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8/The Lease Option 109 your option to purchase and simultaneously sell it to a third-party buyer. If you are speculating that a particular area is ripe for development, you can use an option as a long-term investment technique. An option is a leveraged, low-risk investment; you can obtain an option with 1 percent or less of the purchase price in cash. Again, using options in lieu of conventional financing is cheaper and less risky when you are dealing with a real estate market that has an uncertain future. Case Study: Sandwich Lease Option I was referred to a woman who had a house she needed to sell in a hurry because she had a job transfer. She had tried to sell the property with a real estate agent, but, at the last minute, the buyer could not qualify for a new loan. The house was a small two-bedroom ranch that was worth approximately $45,000. The balance of the existing loan was approximately $38,000, with monthly payments of $380 per month (including taxes and insurance escrows). Although the average rents in the neighborhood were about $575, she was not interested in becoming a longdistance landlord. I offered to lease the property for $380 per month, with an option to purchase at $38,000 (the balance owed on her mortgage loan). I had the right to sublet, but I explained to her that my payments to her were not contingent on occupancy. This alleviated her fear of having to deal with the property if it became vacant. I subletted the property for market rent, which was $575. After about two years, the market value of the property had risen to $75,000, so I exercised my option to buy at $38,000. Based on a $75,000 appraisal, I had no problem obtaining solid, institutional financing for the property. In fact, I even pulled out $4,000 from the refinance to make capital improvements to the property. My payments went up, but so did the rents, based on the improvements and increase in value of the neighborhood.
110 FINANCING SECRETS OF A MILLIONAIRE REAL ESTATE INVESTOR For more information on using lease options, take a look at my home study package, “Big Profits with Lease options,” at . Sale-Leaseback The sale-leaseback is a financing technique that has been used in the United States since the 1940s. The transaction, in its most basic form, involves the sale of a property to an investor who holds title and leases the property back to the former owner. The lease is typically a long-term net lease with the seller/tenant having the option of repurchasing at a later time. The seller/tenant reaps the benefit of favorable 100 percent “financing” and still retains the use of the property. The buyer/landlord receives the tax benefit of depreciation and a guaranteed long-term rental. To do this with nothing down, simply sign a contract to purchase the property from the seller, then another contract to sell it to an investor. In a double closing, you purchase the property from the seller and resell it to the investor, who then leases it back to you, giving you an option to repurchase. You can then rent it out for cash flow or sublease it with an option to a tenant/buyer as described previously in this chapter. The sale-leaseback has its drawbacks. If either party to a saleleaseback is audited, the IRS may recharacterize the sale-leaseback as a disguised financing arrangement. This will result in an immediate recapture of the buyer/landlord’s depreciation of the property and imputed interest on the seller/tenant’s rental payments. The seller/ tenant will lose the deduction for his or her rental payments because the payments will be reclassified as principal repayment of a loan. The United States Supreme Court, in the landmark case of Frank Lyon Co. v. United States, stated the factors to be considered for recharacterization are • the economic substance of the transaction based upon the potential risks and gains of the parties, and
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vi CONTENTS Government Loan Program
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viii CONTENTS 8. The Lease Option 9
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CHAPTER1 Introduction to Real Estat
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1 / Introduction to Real Estate Fin
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CHAPTER2 A Legal Primer on Real Est
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2 /A Legal Primer on Real Estate Lo
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GL OSSARY abstract of title A compi
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GLOSSARY 181 improvements. Also use
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GLOSSARY 185 security instrument A
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RE SOURCES Suggested Reading Altern
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IN DEX A Acceleration clause, 118 A
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INDEX 191 blended, 73 Federal Reser
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INDEX 193 W Washington Mutual, 22 W
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