How would you pitch this owner finance deal?

Question

I have located a property I would like to purchase as a 2nd home. Seller owns home free and clear and may be willing to help finance.

Sale price of the home is 520k. I know the market well and don't anticipate any appraisal issues. Seller has owned the home since 2002. It has always been a rental and never been owner occupied. My income and DTI are excellent. My credit is above 800. I own one rental property free and clear and have a small note on my primary. This will be a 2nd home/vacation property. Would like to keep my down payment to 10%.

I'm considering proposing an 80/10/10 whereby I secure a conventional 417k first, ask the seller to hold a 10% 2nd and cover the rest in cash.

I'm wondering though if it might be more advantageous and attractive for the seller to hold the entire note. Home was purchased in 2002 and has always been a rental. Assuming the seller has been depreciating, he will be facing aprox 190k in recapture. Cap gains will be $0.

I would like to map out and present both options to the seller demonstrating roi and tax implications for each scenario. I'm not a sophisticated investor and am hoping some of the pros on this board can help me crunch the numbers for my pitch.

Thanks in advance for your help.

Shaun Reilly · Answer

Hi Steven Hamilton II,
Thanks for the information. I guess I'm confused about what you meant by a disguised sale before.
Is it because the lease Marc Jolicoeur was a 20yr option with payments matching a loan with that amortization, including principle pay down matching that schedule?
If that is the reason could that issue be eliminated for him by doing the more traditional rent credit that would be the same dollar amount each month?

Bill Gulley · Answer

Mark Wilson, for me to properly advise on such a purchsae and the optimal arrangement/presentation, I'd need much more information and you can do that by a PM, then without disclosing that information we can discuss it here.

IMO, this is not a property for a lease option or any installment contract, that is not appropriate on a half million dollar second home.
If you have the opportunity to buy and the ability, buy it, don't screw around with options or wishy-washy methods unless there is a reason to do so...IMO.

Your 80/10/10 split is an option, but more likely it will be 75/15/10 on a second home for the first mortgage.

There could be more from the seller, but you need to know more about them, age, estimate health conditions, tax issues, other investments/est. net worth....are they a sophisticated investor?

To present these, you need to structure around your financial strength and ability to pay along with the needs of the seller, usually income and tax advantages together with a higher rate earned than they can get get if they received cash after taxes.

We could get as creative as you like, using zero coupon bonds blended with the note to offset interest expenses, but is it appropriate? The best way is usually a straight up deal. :)

PM me if you like, good luck.

Steven Hamilton II · Answer

Shaun Reilly,

They will still claim depreciation as it is not considered a sale until the time at which the option is exercised. This solves the recapture issue.

Not at all, it is no different than any other time a rental is sold. It doesn't matter who it is sold to.

-Steven

Shaun Reilly · Answer

Steven Hamilton II taxes are the thing that have always confused me with Lease Options and one of the reasons I have not tried harder with them.
Am I understanding you correctly that if one were to enter into a typical lease aggreement but also signed an option contract with the same tenant that the Lessor can no longer claim depreciation?
If I am understanding that correctly I have 2 scenerios that I'd be interested in clarification on:
1) Have the above arrangment with a multi year option. Say after 2 years of not claiming depreciation the tenant walks without exercising the option. Would it now just have been a run of the mill rental those 2 years and the IRS will force depreciation recapture upon sale even though it was not claimed?
2) You just happen to sell a rental unit to a current tenant with no prior arrangment. Will the IRS think this is a shady situation and mark you as more likley to be audited?

Thank you in advance!

Steven Hamilton II · Answer

@Marc, that is a sale and is treated as such regardless of wording. The IRS considered that a disguised sale and the owner will pay BIGGER gains on it if he keeps depreciating.

Marc Jolicoeur · Answer

Nick, I am intrigued by this idea of lease purchases with seller financing.

For those of us who are newbies with lease options and how they work, can you help write the pitch? Please clarify or correct this:

[i]"Mr Seller, let me lease the house from you for 2o years with the option to buy at your full asking price of $520K. To establish this contract, I will pay you $100 now for the lease option. I will pay you monthly rent of $2483 which is equivalent to a mortgage payment for the purchase price amortized over 20 years at 5%. I will also pay your property taxes, assessments, and your liability insurance. You are the bank and as long as I keep paying the rent, my equity position will grow in the amount of the principle portion of the amortization schedule. If I chose to purchase the home, I will make a balloon payment of all remaining equity. In the mean time your $520K asset is producing interest income of 5% for you which is better than you can get in bonds and other safe investments. Also, this income is offset by annual depreciation on the building, and you get to defer a big capital gain tax hit that you would get if you sold outright this year. If I exercise the option to buy in a couple of years, I pay you for all of your equity in one lump sum. If I exercise the option in 20 years, the balance will be near zero which means no capital gain tax bill for you at all; in fact, it could be a capital loss that you can use to offset other cap gains. If I never exercise the option and break the lease, you get to sell the house or lease it again, at a probably larger price. I may sub-lease the property or rent it short term to anyone and at any price as long as it does not go against our lease agreement. I may improve the property and make any renovations; and I will be responsible for 100% of any maintenance."

Please clarify if I have not gotten this idea right.

Nick Hulsebos · Answer

Thanks for the clarification. My suggestion will work even better. First of all you can offer more than the house is worth on the lease option because the terms will work in your favor over time, especially as you buy down the principle and enjoy the principle. The benefit to the owner is no tenant headaches, differed taxes and he maintains any write offs till you exercise your option

Mark Wilson · Answer

Thanks for all the replies, but I don't think I did a good job setting this up. The seller is not motivated. This is a prime piece of real estate in a very tight market with very low inventory. It's not on the MLS yet, but it is going to sell quickly once it goes live.

I am trying to create and then pitch a scenario that will be attractive enough to the seller that as to convince him to work with me.

Seller owns the property free and clear and has been renting it for the last 10 years. He lives in another state. The realtor handling the listing believes he will consider a creative offer.

What I have to work with is an 800+ credit score, 10% cash and I'm willing to pay full asking price of 520k.

I'm trying to structure an offer that will be attractive and motivate the seller to accept.

Brian Gibbons · Answer

I like Mark's thought here. Control it instead of own it, exercise price = loan balance. What if the property does not appreciate? Do you have a stop loss? You could have a "either or" exercise price, with a minimum profit. Sandwiches are fun as long as you have a clause that it is a "performance based" arrangement; if the Tenant Buyer does not pay you the REI, you do not have to pay the Seller-Owner-Lessor.

You could do a 2 note arrangement if the seller wanted to carry 80%, but you need 20% down in cash. I know you want 10%. Seller could then sell a partial of the 1st. See http://noteinvestor.com/notes-101/what-is-a-partial-note-purchase/ Note buyers want a big down payment (skin in the game).

I don't like owning right now, I like lease option assignments and sandwiches. Just my HO.

Brian

Nick Hulsebos · Answer

Mark here is a different twist to consider. It is owned free and clear and he is used to it being a rental. So agree on a purchase price. Then offer a lease purchase arrangement, but the terms are to be set on the existing un- paid mortgage balance. Say the seller carries a twenty year note (minimizing his tax consequences), as the mortgage gets paid down your equity position increases, plus any appreciation also works to your advantage. You can exercise your right at any time during the next twenty years. Also include a clause that allows you the right to sub lease, having someone else paying for your house. Your option amount should be $100. (Which can be put in a Roth if you don’t have any intentions of occupying it.) Either way you have the option to own but not the obligation, You’re in for only one hundred dollars and your rent is the same for the next twenty years. Plus you can increase the rent to positive cash flow it.

How would you pitch this owner finance deal?

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