Coach Mitch's Lease/Option with Rehab. Post 219

Coach Mitch’s REFLECTIONS™

Editor’s Note

Recently, a new student got his first property. He got his list, mailed a few letters and one response he got back was from a desperate seller just prior to the tax auction. This highly motivated tax delinquent seller said, “Just take the property.” The student gave her $1 for the deed and paid the $2500 back taxes to the county to secure the property, a 1000 sf, 3 BR, 1 BA, gar, 1+ AC wooded lot in a low density area close to town. While the home has good bones, it needs a total overhaul.

We have done some marketing and have had several offers. The student could have made about $12K clean on a wholesale deal, but we’ve decided to try for a different strategy:

1. Be the bank, and sell the property on a note, then sell the note for cash after the buyer has done a rehab, OR

2. Find a potential buyer with rehab skills, do a lease/option and have the renter put up the monies for fixup, then, after the renter rehabs the property, they get a regular mortgage and cash us out.

The note below summarizes a significant coaching session with the student and I thought I would share it with you.

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The idea is to make the transaction appealing to the prospective buyer by giving them what they want, i.e. a good home for a good deal.

When you told prospects that you would be the bank, they liked that. When you said that payments were adjustable, they liked that. When you said $30K was the purchase price, they probably thought that was a good number for a home that needed a full rehab. However, when you showed the property, they thought that it was too much work and consequently, the easy financing seemed to no longer be as attractive. Because the amount of work was out of their comfort zone, the price became too high, the cozy financing no longer mattered, etc.

Apparently, you did not pre-qualify the prospects well enough. You want as many people to look at the property as possible, versus the few that are the right prospects. Instead of downplaying the level of work to enhance the potential of a showing, you should try using the “push away” sales technique – as shown in my manuals.

You “push them away” by telling people that the property needs significant work, a full kitchen, a full bath, a new roof, sanding floors, etc. Don’t you downplay. When people want something, like a house that they think they can afford, then they will downplay the warnings and come back.

You can pull them back in by emphasizing the good features, like: sanding floors is easy, a roof is hard work but simple to do, painting is easy and cheap, anyone can do it, they can pick the colors and cabinets, etc.; and cabinets aren’t hard to install, you simply create a level line and screw them into the wall.

The right sweat equity person needs to know or be willing to learn how to do residential plumbing and electrical and perhaps tiling. I did. You simply open a book and follow directions. Potentially, the most complicated electrical thing they will do is a 3-way switch, which is no big deal. Tiling is a snap. When using the plastic piping plumbing is a breeze. They can hire out the items that need real expertise, e.g. the electrical service, the furnace install, and if choosing a stone counter top.

Therefore, you need to show the folks that this is a full rehab situation and that the rehab can be done in several ways, some more profitable than others, but in the end, they will get a good home and a good deal.

They can do much of the work, and there is a lot of work, or they can hire the work out, to handymen or to established contractors. There are distinct differences in cost. Your best buying prospect is a low wage contractor with mechanical skills, but one who doesn’t have financial stability. He has the ability to do the work, but not the easy ability to get a bank loan.

The deal is simple, you can do a lease with a purchase option which can be structured several ways. This setup has the added benefit that no large down payment is necessary and the prospects monies can go to purchasing materials.

1. You can charge a significant above market rental, $1000, with a rental credit for work and materials, $500, and an option to purchase for $1. Presuming that a market rental is $500, each $500 credit can be justified to the bank as legitimate because it is above the market.

2.  You can charge a smaller/regular rental, $500, with an option to purchase for $1. The work is scheduled and, if performed, given a real world value that can be justified. The option to purchase can also be paid with value for the work performed and the materials and then given as credit toward the down payment.

You will explain to the prospect, that, by fixing the home with his sweat equity, when he goes to the bank for a purchase mortgage, you can show that the monies owed to him for labor and materials will be considered a credit toward the down payment.

You will not pay him anything, but he will get the benefit of his labor and materials as a credit and he will be able to then get an 80% mortgage at minimum and probably a 95% mortgage.This is similar to a person buying a vacant parcel of land, owning it free and clear, and using the land as the down payment for a construction loan for a new home. As long as the land has a value of 20% of the entire project, then the bank will consider the land as the full down payment.

To justify increasing the price to $40000 from $30000 for old prospects, you need to understand and be able to present the dynamics of the transaction and the financing.

First, you should get a good feel for the cost of the materials for the rehab. They won’t be exactly accurate because the buyer may want different cabinets, etc., however you will be close enough for the sales conversation.

1. Determine the work needed to be done to retrofit the house. Goto Lowes/Home Depot to price materials for the entire job. Get the contractor’s discount.
2. Get their estimates for Good and Better grades of materials, e.g. kit cabinets, bath items, etc.
3. Get estimates for floor sanding rentals, 5 gal poly, floor molding, perhaps crown molding, paint, drywall, mud, etc.
4. Determine if you will need a furnace, updated electrical service or extensive plumbing.
5. Go up on the roof and measure the length and width, multiply by 2, giving you the square feet, divide by 10 for the number of squares. Get prices for roofing materials.
6. Call a realtor, showing your plans for a Good or Better rehab and ask to get BPO’s, Brokers Price Opinion’s, for the After Repaired Values, ARV, of the rehabbed house, using both Good or Better materials, e.g. $80K-$90K.
7. Call in two contactors and two handymen to give estimates for the work, using the materials from Lowes/Home Depot. Get their discount rates for materials as compared to what you were quoted. Using pros with max pricing, the job should be: 40% materials, 60% labor, e.g. $9.6K materials, $14.4K labor. Labor is much less if using handymen, perhaps $20-$35/hour vs. $60-$120 per hour for “pros.” Sweat equity has no cost.
8. Consider doing a rehab yourself OR show figures to prospects so they can see real world figures.
9. Using the BPO numbers from the realtor, e.g. $80K, show how much a mortgage will be and how much equity they will have and how much money in the bank from a mortgage.
10. Redo the CraigsList ad to reflect these ideas.
11. These ideas should make it easier to have people believe they will have a good home and are getting a good deal.

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The financing. This is the real closer.

If you were to hold the mortgage and require the buyer fix up with a contracted work schedule, after six months you could sell the mortgage. The initial note to be created could be:

Num%       Int   PV    PMT(P+I) Tax  Ins   PITI

180m(15y)   5%  $40K   $316/m   $92  $42  $450/m

180m(15)     7%  $40K   $360/m   $92 $42  $494/m

180m(15)  10%  $40K  $430/m  $92 $42  $564/m

 

360m(30y)  5%  $40K   $215/m   $92  $42  $349/m

360m(30y)  7%  $40K   $267/m  $92  $42   $407/m

360m(30y) 10% $40K   $351/m  $92  $42   $485/m

 

If creating and selling a 15 year, 10% mortgage, after six months, you would have collected six  payments of $430 for $2580. The remaining balance would be $39,409. for 174 months.  If the investor wants a 13% ROR, he would pay $33,592, plus the $2580 = $36,172 Your Profit!

However, if you did the lease option, and the buyer went to get a bank mortgage after the six month rehab, you would be paid off in full.

360m(30y) 5%  $80K  $429/m $92  $42  $563/m

As you can see, the 15y, 10% payment is $430 and the 30y, 5% payment is $429. Interesting.

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The big benefit to the buyer is that they should qualify for a 90-95% bank loan which returns to them the rehab monies and puts monies in the bank.

$85K appraised value x 95% = $80,750 loan                                                                                                                                                                rehab = closing costs
Less payment to you                = $40,000 + $500/m rent x 6m
                                                     $43,000 Your Profit!!

Buyers NET                         = $40,750 in bank account
If doing a costly $24K rehab      = $16,750 is buyers equity

Plus they get to deduct all the costs of rehab from income taxes as capital expenses.

Plus they get to deduct all the costs of the mortgage interest from income taxes.

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This is how you explain Coach Mitch’s Lease/Option with Rehab so that prospects see that they get a good deal and a good home.

Additionally, it should be noted that the fixup is at the renters (potential buyer) risk and expense. They only get the credits if and when they get a bank mortgage. This has always made sense and been acceptable when I’ve done lease options with people because the prospect enters this the lease/option with the vision that they will finally become a home owner.

Also, if selling the home and holding the mortgage, be aware that you won’t be able to sell the mortgage to an investor unless there has been a significant rehab. The appraisal will need to be at least $60000. If the buyer has not done or cannot do the work according to the contracted schedule, then you will have to decide if you will foreclose. That is your risk if you hold the mortgage. If this occurs, there is a real possibility that the buyer could remove their improvements, e.g. cabinets, and harm the structure.

I hope this helps. Call with any questions.

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For those considering doing real estate investing with tax delinquent properties, you can see there can be significant profits.

See Coach Mitch’s “Ridiculously Simple System…” ™ for details.

G-d Bless US