Investors - How To Buy a House For Your Rent To Own Inventory
First and foremost, this article is for investors. As an
investor, you should not (must not) have any emotional ties to
any of your properties. You are in this business to make a fair
and honest profit, and you will sell your home(s) when it makes
sense to do so. Your goals should be to buy low and
sell high, generate a positive cash flow while you
own the house and use as little of your own money as
possible. OK, so now how should you go about buying a house
for your rent to own inventory of homes?
Location: Stay in your comfort zone. If you are not
familiar with the laws and regulations in other states, stay in
your home state. If you must "touch and feel" (see) your
properties, stay within a comfortable driving range. If you are
not comfortable with certain types of neighborhoods, whether it
be an urban blight area or upscale posh area, don't go there.
There are plenty of opportunities in your comfort zone. All you
have to do is find them and BE PATIENT.
Buy low: The best way to do this is to find a motivated
seller. Here are some obvious (and some not so obvious) ways to
find that seller:
1. Search the MLS listings in your
preferred location(s) for properties that have been listed for
more than 90 days.
2. Check public records for foreclosures
and/or tax delinquencies.
3. Read the obituaries in your
preferred location(s). There might be a house in the estate that
must be sold.
4. Check public records for divorce filings.
Many times a house must be sold to satisfy a Judgment.
5.
Advertise in local newspapers and on the web (for example, place
a free wanted ad on JSC
Rent To Own Homes).
6. Look for a high growth area
where builders are extremely active. You will discover there
will be people who are unable to sell their home because the
builder incentives are capturing all the qualified buyers. These
neighborhoods are usually very desirable, and there are
motivated sellers unable to sell. That sounds like an
opportunity, doesn't it? Here is your advantage. The person that
you will try to find to rent the house after you buy it probably
is not a qualified buyer to the builder. Builders want bank
qualified buyers. Typically, people who are seeking a rent to
own opportunity do not qualify for a mortgage with a bank. All
you have to do is have a good renter/buyer lined up to move in
to that desirable neighborhood.
7. Let your good
renter/buyers find their own rent to own home. If you have a
good prospective renter/buyer that is asking for your help (and
you will if you do your job properly), give them the opportunity
to find their own rent to own home. You have to set the ground
rules, and they will think you walk on water. It is strongly
suggested you develop a relationship with a good realtor who
will follow your ground rules, take your renter/buyers on
showings (most homes are listed anyway) and save you the time of
doing this yourself.
Bottom line - If you find a motivated seller, you should be able
to buy the property below appraised value.
Sell high: In this scenario, sell high refers to the
option price you will set with your renter/buyer. Keep this in
mind - If your renter/buyer was able to qualify for a mortgage
today, he/she would probably not be your renter/buyer. He/she
would simply buy a house without your help. Furthermore, the
renter/buyer is probably a frustrated renter who wants to be a
buyer. In other words, you have a motivated prospect, and that
prospect should understand that you are a business person who is
entitled to a FAIR profit in exchange for the risk you will take
to help them. Bottom line - your prospect is probably not very
price sensitive, and he/she will probably accept any fair
number. In my opinion, a fair option price should be the current
appraised value (not necessarily what you paid for the property)
plus an amount equal to the average annual rate of increase
compounded annually for each year of the option term. Allow me
to explain by way of example:
First, try to keep all of your option terms to one year. It's to
the seller/landlord's advantage. So, assume you own a house with
an appraised value of $150,000 and prices have been increasing
an average of 8%. For a one year contract, you should set your
purchase price at $162,000 ($150,000 + 8% of $150,000 or
$12,000); a two year contract, $175,000 ($162,000 x 1.08 =
$174,960).
Positive cash flow: Cash flow is defined as the amount of
money you receive per month minus the amount of money you spend
per month. Obviously you want that to be a positive number.
1. First let's look at how to minimize the amount of money you
spend per month:
Your mortgage loan: You could put a large
amount down to minimize your monthly payments, but that would
not be wise. The best thing you can do is find a good lender who
is willing to work with you. They are out there. A good lender
will realize that you will bring in many deals, and most up
front fees should be greatly reduced if not eliminated. Ideally
you should be able to borrow up to 90% LTV amortized over 30
years without having to purchase mortgage insurance. You should
avoid high interest fixed rate loans. You plan to sell the house
in a short period of time so a 30 year variable rate loan with a
fixed interest rate period of 3 or 5 years will be much better.
In our example, we borrow $135,000 at 5% amortized over 30
years. That is approximately $725 per month (principle and
interest) Furthermore we use an additional $300 per month for
taxes and property insurance.
The lease: Your tenant is not just a lessor. Contractually
he/she has the right to become the owner of the home. As such
the tenant should develop a "pride of ownership" attitude and be
responsible for most of the minor maintenance issues that arise
with any home.
Ownership: Get a good real estate attorney and an accountant.
They should be able to explain the advantages/disadvantages of
personal versus LLC ownership including liability issues. This
will help you determine the extent (and cost) of insurance you
will want to have.
2. Now, let's look at how to increase the amount of money you
receive every month:
Here's a little known fact - Over 90%
of all people who enter into a rent to own agreement fail to
exercise their option after one year! Do you remember I said to
try to keep all of your contracts to one year? Besides
maintaining better control of your investments, this little
known fact can be hugely advantageous to you, the business
person. Now, PLEASE keep this in mind; if you have a GOOD tenant
who is unable to exercise his/her option, WORK WITH THEM. You
should renegotiate a second year to your advantage, but not one
that would force a good tenant to leave.
OK, here's what you should consider (by way of example).
Using the above example, a reasonable contract might stipulate
an option consideration of $8,000 (to be fully applied toward
the down payment upon exercising the option) and a monthly rent
of $1,100 per month of which $100 will be applied toward the
down payment providing that monthly rent payment was made on
time. After one year, assuming all rent payments were made on
time, the tenant/buyer will have accumulated $9,200 in credits
($8,000 plus $100 per month). One can view the actual monthly
rent as $1,000 assuming the option is exercised. If the
tenant/buyer fails to exercise the option for any reason, That
$9,200 is forfeited by terms of the contract.
To increase your cash flow, offer the tenant/buyer greater
credits in exchange for a higher monthly rent. For example, in
exchange for $1,300 per month, offer the tenant a $400 rent
credit for every on-time payment received. Now, it can be viewed
as a monthly net rent cost of $900, and the total equity built
would be $12,800. If you present this properly, you can let the
tenant negotiate for higher rent payments! You will have a much
better cash flow, and there will still be a nice profit if the
option is exercised provided you properly purchase the house. If
the option is not exercised (90%+ odds it won't be exercised),
you keep all the rent monies paid. But, again, PLEASE keep this
in mind; if you have a GOOD tenant who is unable to exercise
his/her option, WORK WITH THEM. You should renegotiate a second
year to your advantage, but not one that would force a good
tenant to leave.
Use as little of your own money as possible: With
diligence and patience, you will be able to buy a home for less
than appraised value. Rather than buying the house at the
reduced amount, pay the appraised value and take the difference
as an allowance for, say, remodeling. Take this money in the
form of a bank check. Using the above example, assume you are
able to negotiate a purchase price of $140,000 (this is
possible, in fact, doable if you do your homework). Tell the
seller you will pay $150,000, and they must give you a bank
check for $10,000.
Now you will finance 90% of the purchase price of $150,000 which
equals $135,000. You need a down payment of $15,000. Your actual
out of pocket cost is $5,000 because of the $10,000 allowance.
Summary: We will assume the tenant/buyer takes advantage
of getting additional rent credits, makes all rent payments on
time and the option is exercised after the first year. Using the
above example (which is based on a composite of actual deals)
and not accounting for miscellaneous costs (for simplicity
purposes), here is the deal:
1. Cash spent - $17,300 ($5,000 out of pocket down payment plus
$1,025/month P.I.T.I.)
2. Cash received - $23,600 ($8,000
option consideration plus $1,300/month rent)
3. mortgage
obligation: $135,000
4. Received from sale - $149,200
($162,000 minus $8,000 option consideration minus $4,800 rent
credits)
Profit from cash flow = $6,300 ($23,600 minus $17,300)
Profit from sale = $14,200 ($149,200 minus $135,000)
Total
profit = $20,500
$20,500 profit divided by $5,000 out of pocket = 410% RETURN
IN ONE YEAR!!!
If the tenant does not exercise the option, it can only get
better.