Lease Options vs. Subject Tos

When to consider these techniques

Lease Options and Subject Tos, aka “Getting the Deed” are two very popular ways to purchase real estate with little or no money down. Acquiring investment real estate can be handled with many different approaches, but these two techniques can be implemented with little or no money down in most incidences.

A lease option is a technique which involves gaining ‘control’ of a property, but not owning it. It is the right to possess a property now and purchase that property at some future date with terms you define when you buy it.

A “Subject To” is getting the deed to a property without getting a mortgage for the home. Instead, the seller signs over the deed to his home ‘subject to’ the existing mortgage. The buyer in this case makes the mortgage payments on the old loan, but does not need to get a mortgage themselves to acquire this home.

Both of these techniques usually require little or no money down. In both of these techniques it is possible for the buyer to get money from the seller or the purchaser (or both!) in the beginning of the transaction. These techniques, when used properly, will provide for huge profits. They are both awesome, and when used hand-in-hand by investors are almost an unbeatable pair!

This short article is not meant to give details of each technique, but rather to show when you could consider either of them. If you don’t understand how to document and protect yourself in each kind of technique, then get yourself educated!

Why Knowing Both Techniques Means More Great Deals For You
Unfortunately there are many people that are teaching that you should only do the Subject To – technique. They recommend never buying on an option. I can’t tell you how many times I have heard, “If I don’t get the deed, I don’t do the deal”. I have to disagree with that statement. The more tools and techniques and ways you have to purchase property or to structure a deal, the more likely you will be able to work with a motivated seller to come to a potential solution. If you only buy “Subject To”, you’ll walk away from a LOT of great deals in your real estate career, but you must know when each technique is appropriate to use.

Finding a motivated seller is the first step to any good real estate deal. There are many types of motivated sellers, but we tend to think of motivated sellers as the ones that are financially distressed. I like to look at motivation from a much wider range. Let me explain. I like to divide motivated sellers into two groups:

Sellers that have “Bad Debt” are those in financial trouble. They might be behind on a mortgage, have lost their job, acquired an illness, going through a divorce, etc. In these situations, you need to get the deed either with a Subject To or an outright purchase. Your main concern is that this type of seller will continue to have financial problems that could affect the title to “your” property if the deed is still in their name. For example, if this seller gets judgments from creditors, they can attach to any real estate the seller owns - they will have to be paid off before you can exercise your option to buy. That’s why you want to get this type of seller off of the title.

Sellers that have “Good Debt” are those NOT “in trouble” in the traditional sense, but they do have a reason motivating them to sell. Their problem is not one of financial desperation—it is usually just a change in their life. They might be transferring to a new location for a promotion, getting married (each owning their own home), building a new home, burned out landlords, etc.

Example #1 Here is an example when you MUST get the deed:
A seller calls you on the phone and says he is 2 months behind on payments. Do NOT option this home! This seller is in trouble financially and is not a good risk for an option. Anyone that is in a bad financial situation is not a good seller for an option. This is the type of seller that you must get off of the deed so that his financial situation will not affect the title to the property in the future.

Not every seller who is in financial trouble will tell you so, which is why you ALWAYS need to do research on the title before you get the deed or do an option. In this case, you will need to bring the seller’s mortgage current. Before you do, you want to make sure that he is owner of the property and there are no other liens on the property.

Example #2 Here is an example when you COULD get the deed:
A seller calls you who owes $135,000 on his home—which is worth $135,000. Since there is no equity at all on this property, this type of seller might very well be willing to give you the deed. If there is high appreciation in the area, or a very low payment, you might be able to make a profit even though there’s no equity. However, be careful that you have evaluated the numbers correctly before you take the deed.

On the other hand, if the seller’s payment is too high or the market is slow, you might need to have the seller pay you to take the deed. Yes, there are sellers who will pay you to take the deed to their home. Think about it: if this seller sells conventionally—that is, through a Realtor, he would have to pay up to $10,000 in commission to sell his home. Plus, he’ll have closing costs, transfer taxes, and will probably pay points or fees on behalf of his buyer. If he’s willing to pay all this money to an agent to sell the property and wait 90-120 days to sell, why shouldn’t he just pay you to take over his payments NOW?

If the seller didn’t have the cash to give you, an option would be your best strategy. This way, the seller can pay you the $10,000 over time, or you could arrange for the seller to pay part of the monthly payment during the option period. This way, if he stops paying his portion of the payments, you have the choice of surrendering your option and simply giving the property back to him. When you have the deed, you normally can’t do this.

Example #3 Here is an example where you SHOULD lease option or lease purchase:
A doctor has a new home built for himself. His old home is worth $200,000 and he owes $125,000. He has $75,000 of equity. He is not behind on payments, and he did not need the $75,000 of his equity to buy the new home. His old home is sitting vacant and the realtor has not sold it yet. He qualified for both house payments at the bank and he can technically afford both, but who wants to make an extra house payment?

Although he is motivated to sell because he’s coming out of pocket every month to own a vacant property, this type of seller is NOT going to simply give you the deed and let you take over the mortgage. There is no way is he going to give up all of his $75,000 in equity, and no way are you going to pay that much cash out of pocket.

When you lease option this house, he gets most of his equity back—although it won’t happen until YOU sell the property. The deal might work like this: you option the property for $195,000, and make payments to the seller that equal his total mortgage payments. You SELL the property on an 18 month lease option for $228,000 with payments to match. You get cash flow + $33,000 in profit when your tenant/buyer buys the property; the seller gets his payments taken care of for a few years, then gets the bulk of his equity out. And in the meantime, he doesn’t have to worry about management, vandals, frozen pipes, and all of the other things that owners of vacant houses have to deal with.

Example #4 Here is an example where you COULD lease option or lease purchase:
A seller just inherited a property worth $120,000 from their parent’s estate. It is owned free and clear and they don’t want to be paid off. They don’t need the cash, but they would love some cash flow on this asset. This seller is not going to give you the deed. Let’s say you can lease option this property for $700 per month with $300 per month going to the purchase – or the option credit. Your real payment in this case is only $400. You can compare these numbers with doing a seller financed type of arrangement. See what works the best and make that offer first.

Let’s examine a seller financing deal:
A seller financed deal means that the seller will finance a mortgage for the buyer and the buyer pays their mortgage payment/interest to the seller versus a bank. This is primarily done when the seller owns a home free and clear and they do not have a mortgage on it themselves. It can be called a land contract, contract for deed, or private money mortgage. It will depend on how the offer is made and accepted. Let’s say you negotiate a deal with the seller for a sales price of $110,000 – if you want your payment to be $700.00 as in the above lease option example, let’s see what that really means to a seller for a seller financed deal. First in a seller financing or mortgage your payment includes taxes and insurance (unless the buyer pays them themselves). This must be subtracted from the $700. Each part of the country fluctuates, so I will use an estimate of $250 per month for taxes and insurance. This leaves $450 for the seller. Now we must subtract our principal we negotiated above the $300 per month credit. This now leaves the seller with $150 per month. If this were to be all that is left this would essentially mean the seller is receiving 1.6-1.7% interest on their money. The interest rate has to be disclosed on the loan document or seller financed deal. A very low interest rate is much harder for a seller to accept then a lease option payment of $700 per month. It is the same thing to the seller, but it is spelled out differently. They don’t do the subtraction themselves to calculate the real rate of return. If you do a seller financing deal, you must calculate and show it in writing. Compare the two and see what works the best.

Let’s examine the pros and cons of Subject To vs. Lease Options:

Subject To Pros:

- Title is in your name – full ownership
- Some sellers will pay you to take the deed.

- Easier to prove ‘seasoning of title’ – when you are the title holder. Easier to refinance.

- If you are on the title you will have long term gains vs. short term if you hold the home for longer than 12 months.

Subject To Cons:

- You own it and have ethical responsibility to the seller even if the market changes or you can’t sell the home. You own it! No changing your mind on this one.

- You will need to get new insurance policy naming you or your company on the policy. In some instances this might trigger the ‘due on sale’ clause. You must insure it based on the title (who is the owner) or you will have no coverage.

- In some states mortgage brokers and realtors could be fined and/or subject to revocation of their license. It could be considered against their code of ethics to assist a person in violating a clause in a contract (due on sale clause).

- Sellers with lots of equity will be hesitant or completely against giving the deed. Sellers who get legal advice will almost always be against giving the deed to their home. Attorneys tend to be conservative.

Lease Option Pros:

- You don’t have to buy later – if the market drops or there is something wrong with the home. You can get out! If it goes up you can exercise and purchase the property. If the market stays flat you will have a choice of what to do.

- More sellers will do an option vs. giving up a deed – especially on ‘pretty’ homes.

- After 12 months of payments there are many lenders that will treat a lease option as a refinance – as if you were on the deed. It would be treated like a land contract or contract for deed refinance.

- A way to get nicer homes. It is more likely the seller that is not behind has taken better care of their home. This type of seller is also more likely to consider a lease option vs. signing over the deed.

- Seasoning of title will start when you file a memorandum of option or lien of interest. Most lenders will consider this adequate and similar to recording a deed (with the exception of FHA or possibly some other lenders).

- Sellers with lots of equity are more likely to give you the right to buy the home than they are to give you the deed to their home.

Lease Option Cons:

- Title is NOT in your name – seller could screw it up – must be careful to screen the seller. Only option from strong sellers, not those in trouble or headed for trouble. (unless you put the deed in a land trust)

- You will have short-term capital gains vs. long term if you are not on the title. This can be avoided if you finance it with the 12 months of payments (see the pros) and get on the title and hold it for 12 months before closing with your tenant buyer. This is a minimum of a 24 month solution.

- Some sellers might feel like an ‘option’ is not closure on their home. Some sellers will feel better with a deed being transferred or a lease purchase (which is a guarantee vs. an option).

- Sellers with lots of equity usually want to close and get their equity out.


Warning: There are many factors to consider when making an offer with either of these techniques. What is the current market condition for real estate in your area? Are homes appreciating, depreciating, or staying flat? What is the financial condition of the seller? Are they moving up or down financially in their new home? All of these items make a huge difference on how you will structure a deal. I always say, “Strong market – make a stronger offer. Weak market – make a weaker offer.”
Do your research, but if you keep your mind open to new ways of acquiring real estate, you will indeed make more money! Try using Subject Tos and Lease Options.

Loans For Investing

Here is a website that I came across for borrowing funds for doing flips, etc. The site is called www.prosper.com - I received an email from another extremely succesful investor in the Baltimore, MD area (Steve Cook) recommending I take a look at this site.

I haven't used it yet but I did subscribe to it. The site allows you to borrow money and lend money.

How it Works (This is taken directly from their website).

Borrowing money through Prosper is fast and easy, and because you're borrowing from people, the rates may be lower than you'd expect! 1. Join Prosper Joining is quick and easy. And free! 2. Create your loan listing Say how much you want to borrow, and set your maximum interest rate. 3. Watch the bidding Lenders start bidding immediately—watch the funding go up and the interest rate come down! 4. You win! If your terms are met, your loan will be funded directly to your bank account. 5. Easy monthly payments Your monthly loan payments are withdrawn automatically from your bank account.

It doesn't sound too bad. If I do use it any time soon I will post some feedback on my experience.

Let me know what you think!

The Truth About Flipping Real Estate

There has been a lot written about "flipping" real estate these last two years - and much of it is more fiction than fact. Some say it is great way to make money fast. Some say it is very difficult. Some even claim it is illegal. So, just what is the truth?

Let's take care of the "illegal" claims, first. Flipping, if done the way it was meant to be done, is completely legal. But it becomes illegal when unscrupulous investors, working with unscrupulous appraisers or lenders, conspire to defraud either buyers or lenders. This is done when an investor gets an appraiser or lender to over-value a property for the purpose of selling for a higher-than-market value, or for the purposes of getting a bigger mortgage so the investor can pocket more cash. In short, it is not the flipping that is illegal -- rather, it is the fraud that sometimes accompanies it that is in violation of the law.

Such fraud is not necessary. You can use any legitimate method of flipping, and if you remain within the law and act in an ethical manner, you will profit immensely, and earn yourself a solid reputation as a good person to do business with. In the long run, as you gain a reputation for fairness and sound ethics, you will actually profit more than if you were to defraud anyone.

Now, as for it being difficult. Some so-called "gurus" claim that in order to flip, the investor must first buy the property and only then find a buyer to resell to. Let's put that falsehood to rest right now -- you can buy and resell at the same closing (called a double escrow, or simultaneous closing) without ever having to finance a single penny, because the buyer's money funds both transactions. Under the law, neither transaction takes place first or last in a double escrow, regardless of which one actually is completed first. Therefore, the transaction with your buyer can take place first, providing you with the funds to pay off your seller. In such a transaction, the only requirements are a) you contract to buy a property from the seller at one price, then b) contract to sell that same property to another buyer at a higher price, and for both contracts to call for closing at the same time and place. Both agreements are placed into the same escrow. The key, of course, is to buy at below market value, and sell at no more than market value, to avoid any possibility of fraud.

The reality is that there are a number of ways to flip properties, the double escrow is only one method. Some methods require financing - others do not. Some methods do not require cash or credit. And most methods are quite simple to do. In addition to the double escrow, the investor may also flip by way of "assigning". In this technique, a property is put under contract. Then, instead of reselling the property (double escrow), the investor sells (assigns) the contract to another buyer. The buyer pays an assignment fee -- usually $3000-$5000 -- to the investor at the time the contract is assigned. The investor does not have to participate in any closing -- he is out of the deal, and a few thousand dollars richer.

That said let us look at claims that it is very difficult and time-consuming. Since the most difficult part is finding a suitable property, the rest of the transaction consists of negotiating the deal (no different from any other transaction), find a new buyer (also no different from any other sale), then wait until closing when the closing agent takes care of everything else.

Then there are the unfounded fears that for some unknown reason, your seller and/or your buyer will revolt at closing when they "discover" you are making a profit.

We can only assume that the investors who have this fear feel it is necessary to keep it a secret that they are an investor. I do not advocate that. I stress ethical conduct. Simply make sure your seller and your buyer are fully aware that you are an investor - it is nothing to be ashamed of! If they know this, they will obviously know, up front, that you must make a profit - you would not be in the deal, otherwise. At closing there will be no anger because they were not deceived. In all my years of doing this, I have not seen one case where closing did not complete because of such problems, because the problems never arose in the first place.

Yes, flipping is a great way to make a lot of money in a short period of time. And it, like any other endeavor, can be stressful at times. It is not as easy as many "gurus" would have you believe, but it is not all that difficult, either. The secret lies in 1) knowing which properties lend themselves to flipping , 2) being honest and up front, and 3) using the right contracts, specially designed for flipping.

Real Estate Investing--Starting Right Is the Key to Profits

The following is from an article I was reading recently and I thought it was worth sharing.

You've heard of the potential payoff from real estate investing. The good news is, it's true! The bad news is, it won't happen for most people. Why? They have unrealistic expectations. Real estate investing isn't a "get rich quick" endeavor, although it sometimes happens. No real business is. So, prepare to make a serious time commitment. Would you expect to become extremely wealthy at anything in just a few months? Know that you'll have to keep learning, keep getting contracts, and keep putting time into it.Still in? Great, you're a realist! Your first step is to choose an area to focus on. Do you want to purchase run-down properties and repair them to sell for profit (rehabilitate, or rehab them)? Do you want to buy properties and turn them quickly (flipping)? Maybe you want to buy properties, then lease them to potential buyers with an option for them to purchase them later, while you accumulate equity. There are pros and cons to each of these, depending on your financial position, your location, your available time, and other considerations. We'll be going over them all in future posts to this blog. You'll find the possibilities exciting.Once you know what you're looking at draft your plan IN WRITING. People who do this get three times as much done in the same amount of time. Set long-term goals for 3, 5 and 10 years out for what you want your cash, equity, and cash flow to be. Then, you can work backwards from there to set 1-year, 6-month, and 3-month goals. Without this, you'll be driving without a map, taking or skipping deals without regard to how they fit into your big picture. Leaves lots of room for "Wish I'da's...." Don't do it! You can always adjust your plan as you go along.Keep your day job for as long as possible. If and when it seems time to go, before you do, get some of those low- to no-interest credit cards that are out there. It could really ease some cash flow worries to be able to tap on a $10,000 line if you're doing a fixer-upper and run into an unforeseen problem with no additional bank draw in sight.Get an attorney who knows and understands the creative options of real estate. Some banks just don't understand simultaneous closings, for example; you'll want your lawyer to know how to smooth things so that there aren't any snags that cost you time and money. Some even have their own title companies. A good place to ask for a referral is to ask a mid- to large-sized developer. This is one place not to haggle about price; he or she will be worth their weight in gold when they can get your deals done and you know that you can sleep at night because it's been done quickly and right.As soon as you decide to get into real estate investing, begin building your list of buyers. We'll be covering more on this later; but, when you meet them, learn as much as you can about the kinds of deals they do, how long it takes them to conclude a deal, and so on. Most people love to talk about how they became successful, if you ask respectfully and don't waste their time.Warning, warning! Think very long and hard before taking on a partner. If you do, it should be somebody who brings something to the party that you don't have, and it should be for one deal only until you see how things go.Which brings us to how to set up your company. You should set up a separate corporate entity for each deal. An LLC is cheap and easy to set up. Land trusts are even better, because your name isn't personally in the public records, inviting some chump to sue you. The idea is to keep your personal assets off the table if something goes wrong. Talk with your attorney about it; he has forms that can have you done in a few minutes.Finally, if you've made your plan, you have to work it to get anywhere. If you're not out there making any offers, you're never going to close any deals. No deals closed, no profits. If you're not making any profits, you're not in business, you're dreaming. Set a number of deals you're going to bid on per week and per month, and then get out there. Make it happen!

Welcome Fellow Real Estate Investors

Being a local real estate investor from Luzerne County, I felt that, as this area is becoming more and more attractive to investors near and far, there currently is no way to communicate with fellow investors regarding real estate issues pertaining to Northeast PA (as far as I'm aware).

My purpose for creating this blog is to discuss real estate investing within NEPA - I feel that blogging is the way to go now and by creating this blog I want to be able to discuss with fellow investors such things as follows:

1. Current legal issues affecting investing in this area
2. Advice on using contractors for fix-ups and rehabs.
3. Best deals out there - for example: who's got the best prices for replacement windows, etc. (My opinion on windows is Millers Surplus - $38 a pop!).
4. Share deals, create deals.
5. Share ideas on what works and what doesn't.

The list could go on for ever but hopefully you all get the idea - what I am attempting to do is promote communication between investors in the area and who knows what may come of it. NEPA is an up and coming area for investors so I hope this bog will be accepted by all as a positive way forward to help all investors in this area.

Feel free to post your comments - its free.