Lease Option & Subject-To - Advanced Strategies for Investors

This article explains advanced strategies for well-experienced real estate investors who want extra protection for their investments. Keep in mind that the strategy chosen will depend on the type of investment strategy followed. In other words, not every strategy applies to a particular situation. Also, they some solutions may not be ones an investor commonly used. However, knowledge of those solutions may come in handy in the future.

A Basic Protection-the Memorandum of Option One disadvantage of lease options, in particular, is financial difficulties on the part of the seller, resulting in liens, delinquent property taxes and the like. The result can be the time and expense of getting these issues worked out before the property can be sold.

One basic protection for you is the “memorandum of option.” This document is a record against the title of the property and definitely should be recorded. It lets the public know that you have an interest in the property.

The purpose of the memorandum is to prevent an unethical seller from refinancing and selling the property to someone else. It also provides you protection from bad faith sellers who try to squirm out of their obligations. With lease options, always record a memorandum of option!

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

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.

You should know that this action doesn’t protect against the filing of liens against the property. However, its effect is to impress upon sellers the fact that they’ve actually sold the property. The result-it creates reluctance on the sellers’ part to attempt to back out on lease option agreements.

It also has another advantage: It allows you to close on the property without the seller being present! With the deed in escrow, you should specify how and when the deed is to be released and recorded. The instructions can be simple, such as this example: “When Sam Smith pays $200,000 in certified funds to John Jones, the deed will be released to him. By (date), these funds must be paid.”

Advanced Strategy 2: The Performance Mortgage With this method, the seller pledges the property as collateral for the lease option agreement, and, therefore, 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.

Naturally, some sellers dislike the idea of a performance mortgage and won’t agree to this deal! In the event that a performance mortgage is agreed to, an attorney should review the terminology of the mortgage to make sure the appropriate, specific clauses are included.

Advanced Strategy 3: The Land Trust Land trusts are formed by organizations established to hold land and to administer use of that land. You’ll find that this technique is very useful with subject-to’s because a land trust minimizes your exposure to litigation.

It accomplishes this by hiding true ownership. The actual owner or beneficiary is not recorded in the public records, just the name of the trust. This means potential litigants find it difficult to identify someone to sue.

Land trust contracts tend to be complicated and long so investors will definitely need an expert lawyer to draw them up.

Advanced Strategy 4: Get a Partner In some cases, you may want to consider subject-to high-end properties (in terms of rapidly appreciating value). With these properties, there’s more risk. Since there is more risk, you can spread that risk by taking on the seller as a partner. In this case, 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, an investor would usually back away from this deal. However, let’s assume that the investor finds that this home might be sold for $200,000+ in profits. This deal makes good financial sense for the investor and the seller. So, they agree on a 50-50 partnership (or another percentage arrangement), and they’re both happy.

Ironclad rule: If you use this method, insist that the seller cover all the risks.

Advanced Strategy 5: Refinancing Refinancing is a great 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. The result-you can use that money to reinvest in other properties while still holding on to your original property.

It’s a good idea to check with lenders and brokers in your area to find out what refinancing programs are available.

Tax Concerns Remember that with any of the methods I’ve just described they have to meet IRS regulations. So, make sure that you and/or your tax person are on top of them; the regulations do change from time to time and 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. Currently, a person can sell his or her primary residence (the one actually lived in, not investment properties) every two years.

If you’re single, you can keep the profits up to $250,000; if you’re married, you 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 Never stop learning! Keep advanced strategies in mind as you grow your investment portfolio. It’s not likely you’ll 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 investment situation arises.

Key Point: Always get the lenders written permission. Study advanced strategies in depth, so you can make use of them at the appropriate time for maximum protection of your investments.