House #1: Second Offer

February 27, 2009 · 7 comments

We received an offer on The Corn House yesterday. Not a conventional offer, but an offer for a Lease Purchase agreement.

Basically, the way a “lease purchase” works is that the buyer makes an offer on the property, with the stipulation that he will close on the property at some point in the future (generally several months). The buyer puts down earnest money (to secure the contract) and a security deposit that goes into escrow, and can be used towards the purchase price at closing. Between now and the time the buyer closes on the purchase, he rents the property using a typical rental agreement, though at a somewhat higher rental rate. The excess rent (generally 30-50% above market) goes into the escrow account as well, and also gets put towards the purchase price.

This means that the buyer is actually building up a down-payment during the rental period that will help him close the deal at the expected time. Additionally, if the buyer doesn’t close on the deal as promised, all the money in escrow (the security deposit and the excess rent) go to the seller. The downside, of course, is if the buyer doesn’t complete the deal, the house has been off the market for several months and may need some repairs done.

The offer we received on The Corn House is as follows:

  • Buyer offered full price for the property at $119,900, with the seller (us) paying $2000 in closing costs.
  • Buyer will purchase (close) on the property by August 31, 2009.
  • Buyer will put down $500 in earnest money, and get 10 days of due diligence to inspect the property.
  • After 10 days of due diligence, the $500 goes into escrow.
  • At the end of March (a month from now), the buyer puts down $2000 in security deposit.
  • Starting April 1, the buyer enters into a 5 month lease (April through August).
  • The buyer pays $1500 per month rent for 5 months, with $1000 going to me for rent, and $500 going into escrow.
  • Come August 31, the escrow account will total $5000 ($500 EM, $2000 deposit, and $500 x 5 months).
  • Come August 31, I will have received $5000 in total rent.
  • If for some reason the buyer doesn’t close, the rental agreement is terminated, and the $5000 in escrow comes to me.

The buyer’s situation is that he and his family are currently in a house in the same subdivision on a lease purchase that started a couple months ago. Unfortunately, the owner of the house has not been using the rent to pay his mortgage and the house is falling into foreclosure. So, the buyer is being kicked out. The bank is offering to allow him to buy the house, but his credit is supposedly about 20 points shy of being able to attain a mortgage, and he doesn’t have the full downpayment. So, he got screwed (he lost all his escrow money because he didn’t have a strong contract), and is looking to try again with another lease purchase.

This is an interesting offer. It’s a full price offer (and I may even be able to negotiate more), plus I’ll receive $5K in rent between now and August. Best case, the buyer will actually be able to close earlier than August, and worst case, he defaults and I at least get the $500 earnest money, $2000 security deposit, and any rent that has been paid. Of course, in the worst case scenario, I have to repair any damage and wear-and-tear to the house before I put it back on the market.

The big draw to this offer is that with the full purchase price and the $5000 in rent payments, our total profit could potentially be about $10-12K more with this offer than we could reasonably expect from another — more conventional — offer. Just a question of whether that extra profit is worth the extra risk, and worth not having access to the tied-up cash for at least several months.

We’re not sure if we’re going to seriously consider the offer (we have a lot of cash tied up in the property and would love to get it out before September), but if we do, we’ll take the following steps:

  1. We’ll have the buyer contact our lender so that we can understand exactly how far he is from qualifying for a mortgage, and what steps can be taken to improve his credit. We’ve actually already taken this step, and he’ll be speaking to our lender today;
  2. We’ll meet the buyer and his family, and we’ll take a look at the property they’re currently living in. That should give us an idea of what to expect in terms of what kind of wear-and-tear will be done to the house;
  3. The buyer has told his agent that he has done a lot of improvements to his current place; we’ll ask to see those improvements to ensure that if he completed them in our house that they’d actually add value, and not detract value;
  4. We’ll try to negotiate somewhat better terms, or perhaps try to reduce the lease period to encourage them to close sooner. They should have enough in escrow to pay the downpayment after the second month, so if they can get their credit in order by then, there’s nothing stopping us from closing by June.

Would love to hear any feedback others might have on this scenario, or their experiences with lease purchases.

7 responses to “House #1: Second Offer”

  1. hakrjak says:

    I hate it when you have a lot of money tied up in a house and want to get it out, but you get an opportunity to make a bunch of money with a creative deal like this. Very tempting…. I would definitely increase the purchase price a little to compensate for the added risk to you. The house could be a lot harder to sell after someone has lived in it for 6 months or whatever.

  2. J Scott says:

    Hak –

    Your comment reminded me of the other fact that I hadn’t included in my post (just added it above):

    With the full purchase price and the $5000 in rent payments, our total profit could potentially be about $10-12K more with this offer than we could reasonably expect from another — more conventional — offer.

    So that’s definitely a consideration…

  3. Mo says:

    J Scott, knowing deposits for rental units and deposits for lease purchases, I know that those amounts are great. Especially for your area.

    I would definately pull the trigger on this deal for two reasons: Your number 1 and 2 listed in your post. If I personally got a good vibe from reviewing their current place of dwelling, I would do this. Part of me thinks, “what could they possible do to destroy your house in 5 months?” This would be, in my opinion, one of those times you just go ahead and take the aggressive risk. I’m concerned about whether or not home prices could drop again, thus reducing your profits. If you feel you could make more profit by going with these buyers, then actually this could be the smarter way to hedge your bet.

    Do you already have a very strong lease agreement, and if not, just e-mail me and I’ll send you the one I have. I also had 2 people forward to me their lease purchase agreements if you need those.-Mo

  4. J Scott says:

    Mo –

    Thanks for the input…this makes me feel a little better about the offer…

    As for the lease agreement, it’s a Georgia Association of Realtors (GAR) standard form (my wife is an agent and the offer came from an agent). So, while I can add and subtract things here and there, the lease is pretty much fixed for this deal.

    Thanks again!

  5. Seth says:

    I may be in the minority here (and it looks like it, based on the comments so far) but I’d be wary of this deal, especially given the concern you voiced about wanting to extract the money you’ve got tied up in it.

    That’d be my biggest concern, as far as the capital tied up in it, and your desire to get out of the property. There’s just absolutely no way to predict what the lending environment will be 6 months from now, what your local housing market will look like, where the overall economy will be, if the potential buyer will still be employed, etc. He might need a 700 credit score at the moment to get financing to cash you out but that could easily be a 750 minimum score a month from now.

    As far as the financial terms, I think it’s a slam dunk good deal for you. If you had absolutely no concern about getting your capital out of the property and it was a mere drop in the bucket that you wouldn’t miss for years and years, I think it’s hands down a good deal.

    The bit about being just 20 points shy of getting financing also worries me a bit, but maybe its understandable in light of not having the full downpayment as well. I mean, granted, he really might be that close, but usually when someone emphasizes to me that they ALMOST can pay me x or are JUST BARELY short of being able to afford y, the real answer is that they’re much further away than that.

    I guess it just boils down to how confident you are of getting the house sold if you turn down this offer. If you’re sure you can move it at a point that’s still profitable (and that you’ll get greater utlity out of that capital by getting it out now), I’d lean towards just getting it sold at a lower price and moving on and putting that money to work elsewhere. If getting it sold at a profitable price isn’t a certainty, then this offer looks pretty dang good, despite the uncertainty of getting cashed out 6 months from now.

  6. J Scott says:

    Seth —

    Excellent points, and certainly something we’ve been thinking/worrying about when it comes to the property. Not only do we risk not selling the property in 6 months if the credit markets change, but we might have to deal with putting a nice family out of the house at the same time.

    In other words, it could be a lose/lose situation.

    We’ll also know more in the next day or two when we talk to our lender to get the real story about the buyer’s financial situation.

    Thanks for the input and excellent points!

  7. Luis says:

    Dude, this is exactly what I am trying to pull off. THe fact that somebody actually came to you without you soliciting blows me away.

    You are getting a security deposit so that should cover some damages, plus the extra monthly payments, in case he doesn’t go through with purchase.

    Absolutely do a credit check to see how close he is to being able to qualify for loan.

    You might have to help him to qualify, find somebody that can work with him to repair credit if need be. Then again between nown and August doesn’t leave you a lot of time if there is credit work to be done.

    Offer to renegotiate lease purchase in August for a NEW purchase price if he is not able to close then.

    Have you considered refinancing to pull cash out?

    The stories I have heard of unclosed lease purchases is that the houses come back in significant better shape than straight rentals since the occupants had the intention of purchasing and will take better care.

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