I once bought a parcel of property on a land contract. The property had splitable acres in a town near me which was fairly rare. One part of the property needed development and the other part had a house. The seller of the house was an older lady who had lived there for 30 years. Because the house needed some work, I lease optioned it as a handyman special. Along came Steve who was a licensed builder. Because he was a licensed builder, I had him sign all the contracts under her personal name and his company name.
For Steve, this seemed like the perfect house. There wasn’t anything in it that needed fixing that he wouldn’t be able to tackle or have the resources with other contractors to tackle. It wasn’t too far into the renovations, however, that Steve called me and said, “We got a problem – this house has been in a fire.”
I was unaware of any fire, so naturally my first response was to call the seller and ask if she knew anything about a fire. The seller confirmed that while she lived there that there had never been a fire. Now because the house was built in the 20’s or 30’s, there was a possibility that anything could have happened to it, but she didn’t know of it and my inspectors and I didn’t know of it. Steve said, “Wendy, I can’t even believe the roof is standing because all the rafters are completely charred all the way up and through the decking.”
I asked him what it would cost to repair, and he said $3,500 in materials. I offered to give him $3,500 off the purchase price when he exercised the contract. Now, this was advertised as a handyman special, so I didn’t cheat him or lie to him. How could I know what was up under the plaster?
Everything seemed to go smoothly for months, he was making repairs and improvements, and I was sure he was going to exercise. Month seventeen came and I asked him if he’d been speaking to the lender and if he was going to get a mortgage. He said he had a little glitch in his credit and so I asked if he wanted to extend for another six months. I didn’t really have a problem with this because he’d been paying perfectly, but he said, “No, I’m moving next month. I don’t like all this development happening around me.”
Steve knew about the development when he moved in and it was documented in the contracts that he signed. He moved out and sued me for the option money he had put down in the beginning.
Being sued is scary and nerve wracking for most people. I don’t like it, but I have been through it a handful of times. It’s inevitable, and all the more reason to keep excellent records on every little thing that happens with each house, each conversation, each mailing, every document, etc.
In court Steve told the judge that there were many problems with the home and he showed the judge many pictures of the home and of the fire damage. The judge asked if he thought I knew about the fire. He responded, “No, I couldn’t tell either, it was covered in plaster”. The judge asked me. I said I did not know and that I did offer to pay the $3,500 to fix it. The judge looked over our contracts very briefly, and noted where it said the home was sold “AS IS” and that it was a handyman special and that he had had the home inspected. The judge pulled her glassed down to her nose, pointed to a paragraph in my contract and said to Steve, “Wendy did not have to offer to pay anything for the roof, she was more than fair. So, Sir, I have just one question for you. What part of, ‘This option fee is NON-REFUNDABLE’ do you not understand? Case dismissed. Next.” Steve got up and stomped out of there very mad!
Advanced Selling Strategies for Lease Options
- Handyman Specials
Handyman specials are homes that are less than perfect and require sweat equity to bring them up to a new level of respectability. There can be a lot of money to be made in a handyman special. The tenant-buyer’s overall purchase price, or option fee required, is going to be lower for the privilege of doing the work themselves. I actually can’t provide enough homes for people out there who want this situation. This technique will work in most areas of the country except in areas where the city requires certification or landlord licensing. They don’t work in those areas because the city won’t allow homes that aren’t perfectly up to code to be rented, and sometimes these homes might just need paint or a few items, but sometimes they may need some major items also. In the areas where the city doesn’t require inspections or certifications, it can be a great way to liquidate your properties.
Tenants have a perceived value in the fact that they will do the sweat equity. You’ll make just as much money and you won’t have to go over budget on doing your own rehabbing. One word of caution: make sure the home is habitable. It must be able to be lived in, or you will have problems if the tenant-buyer doesn’t pay and decides to fight you on rent or their option. Any judge will expect the landlord to provide a habitable home for their tenant. The tenant-buyer is going to love you because you are giving them the American dream: a nice fixer-upper.
- Section 8
Section 8 is a rental-assistance program funded by the Federal Housing and Urban Development Department (HUD), which gives approved tenants financial assistance by paying a portion of the rent directly to the landlord. Section 8 now has a new program for lease options.
Section 8 doesn’t control the particulars of how the lease option is set up, but will make the monthly payments on it. After the lease option is started, they will help the tenant-buyer get a mortgage that will convert the lease option to a purchase. It’s not for every Section 8 tenant but for a select few that qualify. Talk with your local Section 8 administrator and have them come in and talk to your real estate or investor group so that you can have all the current information.
As a landlord I love Section 8, because the payments, or most of them, come directly to me from the state.
- Ads for Soft Rental Markets
In soft rental markets there will be many rentals and not many good tenants. In order to get a good tenant into your home you will need to make your rental ads stand out. The ad must contain something that looks better than the competition’s ads. One idea that I have used is to offer a rent of several hundred dollars lower than I actually intend to rent it for. When the applicants come to the home, I screen them to see if they can afford the extra $200 per month. If so, I offer them 50 percent on the additional $200. It will make sense in a minute—keep reading.
I might say, “You, really like this home, don’t you? And you want to buy it, right?” Of course I know they do. “How would you like to make 50 percent on your money?” When they say yes, then I offer to give them a $300 credit to buy the home if they pay an extra $200 per month. Now I am getting my $200 more per month, which is what I originally wanted, but I advertised it at $200 per month less to generate the leads. Yes, it does cost me $3,600 in option credits for the entire year if they purchase, but I rented the home. If they don’t purchase the home, I received my entire rental amount. This is a small amount to pay to get someone in during a slow market.
Strategies for Reducing Your Taxes
Many people worry about paying Uncle Sam. How would you like to have to worry about getting into a lower tax bracket because you are making too much money with lease options? When you have been investing for some time and get your pipeline filled with deals, your income will increase and you will need to begin being creative on ways to save on taxes when you sell. You can keep your properties forever, but if and when you sell there are tax issues. There are some things that I have done to reduce taxes for myself.
Exercise Your Option and Hold for Another Twelve Months
If you are in a higher tax bracket, you might want to consider exercising your lease options with your seller prior to your tenant-buyers exercising their options. If you do a simultaneous closing, it is considered a short-term capital gain. You only owned it for one day. You are taxed at your normal income rate. You can sell your option by assigning it. If you have held it for more than twelve months, it is long-term capital gain, taxed at a much lower rate. Unfortunately, if you assign your option, the profits are not nearly as good as selling it to a tenant-buyer, and very few tenant-buyers can pay an entire assignment fee to get you the profit you would receive if they were to purchase it outright. Therefore, if taxes or high tax brackets are an issue for you, consider exercising after the twelve months of payments to the seller (treated as the refinance so you don’t have to put down cash out of pocket either) and then make sure your tenant-buyer doesn’t close for another twelve months. This would give you long-term capital gains on the ownership of the property and give you a much better tax rate on the profit.