The focus of this article is advanced strategies for experienced real estate investors who want extra protection for your investments. The use of the strategies I'll cover will depend upon your investment strategy. Also, they may not be solutions you'll commonly use, but you'll have the knowledge you need should you decide to employ them. It's always good to have more weapons in your investment arsenal!
The Indispensable Memorandum of Option One of the main negatives of lease options involves financial difficulties of sellers. Such difficulties often take the shape of liens, delinquent property taxes and other similar hassles. As an investor, you can waste a lot of time and money cleaning up these issues before a property can be sold.
The Memorandum of Option is a basic protection for the investor. The memorandum is a document is a record against the title of the property and should always be recorded. It informs the public that you have an interest in the property.
The purpose of the memorandum is to prevent an unethical seller from refinancing and selling the property to someone else. It also provides you protection from bad faith sellers who try to squirm out of their obligations. With lease options, always record a memorandum of option!
Advanced Strategy 1-the Deed in Escrow Most often, escrow refers simply to the deposit of funds by one party for the delivery to another party upon completion of a particular condition or event.
However, the definition also includes the deposit of deeds and other written financial/legal instruments. I recommend placing the deed in escrow at the time the memorandum of option is filed. In this case, the seller signs the deed along with the other contracts, but the deed is not recorded on the title at this point. Instead, it's held in escrow by a title company or attorney, and they're provided with instructions for its release.
Now, this action doesn't protect against the filing of liens against the property. But, its effect is to reinforce to sellers that they've actually sold the property. This, in turn, creates reluctance on their part to try to back out on a lease option agreement.
It also has another advantage: It allows you to close on the property without the seller being present! With the deed in escrow, you should specify how and when the deed is to be released and recorded. The instructions can be simple, such as this example: "When Sam Smith pays $200,000 in certified funds to John Jones, the deed will be released to him. By (date), these funds must be paid."
Advanced Strategy 2: The Performance Mortgage With this method, the seller pledges the property as collateral for the lease option agreement, and, therefore, ensures good faith performance by that seller. Once the mortgage is assigned to the buyer, it prevents the seller from selling the mortgage to other people. (It replaces the memorandum of option filing.)
The performance mortgage allows the seller's insurance company to put the buyer's name on the owner's policy as another insured. It also shows that the buyer is a lien holder and requires that he or she be notified if any type of foreclosure action is taken.
Of course, some sellers don't like the idea of a performance mortgage and won't agree to this deal! If a performance mortgage is agreed to, have your attorney review the terminology of the mortgage to make sure the appropriate, specific clauses are included.
Advanced Strategy 3: The Land Trust A land trust is defined as an organization established to hold land and to administer use of that land. This technique is very useful with subject-to's. The purpose of a land trust is to minimize possible exposure to litigation.
It does this by hiding true ownership. The actual owner or beneficiary is not recorded in the public records, just the name of the trust. This means potential litigants find it difficult to identify someone to sue.
Keep in mind that land trust contracts tend to be complicated and long so you'll definitely need an expert lawyer to draw them up.
Advanced Strategy 4: Get Yourself a Seller-Partner There may come a time when you want to consider subject-to high-end properties (in terms of quickly appreciating value). Since there's more risk involved, it's a smart idea to spread that risk. You can do this by taking on the seller as a partner. With this arrangement, you and the seller share the profits.
Here's an example: Assume a property is worth $800,000 and the monthly rental is $3,500. Under normal circumstances, you'd more than likely back away from this deal. However, let's assume you discover that this home might be sold for $200,000+ in profits. This deal makes good financial sense for you and the seller. So, you agree on a 50-50 partnership (or another percentage arrangement), and you're both happy.
My recommendation: If you take this course, require that the seller cover all the risks.
Advanced Strategy 5: Refinancing This is a tax-deferment strategy. Here's an example: Assume you have a house worth $300,000 and $230,000 is owed on it. Through a new mortgage, you can take out some or all of the $70,000 in equity, and it's not a taxable event. That means you can use that money to reinvest in other properties while still holding on to the original property.
It's a good idea to check with lenders and brokers in your area to find out what refinancing programs are available.
Tax Concerns With any of the strategies I've just described, IRS regulations have to be met. So, you and your tax person should stay up to date on those regulations. They do occasionally change, and those changes can affect the legality and profitability of deals. One area to really be on top of is capital gains.
Capital gains are the profit on the sale of a property. At the present time, you can sell your primary residence (the one actually lived in, not investment properties) every two years.
If you're single, you can keep the profits up to $250,000; if you're married, you can keep up to $500,000. In both instances, the profits are tax free. If the seller of a property lives in his or her home for two out of five years, then that property qualifies for a tax-free gain. The seller can rent the home out for three years - and not a single day more.
My Advice Study advanced strategies and keep them in mind as you grow your investment portfolio. More than likely, you won't need them for the majority of investments (especially early in a career), but, as is often said, knowledge is power. With that knowledge, you'll be able to apply it quickly and easily when the right situation arises.
Key Point: Always get the lenders written permission. Study advanced strategies in depth, so you can make use of them at the appropriate time for maximum protection of your investments.
The Indispensable Memorandum of Option One of the main negatives of lease options involves financial difficulties of sellers. Such difficulties often take the shape of liens, delinquent property taxes and other similar hassles. As an investor, you can waste a lot of time and money cleaning up these issues before a property can be sold.
The Memorandum of Option is a basic protection for the investor. The memorandum is a document is a record against the title of the property and should always be recorded. It informs the public that you have an interest in the property.
The purpose of the memorandum is to prevent an unethical seller from refinancing and selling the property to someone else. It also provides you protection from bad faith sellers who try to squirm out of their obligations. With lease options, always record a memorandum of option!
Advanced Strategy 1-the Deed in Escrow Most often, escrow refers simply to the deposit of funds by one party for the delivery to another party upon completion of a particular condition or event.
However, the definition also includes the deposit of deeds and other written financial/legal instruments. I recommend placing the deed in escrow at the time the memorandum of option is filed. In this case, the seller signs the deed along with the other contracts, but the deed is not recorded on the title at this point. Instead, it's held in escrow by a title company or attorney, and they're provided with instructions for its release.
Now, this action doesn't protect against the filing of liens against the property. But, its effect is to reinforce to sellers that they've actually sold the property. This, in turn, creates reluctance on their part to try to back out on a lease option agreement.
It also has another advantage: It allows you to close on the property without the seller being present! With the deed in escrow, you should specify how and when the deed is to be released and recorded. The instructions can be simple, such as this example: "When Sam Smith pays $200,000 in certified funds to John Jones, the deed will be released to him. By (date), these funds must be paid."
Advanced Strategy 2: The Performance Mortgage With this method, the seller pledges the property as collateral for the lease option agreement, and, therefore, ensures good faith performance by that seller. Once the mortgage is assigned to the buyer, it prevents the seller from selling the mortgage to other people. (It replaces the memorandum of option filing.)
The performance mortgage allows the seller's insurance company to put the buyer's name on the owner's policy as another insured. It also shows that the buyer is a lien holder and requires that he or she be notified if any type of foreclosure action is taken.
Of course, some sellers don't like the idea of a performance mortgage and won't agree to this deal! If a performance mortgage is agreed to, have your attorney review the terminology of the mortgage to make sure the appropriate, specific clauses are included.
Advanced Strategy 3: The Land Trust A land trust is defined as an organization established to hold land and to administer use of that land. This technique is very useful with subject-to's. The purpose of a land trust is to minimize possible exposure to litigation.
It does this by hiding true ownership. The actual owner or beneficiary is not recorded in the public records, just the name of the trust. This means potential litigants find it difficult to identify someone to sue.
Keep in mind that land trust contracts tend to be complicated and long so you'll definitely need an expert lawyer to draw them up.
Advanced Strategy 4: Get Yourself a Seller-Partner There may come a time when you want to consider subject-to high-end properties (in terms of quickly appreciating value). Since there's more risk involved, it's a smart idea to spread that risk. You can do this by taking on the seller as a partner. With this arrangement, you and the seller share the profits.
Here's an example: Assume a property is worth $800,000 and the monthly rental is $3,500. Under normal circumstances, you'd more than likely back away from this deal. However, let's assume you discover that this home might be sold for $200,000+ in profits. This deal makes good financial sense for you and the seller. So, you agree on a 50-50 partnership (or another percentage arrangement), and you're both happy.
My recommendation: If you take this course, require that the seller cover all the risks.
Advanced Strategy 5: Refinancing This is a tax-deferment strategy. Here's an example: Assume you have a house worth $300,000 and $230,000 is owed on it. Through a new mortgage, you can take out some or all of the $70,000 in equity, and it's not a taxable event. That means you can use that money to reinvest in other properties while still holding on to the original property.
It's a good idea to check with lenders and brokers in your area to find out what refinancing programs are available.
Tax Concerns With any of the strategies I've just described, IRS regulations have to be met. So, you and your tax person should stay up to date on those regulations. They do occasionally change, and those changes can affect the legality and profitability of deals. One area to really be on top of is capital gains.
Capital gains are the profit on the sale of a property. At the present time, you can sell your primary residence (the one actually lived in, not investment properties) every two years.
If you're single, you can keep the profits up to $250,000; if you're married, you can keep up to $500,000. In both instances, the profits are tax free. If the seller of a property lives in his or her home for two out of five years, then that property qualifies for a tax-free gain. The seller can rent the home out for three years - and not a single day more.
My Advice Study advanced strategies and keep them in mind as you grow your investment portfolio. More than likely, you won't need them for the majority of investments (especially early in a career), but, as is often said, knowledge is power. With that knowledge, you'll be able to apply it quickly and easily when the right situation arises.
Key Point: Always get the lenders written permission. Study advanced strategies in depth, so you can make use of them at the appropriate time for maximum protection of your investments.
About the Author:
Jack Sternberg is the creator of the renowned "Buyers First Program". As the "gurus' guru", he is well known by the professional creative real estate community as "Obi-Won Kenobi". Having been a full time investor since 1977, Mr. Sternberg has been "at" the closing table more than 1,500 times. Mr. Sternberg has the depth of experience that lend value to his associations. Contact Mr. Sternberg at www.askjacksternberg.com
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