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How To Protect Yourself In A Lease Purchase Deal
By James Gage
First, The Good News. You're holding a cashier's check made out to you
for $5000.00. You also hold in your entrepreneurial hands a contract that
will generate $250.00 per month positive cash flow. Congratulations, you
have just created, negotiated and achieved the first "lease purchase" deal
of your real estate investor career and can envision many more deals of
the same kind.
Unfortunately, Murphy's Law is never far behind. Indeed, there are any
number of ways in which your lease purchase deal can go wrong. More on
that in minute... first, a brief overview of the concept of lease
purchase.
What is a Lease Purchase?
Lease purchasing (also known as "rent to own") is when a potential seller
transfers control of and rents a property to a potential buyer, until the
buyer exercises his or her option to purchase the property. A portion of
the rent money paid each month goes toward the future purchase price.
* Next 37 17 investors only!
The benefit to the property owner, particularly one facing an imminent
foreclosure, is clear: payoff of arrearages and an opportunity to begin
making mortgage payments again. A foreclosure is the "kiss of death," and
even worse than a bankruptcy on one's financial record, so potential
sellers are often highly motivated if you can structure a deal that will
put some money in their pocket.
From your perspective, as the potential investor, a lease purchase enables
you to receive all the benefits of control/ownership of the property...
without ownership. How can you beat that scenario?! (Keep in mind that
in addition to its use in a foreclosure situation, lease purchase is a
strategy that can also be used effectively in many other cases, such as
probates, tax lien properties and in place of low or no money down
strategies.)
With a "sandwich lease" - a particular type of lease purchase arrangement
- you turn around and rent that same property to another party. You
profit from the very beginning, on through to the end, and without ever
taking ownership!
But it's not all good news.
As mentioned earlier, there are many things that can derail your lease
purchase deal, unless... you take some critical steps to protect yourself
and the deal:
- Option Money. Always get enough nonrefundable option consideration up
front. Nothing beats making money at the beginning of a deal, and getting
a substantial financial commitment from your tenant/buyer reduces the
likelihood of a problem. Don't do a lease purchase with a tenant/buyer
unless they can commit a minimum of option money (3 to 5 months rent or
more). Remember, we want to finance like a tenant and invest like an
investor.
- Contracts. Don't use generic real estate office or stationary store
lease purchase contracts. Instead, have a good contract drafted by a
competent real estate investor or attorney; one that contains the verbiage
that will protect you. I use 7 different and specific lease purchase
contracts in my transactions, depending on my strategy or position in the
deal.
- Memorandum. Record a "memorandum of option." This document can be
recorded simply and inexpensively and can offer tremendous protection for
your rights in the property. If for example, the seller tries to sell the
same property to another person without you being notified, the memorandum
clouds the title and the owner is not able to sell the property without
dealing with you first. You can file these documents at your local
Registry of Deeds where the mortgage has been recorded.
- Credit Check on Tenant/Buyer & Owner. Always check the credit of both
the buyer and the seller. Know as much as possible about the people you're
doing business with - knowledge is power.
- Preliminary Title Check. Do your homework and check out the owner and
the property with one of the commercial property on-line services
available. Better yet, contact your local title company or a professional
researcher for information. Do your due diligence.
- Open Escrow. Open escrow and have escrow instructions issued at the
onset of the transaction. It will create a paper trail and show the intent
of the parties in the event of a legal challenge.
Special Tip: Try to always use your own escrow/title company or attorney
in these matters. Working with people with whom you have an established
and ongoing business relationship never hurts, and in many cases these
individuals will go the extra mile to look out for your interests.
- Deed. Have the owner place the deed into escrow as soon as possible.
In the event you or your Tenant/Buyer wishes to close, there will be one
less delay.
- Payment Account. Set up a direct payment account with an escrow
company, title company or a bonded/established accountant or firm to pay
the bank, taxes, etc.
- Insurance. If possible, have the seller make you the loss payee on the
insurance policy. Also, require the tenant/buyer to have renter's
insurance.
- Property Inspection. Do a property inspection/walk-thru with the
tenant/buyer and use a complete inspection form that the tenant/buyer can
sign. Take a camcorder video of the property with the tenant/buyer and
have them sign and date the tape as well.
- Honesty. It goes without saying, but make sure to be upfront and
honest in your dealings with all the parties. Hopefully, in turn, they
will reciprocate and you will all enjoy a win/win deal. In a sandwich
lease, that means letting the seller know that you will be subletting the
property to qualified tenant/buyers.
Final Thought: There are no guarantees in any deal, and unforeseen things
can certainly pop up along the way. That said, the best way to succeed in
any lease purchase is to do your homework, deal with people honestly, and
head off as many problems as possible before they occur.
James A. Gage. is a best-selling author and internationally known expert
in Lease Purchase, AKA Rent To Own Real Estate Investing and Negotiating.
He mentors one-on-one throughout the U.S. and across the world. Director
of the Gage Consulting Group, LLC (www.jgage.com)
in Holden, MA, James can be reached at (508) 595-9567 or coach@jgage.com.
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