Real Estate Ethics - Lease Option Transaction

Buyer Beware!

I just had a client back out of a lease purchase transaction, because the seller - a real estate investor - had failed to pull any permits on the remodel of the house. My client is a builder and general contractor. He spoke with the City to find out about the permits. Without permits, any buyer would not be protected by insurance for a house fire or other problems covered by non-permitted work.

When I shared this information with the listing broker - who happens to be a Managing Broker/Owner (meaning he has the authority to hire and supervise other real estate brokers) - he actually had the audacity to inform me that any buyer who wants to know details (eg. get an inspection) of a house they are optioning to buy is not a good candidate for a lease-option!!! He typically works with buyers who have no professional representation.

I agreed that knowing whether permits have been pulled on a house one is renting or buying is a material fact that might influence a tenant/buyer's decision to rent or buy.

I told him that this spoke VOLUMES about his business model, and that, thank you very much, this is NOT the way I do business.

Foreclosure Pain

"What about lease option or rent-to-own?" my state auditor asked me. "Are they for real?"

"of course they are!" I answered. "It all depends on the terms you can negotiate, and your ability to meet those terms....Why do you ask?"

Because, it turns out, my state auditor recently lost his Magnolia home of over ten years to foreclosure. His story is tragic and reflects the pain that foreclosure costs many homeowners in today's economy.

He and his wife were hardworking Philippine emigrants, she from Canada and he now a US citizen, believing strongly that ours is indeed the land of opportunity. Then his wife got breast cancer about five years ago. The chemotherapy and radiation therapy destroyed her heart. She almost died. She was fortunate to receive a heart transplant.

In the mean time, their medical bills mounted. She had made more money than he as a medical technician; he had a good state job. But now without her income, they could not pay her medical bills and make ends meet.

He applied for and received a loan modification on the house. He made the first two months payments, but was short on the third. He asked the bank if they could wait a week for the balance of the funds. The bank said no.

She lived. But they lost their house. In the process, he lost his faith in the United States (as did LuAnn Lavine in our previous post). They now plan to move to Canada when he retires in three years - but he was still wondering if maybe, maybe they could own a home again. Maybe, with rent-to-own?

Creative acquisition techniques may be the only option for future homeowners, given that so many people have been challenged in this economy. Lease purchase, rent-to-own, options and seller financing are some of the techniques that deserving buyers may use to purchase a home in a tight lending environment, where the banks are faceless, heartless corporate entities, and where 50% of all deserving buyers cannot get loans.

So yes, there are good deals out there on foreclosures. And while each foreclosure represents someone's heartache and pain, savvy buyers are jumping into the housing market where others can no longer go and providing new opportunities for someone else to have a home they can afford. Where one door closes, another opens....

And so yes, Mr. Auditor, rent-to-own is certainly an option for you and your wife. Just make sure that you are doing business with someone you trust, and that you are represented by someone who cares about giving you another opportunity to believe in the goodness of our country....

Lease Option on Rocky Point Waterfront Home

Here is a case study of how I might work with a lease-option buyer on the purchase of the property highlighted in the last few blogs. In my next blog, I will discuss how an investor would profit by underwriting the mortgage for the lease-option buyer.

On a lease option, I typically pay the selling agent 1% of their commission up front, and the remainder when the option is exercised. So the down payment has to cover commission costs, option fee, and other related costs. I typically like to see 3 1/2 - 5% down as a non-refundable option fee. I used to bump up the purchase price by about 10% per year for seller financing and future value on an option, but in this market I'd be okay with $357,500 as a purchase price in three years for the house parcel.

Monthly payments should be equivalent to what monthly payments would be on the take-out loan, including taxes and insurance. Lenders like to see this too, as it demonstrates ability to repay.

If the buyer went FHA with a loan amount of $345,000, the FHA funding fee would be $6,000 so the loan would be for $351,000 then the payment with a 5.50% rate would be $1993 plus $161 for Mortgage Insurance (MI), and $308 for taxes and $50 for a total of $2512 a month.

Assuming the buyer put $12,500 down as an option fee (applied toward the purchase price), then monthly payments on the loan amount above would be roughly $2500 with taxes and insurance. I would be willing to apply $500 of the monthly rent as rent credit towards the purchase price, assuming payments were made on time.

At the end of the three year term, the house would be purchased for $357,500 less the option fee of $12,500 and rent credits of $18,000. The loan amount would actually be for $337,000--and payments would be even less per month. This is a good option for a buyer who cannot qualify for a loan today, but may in 2-3 years.