Face it, if it were not for buyers with less than stellar credit we would not have the opportunities we have.
If we can sell a house outright, that is what we want to do. Selling on land contract is our second preferred exit strategy. We like land contracts because when it comes time for the buyers to obtain their own financing, their lenders can treat the loan as a refinance instead of a new purchase.
What is a Land Contract?
A land contract, or a contract for deed, occurs when a seller finances a property for a buyer for a set period of time, at a set interest rate, until the buyer can obtain their own financing. The buyer puts a specified amount of money down and agrees to payments just like they would if obtaining financing from a bank. The term is generally from one to three years - or whatever the time frame necessary for the buyer to qualify for their own financing. There is an ordinary closing with the deed and mortgage both recorded with the county recorder.
Lease Option and Rent to Own
We also have advertised and sold houses as "Lease Option" and "Rent to Own" purchases.
What is a lease option?
A lease option purchase is when a buyer leases the property and has an option to buy that property at a set price in the future. Two documents are signed at closing, a purchase contract and a standard lease agreement. The purchase contract will have a closing date of sometime in the future.
Rent to Own with ‘Applied Rent'
Applied rent is a monthly rent payment, but a portion of it gets applied to the purchase price and/or a down payment of the property. For us, the money that is designated as "applied rent" becomes the fund that we set aside to fix up the house in case the buyer walks away from the contract to purchase. Ideally, the applied rent is money coming in above and beyond the monthly obligation. Of course if the buyer does what they are supposed to do, providing the buyer a credit at closing that is equal to their applied rent and down payment is a small price to pay for getting cashed out.
Hold in Inventory and Rent
Our least favorite exit strategy is a simple rental. There is nothing wrong with buying, renting, and holding a property, but we prefer to sell. Even selling a property on land contract limits the amount of basic maintenance and utilities we have to provide versus maintaining a rental property.
While we know the odds are that a given land contract candidate will choose not to follow through with a purchase, we know we are going to get a house back at the end of a rental term. Having said that, we have had and continue to maintain several profitable rental properties and some markets quite simply lend themselves to rentals as opposed to land contracts or lease option.
We have done very few lease options compared to land contracts, but this is because land contract is the customary method used here. In general, we welcome the psychological "push" that ownership provides, versus a lease option or rental agreement.
The Facts of Life When Selling Homes on Land Contract:
The odds of getting cashed out on time:
- 1/3 of your buyers will cash out successfully on time as contracted.
- 1/3 of your buyers will renew the land contract at the same or possibly new terms if appropriate.
- 1/3 of your buyers will walk regardless to the down payment they made.
Improving Your Odds
Our goal is to up the odds of getting cashed out. We need the 1/3 history to become 100%. One process is to not only show on paper where the buyer's investment is, but to make sure they "feel" the investment. It is critical that whether they are buying land contract, lease option, or rent to own, that they know they are building equity.
We suggest sending a yearly letter to tenants with their 1099 tax form. This letter should show them how much equity they have built, what their house is worth today, assuming it has appreciated, and implicitly, what they stand to lose if they walk away.
Other things that aid the psychology of building commitment are meeting in the office with all interested parties, formal closings, and lease signings, and the overall professionalism of you and your team. This is a business, and every aspect of the business needs to convey professionalism and outstanding customer service.
Even though your buyer may not have gone to a bank for financing, this is one of the largest if not the largest purchase they will make in their lives. Treat this as the special occasion it is.
This post is an excerpt from our latest E-Book, The Help-U-Buy Way. To request a free copy, visit us at www.TheMcAllisterTeam.com.