Help needed with COMPLEX deal involving 3+ parties (lease option & private money)

[Ray Hurteau]

Hello BP Forum... My partner and I have a potential deal and it's not straightforward... we've never done a lease option, but we're not about to let a little complexity discourage us from this deal.

What will discourage us is if the deal is not a deal or if the potential profit is not worth the risk. Here's a quick background:

There are two parties involved: Party A (lives in subject home as tenant) and Party B (purchased subject home, lives out of state, acts as landlord for Party A).

Party A found the property and their friends, Party B, purchased the property for 240k - they took out a bank loan, it was not a cash purcahse. Party A told Party B they would fix the place and resell it for a split profit. Party B holds the note and mortgage while Party A pays rent to Party B.

This was two years ago. Now Party B wants to get out of the property and get their money back. Party B paid 240k and now wants to sell for 275k (no broker fees for the private sale). There is a signed agreement (not yet reviewed by our attorney) between Party A and B for this sale price and the agreement essentially makes Party A the wholesaler.

Party B contacted us about purchasing the property. They put no money down towards the purchase (to our knowledge), but they have made repairs. They are looking to get 45k out of the deal all said and done.

Party B does not want to leave the house, so they are looking for a buyer who will rent to them. Party B is a married couple and the husband is out of a job, currently looking. They don't have great credit; they disclosed this to us. They also probably have some credit card debt (amount unknown).

They are okay with getting 45k for the work they did along with "sweat equity" and "emotional" attachment.

I'm sure there are a ton of you thinking: RED FLAGS! We recognize it.

Here's our idea...

Purchase the single family home for 320k (today's as-is value is around 400k based on CMA) and finance the 20%, 256k.

Take 275 of the 320 to pay off Party A. Take the remaining amount and use 5-7k to replace the roof, ~10k to pay closing costs, legal fees, pre-paid expenses - unless it can be rolled into the loan - (and assuming we can get a conventional loan, otherwise, this amount may be higher for private money). Use private money @7-8% for the 80k down payment.

We would have the current tenants sign an 18 month lease with option to purchase @389k. No money down, no rent credits. They told us they would want to get some money up front to help with their current credit card debt. Since they are looking for 45k, we were thinking the interest due to the private investor for the 80k down payment would be their back-end non-refundable cost of the option (9.6k). 20-25% of the remaining amount (45k - 9.6k) would come out of the loan proceeds, while the remaining 75-80% would become an unsecured loan between us and Party A payable after closing if they exercise their option to purchase.

If they don't exercise their option to purchase, the remaining amount due to them would become payable upon our sale of the home (whether or not we rehab it or sell it as-is at the later time).

The tenant is currently paying 1800/mo rent - we would increase this to 1900 and would actually be cash flow negative roughly 250/month for the 18 months).

If we ran our numbers properly (and you're still reading this --thanks, btw!), here's how I believe it breaks down:

320k purchase price
64k down payment (financed by private investor @8% simple interest - 7.68k interest over 18 month loan term)
275k to Party B - they are paid off and we then own the property
9.33k (25% of 45k - 7.68k) to Party A
10k closing costs, loan prepayments (escrow)
7k to replace roof
4.5k (negative cash flow - per rent with tenant)
===================================
14.17k positive cash flow - no money out of our pocket

If Party A exercises their option to purchase:
389k purchase price
4k closing costs
27.99k (75% of 45k - 7.68k) to Party A
253.5k - repay outstanding loan principle
71.68k - repay private investor (64k + 7.68k interest)
===================================
31.83k BTCF

In our opinion, we believe this is a deal... If they choose not to exercise the option, we can rehabbing or resell as-is and the numbers still come out at or above the L/O..

We see this as a potential win-win-win-win scenario:
- Party A gets to remain in the home as they wish, make below-market rent payments for 18 months, and has time to fix their credit so they can apply for a loan, as well as get the majority of the money they are looking for - and a home with equity
- Party B gets paid off, plus makes money on the sale
- Our private investor makes money on the loan with us
- We make money on the deal using OPM for structuring the entire deal

Are we missing anything? Is this worth pursuing? How do we handle the agreement between Party A and B where Party A is now in control (pending confirmation from our attorney) - do we have Party A sign an option to purchase contract with us? We also assume if we try to finance this with a conventional loan, the bank will want to see the funds coming from our account and to be seasoned... if we go the HML route, this deal may not be worth the risks and time...

Thanks,
Ray

[Nick Aalerud]

Ray & Dan,

Thanks for bringing this up to me last night.

Your party A&B story made me dizzy - and I'm now more confused than I was last night. Did Party B switch roles? I thought they didn't live in the property, but in PA? Or did they move in?

Here's my understanding:

John finds a property, and gets his buddy Bill to finance it for him (for no money down). John then, in turn, gets Bill to do this by saying he'd work to fix the place up, and they'd both split the profits at resale.

Does John pay rent, as WELL as sweat equity? That wasn't made clear.

Bill now wants to sell, and wants $275K (after paying $245K for it in 2011).

John wants to get his $45K in sweat equity back out of the house as a result of the sale too - so essentially, total purchase price is $320K.

HOWEVER - John has no say in the sale, and cannot purchase on his own due to having bad credit and out of a job.
-----

Good so far?

You want to buy is for $320K, and give a full payoff to Bill for his $275K, leaving $45K.
Was this $45K going to be used for rehab? This means you're using either a 203K reno loan, or hard money? Normally this $45K would also be going to Bill, as the closing attorney would enforce... the only way is for Bill to then give you this money BACK AFTER closing (without closing attorney's knowledge).
Otherwise - hard money will lend you 60-65% LTV - if ARV is $400K, they would give you $260K, but subtract out rehab first (so, $45K)... you'd have $225K for the closing, have to come up with $50K + your first contractor down payment.

I guess this was my first confusing statement - I don't understand where you're getting the rehab money from.

I say you buy the house for $275K, pay off BIll totally (unless you CAN get a renovation loan, which would give you another $30K if it's a streamlined FHA) - so you'd buy it for $305K, and have $30K to play with.

THAT SAID:

You now want to "lease back" with an option, to John, who does not have a job or seemingly, steady income.

If their portion IS to pay your private investor the points & interest - I would get it ALL UP FRONT - in fact, I'd say they need to come up with another $10K.

The other problem - would the house really appraise in 18 months, for the $389K? Most likely, if you've done your homework.
HOWEVER - would John's credit and income be acceptable in 18 months? If he still doesn't have a job, than most likely NOT. And then, you may have had them pay for your investor's points & interest for x months, but you're now stuck with the month to month after that - and all the additional rehab you have to do, after they've lived there and "fixed" the house.

You need to remember that even though John has an option to buy from Bill - he CAN'T right now. So unless that piece of paper is good for another 2 years, they're dead in the water, and you'd only be doing them a FAVOR... worth $45K to them? Your call, but I'd say you should treat them as a wholesaler, and pay them based on your end profit. If you wanted to set a base saying any money over $xxx ($15K?) and up to $45K goes to them, than go for it. Or offer them $15k when you sell, flat rate, and they suck up the other $30K they've already spent. They're desperate to keep the equity they've put into this (that's why they are talking to you), and if there's enough profit in the deal, than go for it.

For me?

So even though I LOVE how creative you're being (I find creative investing very SEXY), let's analyze the deal as a deal:
ARV: $399K (your number)
Soft Costs: 5% Resale commission (in case buyer walks or can't perform), 7% holding costs (high due to 18 month hold), 3% Acq & Legal (around $58K)
Rehab: Roof & Cosmetics: $15K Minimum (flooring refinished, paint throughout, upgrading appliances, minor touch up)
Required Profit (mine, not necessarily yours): $30K
Nick's Max Offer: $296K

Not enough juice in this one to keep tenant buyer happy.

ANd I would NEVER, EVER get into a situation with negative cash flow when it depended on another party to live up to their payments / side of an agreement - especially one that didn't have a job or good credit.

You asked for my two cents? That's it. In a nutshell. :) Deal is way too skinny for the effort, but it was awesome how you're trying to work it.

I say buy it from the other guy at $275K (ensure you can raise the additional $15K Rehab + $4K closing costs, and have enough $$ in escrow to hold for 6 months), tell John "you'll do your best to help him out," tenant has to leave (OR... pay him $20K to relinquish his option... you're still below the $296K max mark), he's out of the picture. Rehab and sell it, make $30K, and anything above that, you can give to him.

That's MY plan. :)

Good luck guys!!