Rent to Own Investing
Some ideas and strategies for real estate investors interested in the rent to own market. Rent to own is sometimes referred to as lease with option to purchase.
1. Use buyer’s purchase deposit or down payment.
If you are following my advice and methods for buying houses, then you’re occupying your houses with either Tenant/buyers or Buyers.
TENANT/BUYER: Rents the house and has the right to buy the house at a preset price. Most of my houses are occupied by tenant/buyers. They put at least 3% down, non-refundable purchase deposit on a sales contract. I prefer 5% down. If they don’t have 5%, I get a promissory note and have them pay extra money each month to build up to 5% as quickly as possible. If they have less than 3% then they may be able to get into one of my “sweat equity fixer upper” houses. Their down payment can be partial supplemented by doing required work to the house before they move in. This is work I would normally hire a contractor to perform so if I don’t have to write a check to fix up the house, the money saved is less cash I need from my tenant/buyer.
BUYER: Puts down 10-15% down and you close with owner financing, typically via a wrap. Or the buyer gets a new loan cashing you out completely, or perhaps you take part of your profit back in a second mortgage.
Every house I buy will be sold to a buyer or occupied by a tenant/buyer. Since I cannot predict which it will be, I get into deals where it does not matter to me either way. Most buyers calling on my ads do not have 10% down or the ability to get a new loan now. It’s much easier finding 3-5% down, so why not buy houses where that will work for you?
Bottom Line: You should be collecting at least 3% down on every house you buy once it’s occupied. If you need cash to do a deal, you have 3% of your “resell” price to commit for cash to seller, holding costs, closing costs, minor repairs and maintenance.
2. Private money or hard money loans.
If you pay cash for a house you’ll never offer more than 70% of the after repaired value less the cost of any repairs. You can borrow 65-75% of the value of a house from a “collateral” lender. The lender will charge you 11% to 16% interest, and maybe 3 to 10 points. They should only be concerned with the value of the property that secures their first mortgage. Many private lenders will offer you interest only loans so all their investment is working for them, getting them a nice return. If you borrow $75,000 on a $100,000 house, 12% interest only payments are $750 a month. You should be able to get more than that each month from your buyer in rental income or from a wraparound mortgage payment. This formula does not work as well on expensive homes.
If the seller owes $50,000 on a $100,000 house, you can sometimes borrow another $25,000 on a second mortgage. Take over the first mortgage “subject to” which will have a better interest rate and no points. This saves you money and allows you to pay more for the house. You can give part or all of the $25,000 to you seller. If they have more equity coming to them, you can give them a 3rd mortgage on this house or a 2nd mortgage on one of your other properties.
3. Deferred down payments.
Take over an existing loan with good terms. Any equity still due to seller can be offered in the form of a deferred down payment. Basically, you will pay the seller the balance of their equity (if any) in a single lump sum payment when you resell or refinance the house down the road. Ideally, there will be no monthly payments or interest. If the seller insists on interest or monthly payments, get a lower price to make it worth wild. This is a “no money down” method. The cash you need for this type of deal comes from your buyer’s new loan, normally 6-36 months in the future.
4. Substitution of collateral.
I am buying a house on Thursday for $153,000. It is worth $165,000-$170,000. I’ll soon advertise it for $179,500 with “flexible owner financing” and enjoy a $26,500 equity spread.
The seller owes $18,000. He has agreed to take $63,000 in cash ($18,000 of which will pay off his lien) and $90,000 in second mortgages on several other properties I own. He wants 6% interest but doesn’t need monthly income. So his interest will accumulate for 5 years. 6% interest, no payments, 5-year balloon on $90,000.
This allows me to tap into equity tied up in my other properties at a low rate, and my seller is happy. He would have put his money in the bank at 1-3%. He is waiting for his mutual funds to come back up so he can get out of them. Good luck!
Here’s the kicker. I am borrowing $130,000 from a “hard money lender” at 10.99% and paying 8 points. I will net $120,000 in cash from that loan after costs. That means I collect $57,000 in cash on Thursday when I buy!
In my audio training course I reveal how to get a guaranteed 35% return on any extra cash you want to invest. That’s what I will do with this extra money.
A couple of weeks ago I collected an extra $24,000 in cash using this same type of method when my tenant/buyer closed on one of my houses.
5. Open an equity line of credit.
Raise cash by borrowing against equity you have in your personal residence or other investment properties. You can also pledge a number of second mortgages you hold as the collateral. Set it up as a line of credit. Use the money to do a deal and pay it back immediately when you sell or occupy the property. You only pay interest on that portion of the credit line you have tapped into.
Last month I setup a $100,000 credit line pledging $130,000 of equity I have acquired through taking back installment land contracts, all-inclusive deeds of trust and second mortgages.
Having this cash readily available allows me to make multiple offers to a seller:
A. All cash for lowest price. My offer price is 70% (maximum) of after repaired value less the estimated cost for repairs.
B. No cash for highest price. My offer is $30,000 less than my planned resell price. The seller gets their equity in the form of a deferred down payment. I take over existing debt “subject to.”
C. Some cash. My offer is somewhere between Offer A and B. The seller gets debt relief and some cash. The more cash, the lower the price.
Would you pay the seller 5% down if you could get an extra 10-15% off the price? You have that opportunity if you have established lines of credit to tap into. This could be a line of credit, a credit card or checking account overdraft protection. Be careful of having too much cash laying around in an operating account. You may be inclined to offer more cash on a deal than you need to, just because you have it.
6. Sell off a house or real estate note for cash.
I have been sitting on one house since February. Ouch! I bought it for $160,000 and I have $10,000 of my money tied up in it, which is unusual. It was on the market for $197,000. For one reason or another I just could not get it under contract. That’s a fair price and the home is in good shape.
I called a real estate agent I have used to buy listed “fixer upper bank owned houses.” I asked the agent to look at the house and tell me what he would market it for if I wanted to dump it fast. He recommended $179,500. I gave him the listing. Within a week I had a contract for $177,000. I decided to slash the price to get this house out of my hair and recapture the money I have into it. Plus I can focus on occupying my other, more marketable houses.
If you have cash or profits tied up in real estate or notes, one way to raise cash is to take some aggressive, proactive steps to liquidate some of those investments. Then put that money to work on better deals.
Written by Richard Roop
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