Rental to Flip Deal Advice

[Beka Shea]

Here's the situation:

Friend's dad, nearing retirement, owns the property next door to his house as a rental. He is losing money on it each year and owes back taxes. Current mortgage is $88k, $1280 PITI/month. 1 tenant in place paying $900/month. Second unit needs about $8k of work to be rentable, will bring in about $800/month. Third space is his office which he wants to rent back for 3-5 years for $500/month. So total income could be $2,200/month. He does not want to sell outright at the moment and really wants to get a chunk of cash out but keep his office. A medical situation has caused him to eat up his savings and go into debt, and his credit is shot so a traditional refinance is out for him.

The house is zoned as single family, and the rentals are not "legal".  Transferring the deed will incur a use and occupancy inspection, and I don't really want the rentals.  What I want is access to this property when he retires and moves on.  At that point, it's a great single family flip candidate, but even more, it's on a 1 acre lot with subdivision potential.  The current tenant has been there for 10 years and wants to stay as long as possible.  If I fixed up the second unit, the current owner says he has a tenant who would also want to live there.  He would stay in place and take care of property management.  He initially wanted $185k for it, I've talked him down to $135k, but I'm trying to figure out how to structure this.  Here is my current thought, but I'd love to hear other opinions:

Legally - lease option.  I give him the $47k ($135k-$88k) as a downpayment with the option to buy the property in 3-5 years for the balance on his mortgage.  He uses the downpayment to pay back taxes and medical bills.  If I can structure it so that I capture rental income, even with vacancy/repairs allowance each month, I'd cashflow (although how much depends on the answers to my questions below).

Questions: How do I protect my $47k downpayment? 

I am a rehabber and don't want to tie up $55k for 3-5 years ($47k down plus $8k in repairs).  How could I finance out that money so that the cashflow from the rental pays some sort of note?

I don't want to have to pay him a monthly lease amount, so I'm not sure if this is the way to go.  And that's my brain dump.  OK, BP community, tell me what you think of my brain teaser! :)