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:
- 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;
- 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;
- 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;
- 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.