March 2010 Archives

This has always been a portion of the market, but right now, more and more people are emphasizing it, or at least the ones who are able.

Actual Rent to Own is rare these days, a sign that the market is being driven by sellers, selling to poorly advised buyers. I can't remember the last time I heard of one happening, because there is an actual ownership interest right away, and the buyer is entitled to a share of the money put into rent, whether or not the deal is actually consummated. On the other hand, Lease Option seems to be a common Idea of the Moment, because the prospective buyer basically gets nothing if they don't want to buy, or if they cannot qualify for the loan.

Just like any other purchase contract, everything about these is negotiable, but the basics are thus: Buyer and seller reach a purchase agreement, with the date of actual purchase delayed by some amount of time. In the meantime, the agreement is for for the buyer to rent the property, usually for an above market rent. Part of each payment gets set aside for the buyer's down payment if and when the option is exercised. The difference between Rent to Own and Lease with Option to Buy is that in Rent to Own, a part of each payment is actually due back to the buyer if they decide not to buy, whereas in Lease with Option to buy, that money is just gone if the option to buy is not exercised.

Why do this?

For the prospective buyer, it's a way to engage in forced savings for a down payment. If rent is $2000 per month, with $1000 being credited to the buyer and $1000 in rent, over a period of two years, you've got a $24,000 down payment, and this is treated exactly like any other down payment, except that the seller already has it, so you only have to come up with the purchase price less this down payment money. This is useful for people with rotten credit and/or poor savings habits, especially if credit is expected to improve within the time frame of the agreement. It's horridly inefficient, and I've never seen a residential situation where it wasn't better to buy outright, but if you have a problem qualifying for a loan or saving for a down payment, this is one way to go about dealing with that problem. With 100% financing currently dead except for VA loans and a few Municipal first time buyer programs that run out of money at warp speed every time they get a fresh allocation, this is one way for people to get their foot in the door of property.

For the seller, it's a way to create a captive purchaser. These buyers have rotten credit and/or zero dollars for a down payment. Nobody else can do business with these buyers, because the buyers will not qualify for the necessary loan. They have Hobson's Choice: This one or none at all. This creates bargaining power for the seller even in the strongest of Buyer's Markets, because most sellers in such markets do not have the ability or willingness to offer a Lease with Option to Buy. They're not as powerful as offering a Seller Carryback, but they definitely give sellers pricing power they would not otherwise have. You can get an above market rent and an above market price, to boot, and the prospective buyers are more motivated than your average tenant to take good care of the property.

So why isn't everybody doing them?

First of all, the reason the seller has the property on the market is because they want or need to sell now, not two years from now. With either rent to own or Lease with Option to Buy ("Lease Option"), they aren't getting any equity out of the property now to enable them to buy their next property. Furthermore, they've still got all of the expenses of owning that property. Finally, the reason that buyer can't buy anything else is because the most generous assessment of their financial skills possible is "Needs improvement." Bad credit does not, generally speaking, happen like a lightning strike out of a clear blue sky. It happens because they don't pay their bills on time. There are some exceptions - mostly people who had major unexpected medical expenses, but there are limits to how badly one account can hurt your credit. Chances are high that they'll be late with the rent - which is money you're counting on to pay your mortgage, your property taxes, your insurance, etcetera. It takes a certain financial solvency to be able to offer these. Not to mention that until the tenants exercise the option to buy, you still own that property, which means you've got all of the headaches and obligations of being a landlord, or you're going to have to pay someone else to take care of them. Repairs, maintenance, etcetera.

For buyers, the prospective pitfalls are even worse. First, you're paying above market rent and agreeing to a price that is usually significantly above the current market. It might be below market when you actually exercise the option, but right now, it's almost certainly a goodly premium over the price that you can get similar properties for - because they're offering something extra that most sellers are not willing or able to offer, and if you didn't need it, you wouldn't be willing to pay for it, right? If you don't exercise the option to buy, the extra rent money you fork out is basically gone. There has to be equity in the agreed upon sales price, and there has to continue to be actual equity. No lender in the known universe is going to approve a short payoff for a Rent to Own or Lease Option, no matter how ironclad your contract. If the current owners lose the property to foreclosure, you're basically SOL. And it wouldn't be the first time sellers pocket the rent while not paying the mortgage, or even taking a cash out refinance. I'm not certain what the law is on this point, but I don't see a way to keep the current owners from doing any of this. It's a good idea to record the option, but that doesn't mean anything if the lender forecloses or is owed more money than the strike price. You can sue, but suing broke people is throwing more money down a black hole from which you're not going to recover it. Finally, and here's the rub that kills a very large proportion of the prospective buyers who enter into these agreements: You're still going to have to qualify for a loan for the rest of the agreed upon purchase price ("strike price") before the option period expires. Usually the market goes up, but sometimes it does go down, and the appraisal is less than the purchase price. If you can't make up the necessary difference between the biggest loan you can get and the strike price, you're not going to be able to buy. For that matter, if interest rates go up significantly, you could find yourself unable to afford the payments on that loan. In fact, these two phenomenon usually go together. Rates go up, therefore payments and cost of interest on the same number of dollars rises. People in the aggregate cannot afford to pay as much for real estate as they could formerly, and therefore, prices fall. Basic economics.

There usually is a significant deposit made, as well. Not as much as a regular purchase contract, but just because there's a time delay involved doesn't mean the seller isn't going to demand a deposit they can keep (maybe), or rent to a tenant without a deposit. The rules on whether they can keep a tenant's deposit are also somewhat different and more advantageous to the current owner than California's renter-landlord law generally is (Don't ask me for details - I'm not a lawyer. I'm mostly parroting what I've been told on this point).

The prospective seller is entitled to do all the due diligence than any normal prospective seller or landlord is, and ditto the prospective buyers/tenants. Personally, I would want that inspection contingency period to run the full duration of the option period, and there really isn't an effective loan contingency period, as the owners already have the prospective buyer's money, and most Lease Option contracts are pretty solid upon the point of not getting it back. This point is negotiable, but usually that money has already gone to pay mortgage, property taxes, etcetera. What did I just say about suing broke people?

Rent to Own real estate and Lease with Option to Buy real estate are always a risk for both parties. The tricks are myriad, at the very least. This is not something to try without a very sharp agent representing your interests, and as for dual agency in this situation, I have it on excellent authority that slow roasting yourself while basting with acid is less painful for prospective buyers. With that said, if the situation is right and both parties act in good faith, it can be a way to make both sides of such an agreement very happy, when otherwise they would both have been very unhappy. The seller gets an above market price, albeit delayed, and a much improved cash flow in the meantime. The buyers can buy property, where otherwise they would not be able to.

Caveat Emptor

Original article here

People ask for referrals all the time, and many folks will stumble all over themselves to provide referrals. Some of them really are excellent providers. Others are not so good, but the person providing the referral has an agenda of their own, and you have to be aware of the possibility. Never give anyone your business without shopping it around just because someone referred you to a certain provider.

In many cases, the reason why you are referred to Company X Realty or Company Y Loans has nothing to do with any allegations of them being an efficient, diligent, effective or inexpensive provider of those services. Number one on the list of reasons why people tell you about X Realty or Y Loans is because company X or company Y refers business back to them. This isn't illegal, but when you ask a real estate agent for a referral to a low cost mortgage provider and you get referred to one of the ones that's competing on the basis of consumer name recognition, you should realize that the mortgage providers with national advertising campaigns are not among the low cost providers. For analogous reasons, I usually advise people to stay away from the national realty chains, even if they're not local to me. But I digress. The point is that the person who refers you to this person is effectively getting paid by referring you to them. Not exactly a sterling reason to trust their motivations in making this referral.

Indeed, this is one of the ways that lenders in particular avoid competing on price. Ladies and gentlemen, so long as it is the same type loan on the same terms, a loan is a loan is a loan. The only real difference is the tradeoff between rate and cost, or, in other words, price. But lenders do not want to compete on price, because that means they don't make very much money. In fact, they want to avoid competing on price, and the captive audience from referral business is one prime example of how they do it. Joe Realtor sends Jane Lender business because Jane refers business right back to Joe Realtor, and because the client has been told that Jane Lender gives great loans at a great rate, the client doesn't shop loan providers like they might otherwise have done, leaving Jane a freer hand to charge a higher markup.

These are not the only reasons why referrals happen. For instance, here in San Diego, many real estate agents will refer to one particular loan officer because they know that loan officer won't tell the client any inconvenient truths, such as, "You cannot really afford this house." They refer to this loan officer because that loan officer will just keep their mouth shut about the buyer's ability to actually afford the loan and figure out some way to get it through so that agent gets paid. Never mind that it's an unsustainable loan. This sort of thing happens everywhere, but particularly in markets where there are affordability issues for the average person.

Finally, explicit kickbacks are illegal, and there are limits on how often Joe and Jane can buy each other dinner out or whatever arrangement they have to transfer wealth, but that doesn't mean it doesn't happen sometimes. After all, there aren't any Department of Real Estate employees following Joe and Jane around 24 hours per day, so this kind of stuff gets hidden all the time. I've had more than one blatantly illegal offer of referrals for kickbacks since I've been in the business. Some of these folks are brazen. No, there's no percentage in turning them in, either. This is one of those situations the saying about, "No good deed goes unpunished," was invented for. One guy I knew who did turn someone in years ago told me about the thousands of dollars in legal fees he incurred, plus three years of investigation that shows up on your license inquiries as an unresolved complaint until it's over. No thank you. Sometimes, you have to content yourself with remaining apart from any illegalities, while warning people that this sort of thing does happen.

There's nothing wrong with asking for a referral. But that doesn't mean you should just blindly follow that recommendation. All too often, there's an agenda behind that referral. If the person making the referral pushes it too hard, let alone tries to make that referral a condition of their own work, the correct response is to fire them as well.

Caveat Emptor

Original article here