with.

Wasn't there a website about a guy who bought a moneypit because the 'flipper' made improvements like removing a load bearing pillar?

As someone who recently posted on FWF about doing a deal with friends ... you are likely to get lots of comments that doing deals with friends is a bad idea. There are valid reasons why, and your risk the relationship by entering into this deal, and it's a long deal, with lots of time to go south. As already noted, what if he has employment issues and asks, as a friend, to be given just a little more time to pay this month ... and next month, etc.? What if he just decides the area is not right for him, or gets in a tif with neighbors? You expect that he will do improvements and needed repairs to the property, but you are structuring this as a rental, and it will be your responsibility to get things done (CA has a lot of codes for landlords) if he decides he doesn't want to do them. I suppose there could be some contractual agreement where you agree to discount/compensate him for work, and agree on some specific work up front (but I have no familiarity with things like that). If this is a good deal, and you see some real positives for you and your friend, than maybe it is worth the risks. If not, and you care about your relationship, it's probably not worth it. Maybe you can work with him to figure out why he can't get a loan and help him get past that obstacle? FWF might have ideas for him, if he really is financially stable.



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