Thursday, February 4, 2010

Equity Partner on Lease Option Deal

So how would I approach an investor to partner on the lease-option deal described in the previous blog?

In my previous blog, I talked about how I would structure a lease-option purchase for a waterfront property listed for $325,000. In this blog, we will look at how this agreement would appeal to an investor and equity partner.

A conventional mortgage of $250,000 would be needed to replace a hard money loan currently in place on the property. So an investor/equity partner would be someone who was able to qualify for a $250,000 mortgage. As owner of the property, I would be listed on the loan with my equity partner.

The loan would be a conventional, non-owner occupied, interest-only loan, as we expect our lease-option buyer to be able to purchase the property from us in 2-3 years. We could also take out a fully amortized 30-year loan, if we had doubts about the ability of our buyer to exercise their option to purchase, or if we wanted to build in flexibility for future exit strategies. A fully amortized loan would cost us more, but interest only, with taxes of $308 and insurance of $50, would cost us $1800 per month.

If our buyer is paying us $2500 per month (see previous blog), then my investor and I are splitting $700 per month for three years ($25,200 total over three years).
I will cover all the costs of the loan out of the down payment provided by the buyer, so there is no cost to the investor to take out the mortgage—and they are making $8400 per year. In addition, as my equity partner, they get to deduct mortgage interest from their taxes and depreciation on our investment property. Since we are paying interest only, approximately $1440 per month of interest is tax deductible. In addition, they get to depreciate the value of the house (but not the land) over 27.5 years, further reducing taxable income.

As added incentive, I agree to split the net profit on the house over and above my basis of $325,000. So if the house sells for $337,000 ($357,500 less $12,500 as option fee and $18,000 in rent credits), we split another $8000.

So my investor/partner earns a total of around $29,000 over three years for their ability to take out a mortgage, an infinite return on their initial investment of $0. Not bad, eh?

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