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Lease Option & Subject-To - Advanced Strategies for Investors

Mar 6, 2008
If you're an experienced investor, sooner or later you'll want to seek extra protection for your hard-won investments. This article will cover key strategies for getting that protection. Of course, not every strategy I describe will apply to every situation. In other words, you may not have a use for all of them, but I'm willing to be they'll come in handy at some time during your investment career.

The Indispensable Memorandum of Option One of the main negatives of lease options involves financial difficulties of sellers. Such difficulties often take the shape of liens, delinquent property taxes and other similar hassles. As an investor, you can waste a lot of time and money cleaning up these issues before a property can be sold.

The Memorandum of Option is a basic protection for the investor. The memorandum is a document is a record against the title of the property and should always be recorded. It informs the public that you have an interest in the property.

Why do you need the memorandum? Simple-it prevents an unethical seller from selling the property out from under your nose to someone else. It also gives you protection from bad-faith sellers trying to squirm out of their obligations.

Advanced Strategy 1-the Deed in Escrow Usually, the term escrow refers to the deposit of funds by one party for delivery to another party upon completion of a specific event or condition.

But, the definition also refers to the deposit of deeds and other written financial/legal instruments. My recommendation is to place the deed in escrow at when the memorandum of option is filed. In this event, the seller signs the deed along with the other contracts; however, the deed isn't recorded on the title at this point. Rather, it's held in escrow by an attorney or title company, and they're provided with instructions for its release.

Now, this action doesn't protect against the filing of liens against the property. But, its effect is to reinforce to sellers that they've actually sold the property. This, in turn, creates reluctance on their part to try to back out on a lease option agreement.

This action another benefit for you; it allows you to close on the property without the seller being present! With the deed in escrow, you can then specify how and when the deed is to be released and recorded. The instructions can be simple, such as this example: "When Joanie Jay pays $200,000 in certified funds to Stan Wild, the deed will be released to him. By (date), these funds must be paid."

Advanced Strategy 2: The Performance Mortgage With this technique, the seller pledges the property as collateral for the lease option agreement, and, thus, ensures good faith performance by that seller. Once the mortgage is assigned to the buyer, it prevents the seller from selling the mortgage to other people. (It replaces the memorandum of option filing.)

The performance mortgage permits the seller's insurance company to put the buyer's name on the owner's policy as another insured. It shows as well that the buyer is a lien holder and requires that he or she be notified if any type of foreclosure action is taken.

I'm sure it's no secret to you that many sellers dislike the idea of a performance mortgage and won't agree to such an arrangement! However, if you do find a customer who agrees, your attorney should review the terminology of the mortgage to make sure the appropriate clauses are included.

Advanced Strategy 3: The Land Trust A land trust is an organization established to hold land and to administer use of that land. This technique is useful with subject-to's. Its purpose is to minimize possible exposure to litigation.

It achieves this by hiding true ownership. The actual owner or beneficiary is not recorded in the public records, only the trust's name. In other words, it's difficult to get sued because litigants find it hard to identify anyone to sue.

A word of caution: Land trust contracts are often complicated. That means you'll need an expert lawyer to draw one up for your investments.

Advanced Strategy 4: Form a Partnership There are times when investors may want to consider subject-to high-end properties (in terms of rapidly appreciating value). There's more risk with these properties, and since there is more risk, you can spread that risk by taking on the seller as a partner. With this method, the buyer and the seller share the profits.

Here's an example: Assume a property is worth $800,000 and the monthly rental is $3,500. Under normal circumstances, you'd likely back away from this deal. However, let's assume that you discover this home might be sold for $200,000+ in profits. This deal makes good financial sense for both you and the seller. So, you agree on a 50-50 partnership (or another percentage arrangement), and you both end up happy.

My recommendation: If you take this course, require that the seller cover all the risks.

Advanced Strategy 5: Refinancing This is a tax-deferment strategy. Here's an example: Assume you have a house worth $300,000 and $230,000 is owed on it. Through a new mortgage, you can take out some or all of the $70,000 in equity, and it's not a taxable event. That means you can use that money to reinvest in other properties while still holding on to the original property.

It's a good idea to check with lenders and brokers in your area to find out what refinancing programs are available and which ones best suit your needs.

Tax Concerns The methods I've just described have to meet IRS regulations. So, you and your tax person should be on top of those regulations. They do change from time to time, and those changes can affect the legality and profitability of deals. One area to really stay on top of is capital gains.

Capital gains are the profit on the sale of a property. At the present time, you can sell your primary residence (the one actually lived in, not investment properties) every two years.

If a person is single, he or she can keep the profits up to $250,000; if a person is married, he or she can keep up to $500,000. In both instances, the profits are tax free. If the seller of a property lives in his or her home for two out of five years, then that property qualifies for a tax-free gain. The seller can rent the home out for three years - and not a single day more.

My Advice Study advanced strategies and keep them in mind as you grow your investment portfolio. More than likely, you won't need them for the majority of investments (especially early in a career), but, as is often said, knowledge is power. With that knowledge, you'll be able to apply it quickly and easily when the right situation arises.

Key Point: Make certain you get the lenders permission! Study advanced strategies in depth, so you can make use of them at the appropriate time for maximum protection of your investments.
About the Author
Jack Sternberg is the creator of the renowned "Buyers First Program". As the "gurus' guru", he is well known by the professional creative real estate community as "Obi-Won Kenobi". Having been a full time investor since 1977, Mr. Sternberg has been "at" the closing table more than 1,500 times. Mr. Sternberg has the depth of experience that lend value to his associations. Contact Mr. Sternberg at www.askjacksternberg.com
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