Exit Strategy for Lease Option Buyer

[Keith W.]

This is a 30 thousand feet overview of the process. Correct me if I"m wrong, then a couple questions at the end.  

1. Motivated Seller has a property in pre-foreclosure
2. We set up a Subject 2 agreement with the seller
3. We pay the arrears to make loan current and pay mortgage going forward
4. Have a Lease Option Tenant with an annual lease that auto-renews (Option expires after 3 years)
5. This rent covers the mortgage plus provides cashflow
6. After 3 year term, Tenant purchases the property at a predetermined price minus downpayment (maybe a portion of rent goes to the principal?)

Questions: 

What would be a fair consideration to pay seller to walk away with? Perhaps a percentage would work here?

How much should we expect the tenant/buyer to pay for the non-refundable "option" payment?

When the tenant is ready to purchase, do they get their financing from a traditional bank? 

Does this mean they have to come up with another downpayment? 

[Brian Gibbons]

@Keith W.

Sub2 then lease option is not always the best. The loan can be called by the bank. Not will be called but could be called.

So an all cash payoff within 6 months or so (fast) versus a long hold (slow 36 month plus) is strongly advisable.  I like rehab sub2 , fix and resell fast model better, less risk of loan being called.

Use a land trust.

If this is a MASS property, like 600K SFR FMV

Lease Option Sale Terms

• market rent monthly
• 3% from TBer $36K
• 1 year lease then a possible 1 year extension if the TBer performs, new lease and new option in 12 months.  It is called a rolling option.
• Strike price tied to new appraisal, buyer pays all closing costs and appraisal fees.
• Watch your language: NOT a down payment, option fee for the option to buy, nothing else.  No DOWN PAYMENT.  An option fee consideration for the option to buy.
• Yes they need to save up for the down payment ON TOP of the option fee.
• I would DISCOUNT the sales price by the amount of the option consideration, eg  sales price $564,000.

[Steve Vaughan]

Originally posted by @Brian Gibbons:

@Keith W.

Sub2 then lease option is not always the best. The loan can be called by the bank. Not will be called but could be called.

So an all cash payoff within 6 months or so (fast) versus a long hold (slow 36 month plus) is strongly advisable.  I like rehab sub2 , fix and resell fast model better, less risk of loan being called.

Use a land trust.

If this is a MASS property, like 600K SFR FMV

Lease Option Sale Terms

• market rent monthly
• 3% from TBer $36K
• 1 year lease then a possible 1 year extension if the TBer performs, new lease and new option in 12 months.  It is called a rolling option.
• Strike price tied to new appraisal, buyer pays all closing costs and appraisal fees.
• Watch your language: NOT a down payment, option fee for the option to buy, nothing else.  No DOWN PAYMENT.  An option fee consideration for the option to buy.
• Yes they need to save up for the down payment ON TOP of the option fee.
• I would DISCOUNT the sales price by the amount of the option consideration, eg  sales price $564,000.

 Good to see you again, Brian!

I don't like sub2 with arrears  / pre-foreclosure.   House already under scrutiny, title searches, lender anxious.

I don't like Lease Options with work needed unless low consideration (<1%) paid and I assign to qualified contractor TB Optionee. 

Know equity skimming foreclosure rescue laws in your state. In WA you will get hammered, MA may be same.  Buy pre-foreclosure outright with title insurance only if at all, NOT sub2👍

[Keith W.]

Thanks @Brian Gibbons @Steve Vaughan for your input. Is it fair to say that everyone has their own viewpoint or investing niche that they feel comfortable with? As a newbie investor (haven't did a deal yet), I'm trying to figure out which niche or tract I should follow. What I've found is that you can have a bunch of investors who swear by sub2 / option lease investing. Then other investors that say stay away from them!

For example, I'm just starting to feel comfortable that the bank's Due on Sale Clause is not a law, but a rule the banks have in place. Although they are enforceable, I have investors with 20 years experience say they've never had one called. Then I would have other guys, like in this post express this a concern. As a  new investor, maybe I need to choose my path and filter the information coming in. Just wondering how was it for you guys when starting out. 

That being said Brian, you pretty much broke the whole thing down for me. That's the info I was looking for thanks!

And Steve, thanks for alerting me that there are equity skimming foreclosure rescue laws. I've never heard of that. I will definitely research it. 

I appreciate both of you guys' time and input. I'd like to hear your thoughts on the whole newbie investor thing I talked about. 

[Steve Vaughan]

Originally posted by @Keith W.:

Thanks @Brian Gibbons @Steve Vaughan for your input. Is it fair to say that everyone has their own viewpoint or investing niche 

Keith, I wasn't trying to share a philosophy on sub2. Pontificating is not what I do or Brian either from what I know and we have been colleagues for years.

FACTS: Sub2 and pre-foreclosure don't mix.

LOs and pre-foreclosure don't mix either.  

LOs and lots of work needed also don't mix. 

Trying to save you pain. Learn one thing at a time👍

[Brian Gibbons]

@Keith W.

Massachusetts laws

MGL c.244 Foreclosure and redemption of mortgages

MGL c.260, § 33 Limitation of mortgage foreclosures; obsolete mortgages

Massachusetts regulations

209 CMR 56 Foreclosure Prevention Options (with form for notice)
940 CMR 25 Foreclosure Rescue Transactions and Foreclosure-Related Services

Selected case law

Bank of NY v. Bailey, 460 Mass. 327 (2011)
"[T]he Housing Court has jurisdiction to decide the validity of a challenge to a title, raised by a former homeowner as a defense to a summary process eviction action by a party acquiring the property pursuant to a foreclosure sale."

Commonwealth v. Fremont Investment and Loan, 452 Mass. 733 (2008)
Upholds a Superior Court order "that restricts, but does not remove, Fremont's ability to foreclose on loans with features that the judge described as 'presumptively unfair.'"

Easthampton Savings Bank v. City of Springfield, 470 Mass. 284 (2014)
Discusses the preemption of local foreclosure ordinances by state laws.

Eaton v. Federal National Mortgage ***'n, 462 Mass. 569 (2012)
"The meaning of the term "mortgagee" as used in the statutes is not free from ambiguity, but we now construe the term to refer to the person or entity then holding the mortgage and also either holding the mortgage note or acting on behalf of the note holder." The ruling will only apply to " foreclosures under the power of sale where statutory notice is provided after the date of this decision."

James B. Nutter & Co. v. Murphy, 478 Mass. 664 (2018)
A reverse mortgage did not contain the formal language of "statutory power of sale," but only said that the company could “invoke the power of sale and other remedies permitted by applicable law." The SJC held that, given that this was a reverse mortgage, and not a traditional mortgage, "where the lender cannot hold the borrower personally liable for the debt, and where the lender’s only recourse on default is to obtain repayment through a foreclosure sale," "the only reasonable and practical interpretation of the mortgage was that it incorporated the statutory power of sale."

Lenders Commercial Finance LLC v. Pestilli, et al, Southeast Housing Court, Feb. 3, 2017.
A bank that purchased a home at foreclosure could not evict the former owners with just a 30-day notice to quit. "The Court finds that there is no evidence in this action that there was ever any agreement between the parties for the defendant to pay any rent to the plaintiff, or for any definite rental period. Accordingly, the court finds that G.L. c. 186, s.12 requires that the plaintiff terminate the defendant's tenancy at will by service of a 90 Day Notice to Quit for possession."

Property Acquisition Group v. Ivester, 95 Mass. App. Ct. 170 (2019)
Before conducting a foreclosure sale, the mortgagee must use reasonable diligence to determine the fair market value of the property.

US Bank National Association v. Ibanez, 458 Mass. 637 (2011)
Upholds the ruling of the Land Court (MISC 08-384283) below, regarding the requirement that mortgage holders must be accurately identified in a foreclosure proceeding. "We agree with the judge that the plaintiffs, who were not the original mortgagees, failed to make the required showing that they were the holders of the mortgages at the time of foreclosure. As a result, they did not demonstrate that the foreclosure sales were valid to convey title to the subject properties, and their requests for a declaration of clear title were properly denied."

U.S. Bank National Association v. Ibanez, 17 LCR 679, Land Court MISC 08-384283, October 14, 2009
Foreclosure sales are invalid where they fail to name "the “present holder of the mortgage” at the time of the notice and sale (i.e., that post-sale mortgage assignments to the successful bidder, even if backdated, do not suffice)..."

Web sources

Abandoned Housing Initiative Receivership Manual, Mass. Attorney General, March 2014
Extensive (89 p.) manual for municipalities that "cover all facets of receivership from the initial communication with a property owner to the termination of a receivership." Includes sample pleadings and more.

Mortgage Lending and Foreclosures, Mass. Attorney General.
Find information and answers to frequently asked questions from the Attorney General's Office. If you are having an issue with your mortgage lender you can file a complaint with their Consumer Advocacy and Response Division.

Defending Against Mortgage Foreclosures in Massachusetts, Michael Pill, October 2010
This 27-page supplement to Mass. Practice delineates five ways to challenge a foreclosure, with detailed references and footnotes

Frequently Asked Questions on 150/90 Day Right To Cure Notice, Division of Banks.
Helpful information for lenders on requirements for a right to cure notice.

Foreclosure Timeline, Middlesex North Registry of Deeds, July 2013
Blog post uses an example to illustrate the timing of an Order of Notice in the foreclosure process

Foreclosure Prevention Counseling Resources, National Consumer Law Center
"Practical tools and resources for housing counselors, attorneys, and other advocates who are counseling homeowners threatened with foreclosure." Includes Sample Documents and Practice Aids, Fannie Mae Information, Freddie Mac Home Affordable Modification Program, and more.

The foreclosure survival guide: keep your house or walk away with money in your pocket, by Stephen Elias, Nolo, 2019
Covers workouts, foreclosure, and walking away. Requires free library card for access

Avoiding Foreclosure, US Dept. of Housing and Urban Development
Primarily written for homeowners with FHA Insured loans, much of the information may apply to anyone facing foreclosure

Making Home Affordable, US Treasury Dept. & US Housing and Urban Development Dept.
Explains eligibility for federal programs for refinancing and modification of mortgages, including a self-assessment tool

Questions and Answers on Home Foreclosure and Debt Cancellation, IRS
Provides critical information on the tax consequences of foreclosure and debt cancellation, with links to forms

What Happens When the Bank Forecloses, MassLegalHelp, 2013.
Outlines the steps from a missed mortgage payment through the foreclosure auction.

Print sources

Massachusetts Mortgages, Foreclosures and Workouts , MCLE, loose-leaf.

Short Sales, Deeds-in-Lieu & Receiverships , MCLE, 2010

[Brian Gibbons]

@Keith W.

Here is some out of the box thinking

1. Traditional Financing - any bank needing credit report, down payment, personal guarantees, balance sheet

2. Non traditional Financing

- crowd funding, etc.

see 

https://www.nerdwallet.com/blog/investing/real-estate-crowdfunding-worth/

- JV Partners, Limited Partnerships, Privates Lenders (PLers are not JV Partners)

- Learning SDIRAs (Self Directed IRAs), custodians, Prohibited Transactions, code 401 of the IRC and 4975 
https://www.law.cornell.edu/uscode/text/26/4975

- syndications - See @Joe Fairless and @Brian Burke

----------------

Preforeclosures you need to come in and offer all cash and buy the property 20% equity or more.  Profit when you buy.

[Keith W.]

@Brian Gibbons Thanks so much for those resources. I know people pay big money for that info. I read over the excerpts but will definitely dig deeper. 

@Steve Vaughan As far as working with pre-foreclosures, the plan would be to have different options based on the scenario. So for instance, we wouldn't do an LO's that needs work. If by using the 70% Rule, the work would bring the property up to a good ARV, we may purchase it outright to flip, or hold, or however, the numbers work. If there's equity already there, we would definitely be looking to purchase outright, again using the 70% rule. I guess our thing is coming up with solutions for owners with low or no equity and facing foreclosure.

Can we look at this real-world example?

A woman owned a property that her family members were living in and they had stopped paying the mortgage without her knowledge. By the time she found out, they had moved and the mortgage was about 4 months not paid and in pre-foreclosure. She tried to list the house to sell but didn't put in much effort. Because the property had little equity, she owns a home she lives in crosstown, she was going to just let the house go into foreclosure. 

An investor contacted her about selling the property. She agreed to a Subject 2 deal where the investor paid up the arrears to make the mortgage current. They did all the legalities, (Land trust, disclosures, Deed, etc). He didn't give her any payment consideration. (I am advised that you always give the owner some payment)

This investor then brings in a Tenant Buyer on a Lease / Option Deal who pays a non-refundable $20K "Option Fee" and $1000 per month rental payment. (the mortgage payment is $700)

At the end of three years, this Tenant Buyer gets their own financing and buys the house at a predetermined price of $150K. (The house was valued at $135K at the time. During the rental period, the TB paid extra towards the principal, and the price of the house was inflated a little to compensate for value increase during the 3 year period.)

Just to be clear, it is your position that this is not a viable way of doing business at least in the pre foreclosure market? 

Not trying to be any kind of way about this or go back and forth, it's just like with COVID19, one leading expert says you don't need to wear a mask if you're not sick... turn the channel and another leading expert says everybody wears a mask! NOW! Lol

IM SO CONFUSED111

[Brian Gibbons]

@Keith W.

Turn the channel then.  

Before you do, look into Foreclosure Rescue, fraud, FBI and Massachusetts Attorney Generals Office.

See 

https://www.justice.gov/usao-ri/pr/foreclosed-property-preservationist-charged-10-million-fraud-scheme

[Keith W.]

Thank you!

[Steve Vaughan]

Originally posted by @Keith W.:

@Brian Gibbons Thanks so much for those resources. I know people pay big money for that info. I read over the excerpts but will @Steve Vaughan  Can we look at this real-world example? An investor contacted her about selling the property. She agreed to a Subject 2 deal where the investor paid up the arrears to make the mortgage current. They did all the legalities, (Land trust, disclosures, Deed, etc). He didn't give her any payment consideration. (I am advised that you always give the owner some payment)

Just to be clear, it is your position that this is not a viable way of doing business at least in the pre foreclosure market? IM SO CONFUSED111

The steps to the process sound solid, depends on WHICH STATE the property is in. I won't touch pre-foreclosures with the elderly, sub2 or anything creative in WA with a 10ft pole even with a FSBO Form 22 disclosure. I do cash and a 22. Good to go.

Your real life example was done in a red state, pre GRC/DF, Safe Act or both. A Land Trust in my state is also a no-go. You will be declaring your property 'open space'. Oops.  Then no consideration given to the seller?  Dumb.

But the process looks good.  Low equity sellers with pretty houses that are current would  be my target and the timing for that seems about perfect or will be soon.

[Keith W.]

@Brian Gibbons Thanks a bunch. I will check it out. 

[Brian Gibbons]

If a low equity seller wants out, sandwich LO or land contract to control, but it has to cash flow, and MA does not cash flow for SFH.

Ex  MA $600K house rents for $2500 to 2800?  20% down note to finance?  You have neg cash flow.

Ohio or PA or IN get houses $150K that rents for $1500 - 1800 then that works.

Think of Master Leases that cash flow, dont buy, control and profit.

Or multi family.  Triple deckers.

Watch your property manager/agent laws for Master Leases.

[Keith W.]

@Steve Vaughan 

What is a 22? 

I think the transaction was in Tenessee. Somewhere south so maybe a red state. Im in Massachusetts. People going through foreclosures are just out there on there own really. I went through it years ago and I think something like what Im talking would have helped me terms of not having the foreclosure on my credit which kept me from getting a decent apartment. Had no money to hire a lawyer, the house had issues that I had no money to fix to get the house ready to sell. I got out of that actually by filing bankruptcy. 

I meant to mention to you before that my preferred strategy for Subject 2 is to fix and sell in short time frame as you said. Like 6 months or less. 

[Keith W.]

@Brian Gibbons You're that teacher that gave us all that homework in school! I appreciate it though. I did come to the conclusion that Single-family residential won't cash flow. Especially in Boston. We do have a lot of "transitioning" neighborhoods around here where people owned houses for years that's in bad shape but the ARV's are astronomical! My Grandmother's house was bought for $10K and was appraised at $640K. That's before much-needed repairs and updating!

Just a couple years ago, that would've been considered a war zone neighborhood. I'm in a middle-class suburb and was lucky to appraise at $643K and my house is 10 years old!

But I digress. I know what a sandwich lease, but I have to look into Master Lease. Don't know what that is. 

Thanks again. 

[Brian Gibbons]

Let's say a house rents for $2000 a month and you can rent from owner for 60 months at $1600 a month, with the stipulation if it is vacant you have 30 days to get it rented or you as the master lessee will have to pay the $1600 to the owner a month, even if vacant.

Would you take the $400 a mo cashflow?  That is master leasing.  No Option to buy.

[Keith W.]

I guess I would. Who is responsible for repairs, taxes and insurance, and what is the incentive for the owner to let me lease it?