Getting the Best Profits on a Real Estate Lease Option

Those who know how to achieve real estate investing success have many different strategies when it comes to lease options. Some simply use the lease period to fix up the home and check it out to ensure that it is structurally sound and a good investment. Others will rent it out and make some profit until they can exercise the option to buy, at which point they turn around and sell the house. Still there are others who get more creative and find other strategies that let them make a nice profit out of a real estate lease option situation.

Simple Methods

If you choose to fix up the house during the lease period then you will be taking a slight loss in the beginning. You will have to pay money each month on the lease while also paying out money to fix up the house. Some investors prefer this option, though, to simply buying a house and flipping it. It allows you to see everything wrong with the house. If you run across something that would be too costly to fix or something that is a deal breaker then you ride out the lease option contract and not buy in the end. If everything is fine then you can usually turn around and sell the house for a nice profit once your lease option ends and you buy the property.

Many people rent out a real estate lease option property. This will allow you to have renters who pay the monthly lease until you get the option to buy. You can do repairs or have your renters do repairs for a reduced rent cost. Like the first option you still get a chance to see what is really wrong with the house, but with this method you are not losing so much money on the deal in the beginning. You still get the chance to sell the house once your lease option contract is up and you buy the property. When you sell you can increase the price over what you paid due to the fact that you have done repairs and made improvements and make a nice profit.

Find a Buyer Early On

Some investors who achieve real estate investing success make sure their lease option will pay off. Instead of waiting to sell when their real estate lease option is up and they buy, the investor will start actively looking for buyers before their option of lease is up. This way they can find someone to buy the property instead of them once the option is up. To make this work you will set the price on the property for the buyer you find to a higher price than what you are supposed to pay.

There are many ways that you can make money off a lease option. Some who achieve real estate investing success just fail to see exactly what they need to do to make a profit on this type of deal so they walk away without ever giving it a try.

There is actually little to lose by just trying a real estate lease option. If you are a new investor or you are having trouble finding good properties to flip then a lease option may just be the best choice for you as you search for real estate investing success.

The worst bet in real estate today: Construction loans - USATODAY.com

By Paul Wiseman, USA TODAY

The biggest bank killer around isn't some exotic derivative investment concocted byWall Street's financial alchemists. It's the plain old construction loan, Main Street banks' bread and butter for decades.

Deutsche Bank has called them "without doubt, the riskiest commercial real estate loan product." The Congressional Oversight Panel, a financial watchdog, has warned that construction loans have deteriorated faster and inflicted bigger losses on banks than any other real estate loans.

And the worst may be yet to come. Banks, adopting a desperation strategy known as "extend and pretend" or "delay and pray," have been reluctant to admit defeat, repossess half-completed housing developments and strip malls — and dump them on a depressed market at a big loss. "There probably are many loans out there that are in worse shape than reflected on lenders' books," says Chicago construction lawyer Joshua Glazov.

Even so, the numbers are already grim:

•Across the banking system, nearly 17% of construction loans were non-current — at least 90 days past due or otherwise in trouble — at the end of March, a record level and a stark contrast to less than 5.5% for all loans, according to the latest numbers available from the Federal Deposit Insurance Corp. For construction loans on one- to four-family residences, the percentage of bad loans is even worse: nearly 23%.

"Construction loans are experiencing the biggest problems with vacancy or cash-flow issues, have the highest likelihood of default, and have higher loss severity rates than other commercial real estate loans," the Congressional Oversight Panel, tasked with overseeing the federal bailout fund, reported earlier this year.

•The 10% of banks that had the highest concentration of construction loans at the end of 2007 account for more than half of the 274 banks that have failed between then and Aug. 6, according to an analysis for USA TODAY by SNL Financial in Charlottesville, Va.

•Even the banks that have survived despite holding high concentrations of construction loans remain vulnerable. Their average "Texas ratio" — which measures their bad loans as a percentage of their capital and reserves against loan losses — stood at 101% on June 30, up from 90% three months earlier, SNL found. Anything over 100% signals that a bank is in danger of failing. For construction-loan-heavy banks, the median Texas ratio — which weeds out the worst cases — was still high, at 62%.

"It's been a bloodbath out here," says bank consultant Tod Little of BNK Advisors in Las Vegas.

Developers typically take out short-term, adjustable-rate loans to buy and develop property. The bank releases money in increments — as the developer needs it — and puts some of the proceeds in a reserve from which the builder makes interest payments before the project starts generating revenue. After the project is completed — and tenants have moved in and started paying rent — the developer takes out a longer-term mortgage to pay off the construction loan.

'Cocaine' for banks

Many small and midsize banks, eager for growth, grew addicted to construction loans during the housing boom. "Construction lending is really the cocaine of the banking industry," says veteran banker Rollo Ingram. "They're easy to do. They're big-dollar loans that can bulk up a balance sheet. And there are always developers who want loans."

Construction loans — officially labeled "acquisition, development and construction" loans — surged more than 150% between the first quarters of 2003 and 2008, when they peaked at $631.8 billion. (Overall loans rose just 55% during the same period.) If a bank said no to a construction loan, "The developer could just go down the street," says Brandon, Fla., bank consultant Jon Campbell.

And some of the people getting loans during the real estate frenzy of the mid-2000s were amateurs, says Boston bank consultant David Brown: "They were contractors who got the bug and felt they could make a living at being a developer."

It did not end well. Construction loans started blowing up when the real estate market collapsed and the economy tumbled into recession. The 10 biggest banks, facing problems of their own with subprime mortgages, were largely immune to the deterioration in construction loans, which accounted for just 2% of their assets in 2007, according to the Federal Reserve. By contrast, construction loans accounted for more than 10% of assets at banks that didn't rank in the top 1,000. "What's causing the problem is Main Street America, the construction loan made by the bank down the street," says Bill Bartmann, who owns a debt advisory firm. "They built, and nobody came."

Making matters worse: Community banks never sold the construction loans to investors the way banks unload auto loans and residential mortgages. "Most construction loans are so unique, so different, so non-homogenous, that you can't securitize them," Bartmann says. "They were kept on the books of the banks that originated them." And there, many of them started to turn rotten.

A failure's postmortem

Rollo Ingram witnessed one spectacular flameout up close. He was chief financial officer at Atlanta's RockBridge Commercial Bank, which opened in 2006, backed by other members of the city's business elite.

RockBridge told banking regulators it planned to specialize in business lending. It didn't, plunging instead into real estate and construction loans. The bank told regulators in 2006 that construction loans would account for 5% of its portfolio. By the end of 2007, they accounted for 42%. Business loans, which were supposed to make up 50% of RockBridge's lending, came to just 28%, according to an after-the-fact autopsy by Federal Deposit Insurance Corp.'s inspector general.

Nor did RockBridge recruit veteran loan officers with enough experience to safely assemble its risky portfolio, the inspector general concluded. "They hired younger, less-experienced ones, and didn't hire enough of them," Ingram says. He says he was forced out in 2008 when he complained about the risky direction the bank was taking.

By the time RockBridge failed last December, more than 60% of its construction loans had gone sour.

Other banks on SNL Financial's list of failed construction-focused banks fared even worse: At Chicago's Ravenswood Bank, more than 69% of construction loans went bad before regulators pulled the plug Aug. 6. By the time Wheatland Bank in Naperville, Ill., failed in April, more than 80% of its construction loans had gone belly-up. Security Bank of Gwinnett County, Ga., failed a year ago with three-quarters of its construction loans underwater. Georgia saw more construction-focused bank failures (34) than any other state between the end of 2007 and August, according to SNL.

Brown of RMPI Consulting in Boston blames the banks themselves. He says many banks, trying to cut costs and boost profits, dropped training programs that would have taught loan officers how to assess risks on construction projects and other loans: "I could see it coming for five years," he says. "Banks got sloppy; banks got greedy; banks got lazy."

But Little says many construction loans were prudent when banks made them. Some banks demanded that developers make 50% down payments only to see the value of the projects drop 80%: "That's really killing the community banks."

He says regulators are unreasonably forcing banks to take losses on real estate loans and pushing them out of business when they would rebound if given enough time to work with borrowers and await a recovery in real estate. "They're bayoneting the wounded," he says.

Then again, a council of federal bank regulators issued a statement last October encouraging banks to work with commercial real estate borrowers struggling with empty office space and storefronts, evaporating rental income and collapsing property prices. "Prudent loan workouts are often in the best interest of both financial institutions and borrowers, particularly during difficult economic conditions," the council said, adding that regulators wouldn't force banks to write down otherwise good loans "solely because the value of the underlying collateral declined."

"The regulators have probably held back in places," lawyer Glazov says.

Troubled construction projects are a nightmare for banks. "If a bank forecloses on a house, it's a house. Everybody knows what to do with it," Bartmann says. "But if you're dealing with a half-constructed hotel or a half-constructed strip mall, not only does no one want it, you now have to maintain it" — trim the hedges, pay the property taxes, write checks to the power company. So, many bankers have chosen to wait it out, extending the terms of loans to troubled developers to keep from having to foreclose and take possession of a half-built headache. Which leaves bad loans and troubled property in limbo.

"The loans aren't coming to market," says Sam Chandan, president of Real Estate Econometrics in New York. "The distress is sitting on bank balance sheets."

Concludes Wayne Heicklen, co-chair of the real estate practice at the New York law firm Pryor Cashman: "They're hoping the existing borrowers or someone else will come along and put more money in the project and make it right."

Making Real Estate Money-Discounted Cash Flows | Beware on "Silent" Seconds

The key to making money when buying discounted cash flows is to be able to find the best notes at the best discounts with minimal to no risk. In other words, the key is to "sift the wheat from the chaff." This advice is especially important when buying a second.

Many of us have purchased and profited from buying second mortgages. However, as with any investment, you want to avoid any pitfalls. You should be on the look out for what FNMA calls "Silent Seconds."

These are notes created from the sale of real estate with a seemingly good down payment, a new first loan and the second trust deed or mortgage note. However, the first lender is unaware of the second note, which is where the name "Silent Second" comes in. These notes are usually kept silent because the buyer cannot qualify for a large enough first loan.

An example...

Let's take a look at a real-life example. The buyer purchases a single family home for $135,000. The first lender agrees to make a loan of 80% or $108,000. Therefore, the buyer has to come up with $27,000, right? Normally this would be correct, but not in this case!

The buyer and the seller make a side agreement to create a note outside of escrow and without the knowledge of the first lender. They claim the buyer has put down $27,000, but in reality he only puts down $15,000. The buyer gets the first loan for $108,000 and gives the seller a "Silent Second" for $12,000 which is the remaining balance.

The first lender is unaware of both the smaller down payment and the second note for $12,000. If the lender knew about these factors, it would have never approved the loan. Is this practice illegal? You bet it is! Do you want to buy these type of notes? NO!

Always examine the closing statement

So how can you tell if you have a "Silent Second"? One way to tell is to look at the closing statement which should include when the note was created. If the second you hold or are thinking about purchasing is not shown on the closing statement, then it's probably a "Silent Second."

But, here's another problem...What if the closing statement you have received from the note seller has been forged? What if the note seller has added in the second note to the original closing statement?

Always cross check your documents with the documents from the title or escrow company before closing the transaction. This way you will be able to check whether the figures and signatures are correct.

A widespread problem

Many buyers and sellers of real estate enter into these types of "side" transactions without realizing that this practice is illegal. If deliberate fraud is involved (and what kind of fraud isn't deliberate?) then the penalties are severe. This is a very widespread problem. If you are careful, you can avoid this pitfall.

So, in short, always do your homework when buying any note! If it's a second trust deed or mortgage note, do a little more work! When you call or write to the senior lender to check the loan balance, also ask him if he is aware of a second note that exists. 

Making Real Estate Money-Discounted Notes | No Money Down--Cash Back at Closing

This article will suggest the most creative way to buy real estate with discounted notes. It is a wonderfully intriguing method. Even if you cannot do this exactly, you will still have the very real possibility of trading notes you bought at a discount for full face value on a piece of property. These ideas come from such innovators as Joe Land, Pete Fortunato, and others.

The scenario 

First, consider that there is a $160,000 duplex for sale with a $40,000 first trust deed on it. The owner of the property, Sally Seller sells the duplex to Paul Payor. Paul puts down $40,000 cash, he assumes the $40,000 first mortgage, and Sally agrees to carry back an $80,000, 30-year second mortgage. She is happy with the extra income from the second mortgage, and the $40,000 cash down payment.

Second, consider the older, conservative home owner who owns his home free and clear, Harry Homeowner. He decides to sell the home. He does not need all the cash but would like to have a steady income for retirement. Their home is worth $100,000., so Harry and his wife advertise that they will sell their home with a 20% cash down payment, and they are willing to carry an $80,000 first mortgage.

Third, reconsider Sally Seller who has been receiving payments on her $80,000 note. She is offered a chance to buy a share in a restaurant with a friend. She is excited about the opportunity, but has spent all of her money including the down payment she received. She is not able to borrow the cash to invest.

The only asset she owns is the $80,000 note. She calls you, Ned Notebuyer (or Nancy Notebuyer). You offer Sally Seller $48,000 for her long-term $80,000 note, which she gladly accepts after you skillfully explain to her the discount she must take on this very long-term note.

Buy a $100,000 house for $68,000 

Think for a moment about this situation. You have Harry Homeowner who wants an $80,000 note and Sally Seller who wants to sell her $80,000 note. The only person missing from the picture is you, Ned (or Nancy) Notebuyer!

Your obvious solution to helping the two parties is, perhaps, shortsighted. You are saying, "Great, I will buy the note from Sally Seller for $48,000 and trade it to Harry Homeowner for the full $80,000. If I give Harry Homeowner $20,000 cash down, and he agrees to accept Sally's note, I will have bought a $100,000 house for $68,000." ($20,000 down plus $48,000 for Sally's note.)

"Terrific," you say, "but this costs a lot of money". You would need $68,000 in cash. Can you think of a way to consummate this transaction with no cash??

Make a great deal even better 

First, you must convince Harry Homeowner to take back a note on a property other than his own. He was expecting to have a mortgage on his own home. But you can point out to him that by taking the second mortgage on the duplex he has more equity protection and a seasoned note.

He has no idea how you, the new buyer, will perform on the loan. But Sally Seller's loan is several years old and is well seasoned with a good payor. After seeing Paul Payor's credit report and his payment record, Harry agrees to accept Sally's note from you. If Harry is willing to sell you his house and accept Sally's note, then his house if free and clear.

If you are buying Harry's house, and it is free and clear, you can get new financing! You go to the bank, and the bank says they will loan you $80,000 if you will make a $20,000 payment. You say okay, and perhaps show the note as your down payment.

I'll take the leftovers, please 

All parties agree to the deal, and you go to escrow to close the purchase of Sally's note, and the purchase of Harry Homeowner's house. The bank has given the escrow officer a check for $80,000 secured by the house you are purchasing from Harry. The escrow officer writes a check for $48,000 to Sally Seller for her note.

The escrow officer then writes out a check for $20,000 to Harry Homeowner and gives him Sally's note. She transfers the house to you with the $80,000 mortgage on it. She writes out a check for $4,000 in closing costs to the bank. She then says to you: "Wait a minute, I still have $8,000 left! What should I do with that?" You raise your hand and say, "I'll take it!"

You have picked a home with $20,000 equity, you have $8,000 in cash, and you have spent none of your own money! The lesson is that real estate notes bought at discount can trade at full face value in the real estate market. Great profits can be made if you learn this lesson.

About the author...

Jon Richards was the founder of NoteWorthy Newsletter, the major newsletter for buyers and brokers of cash flows on the secondary market. It has been published monthly since October 1989 and is the largest paid subscription newsletter in the industry. Jon was the publisher of the NoteWorthy Newsletteruntil his death in 2003.

Jon was a licensed real estate broker, long time real estate investor, and an expert in finding, appraising, buying, and brokering discounted notes and mortgages. He was the professor and tenured instructor of Real Estate at the College of Alameda in California.

Making Real Estate Money-Ten Simple Steps to Buying Bank Notes

As the real estate market slow down continues, and with foreclosures on the rise in most of the country, lenders are finding themselves overwhelmed with many sub-performing and non-performing loans.

Many lenders are willing to consider a "short sale" where the lender will accept something far less than what is actually owed to them. However, actually owning the debt instrument itself (the promissory note) may be more useful for the savvy investor.

So, what are "sub-performing" and "non-performing" loans?

Sub-performing loans

Often called a "high maintenance" account--that is an account that requires a tremendous amount collection effort in order to reason, cajole, harangue, and beseech the tardy borrowers to make their payments month in and month out.

In some cases there may be rolling late payments, back payments already added to the outstanding principal, or an existing forbearance agreement between the lender and the borrowers to stave off a foreclosure.

Non-performing loans

These are accounts where attempts to collect have been unsuccessful and the account is simply not paying at all. It is in arrears with back payments and other expenses due.

Often, lenders in need of cash liquidity are willing to steeply discount the amount they will accept for the sale of their sub-performing or non-performing loan accounts (the promissory notes). These problematic accounts are a drain for the lender both monetarily and from a human resources standpoint.

For astute real estate investors, opportunities can be created by acquiring these secured loans, which can then be "scrubbed" up and become performing again or simply foreclose and repossess the collateral securing the loan. Lenders sell these notes to create liquidity and get these loans off their books.

Ten simple steps involved in buying bank notes

The mechanics surrounding the purchase of ANY real estate secured debt instrument (the note) are essentially the same whether you are purchasing from a private note holder or from a bank-type lender.

The Unity of Real Estate & "Paper" home study course contains the forms and useful documents you need. It also contains several pre-closing, closing, and post closing documentation checklists for handling such transactions.

Here are ten steps to follow: 

1. 
   
   Verify the outstanding balance due on the note and theactual repayment terms of the note. I cannot stress enough that you MUST review the actual documents that were executed!
2. 
   
   Verify with the seller of the note (the Assignor) the interest paid through date (or last paid date)
3. 
   
   Verify the next payment due date.
4. 
   
   Ascertain that the mortgage (or trust deed) is an insurable FIRST lien position loan (assuming you are buying a 1st lien). This is where a review of the existing mortgagee/lenders title insurance policy comes into play. Such a loan title insurance policy was probably issued when the loan was originated.
   
   You also want to establish the status of the property taxes, whether they are current or delinquent, and any impound escrow funds that might be held and be transferred to you for such payment as taxes and fire hazard insurance premiums.
5. 
   
   Confirm the value of the collateral property that secures the note (that is today's fair market value). You can do your own evaluation, or have a BPO (broker price opinion) report done, or a formal drive-by, exterior only appraisal, etc.
6. 
   
   Get the actual mortgage (or trust deed) security instrumentassigned over to you or your entity. The assignment, once executed and recorded, will accomplish this and transfer all rights, title, and interest in the instrument to you; the assignee.
7. 
   
   Have the original promissory note instrument endorsed over to your or your entity (making sure the assignment of the security instrument and endorsement of the note match one another). The endorsement can take place right on the actual original promissory note instrument or via a separate note allonge (an attached endorsement).
8. 
   
   Have physical possession of the original promissory note instrument given to you. This is the negotiable instrument you are purchasing and whose rights you will be able to enforce for non-payment of the debt.
9. 
   
   You may want to obtain an estoppel affidavit from the Assignor. They will affirm for you the actual balance and terms of the note and might be useful in a later dispute with the debtor.
10. 
    
    Obtain notification letters to both the note payor and fire hazard insurance agent notifying them of the transfer of the note account. (These are often referred to as so called "goodbye," "welcome," and change of loss payee letters).

It would be wise to further consult with your own attorney to make sure that what you are purchasing is what you bargained for. Once you own the actual debt instrument (the note) there are a number of options available for you to pursue in an attempt to collect or get the note instrument performing.