Commitments to the Tenants

If you have tenants in your home, you have certain responsibilities to them.  If you’ve got contracts with them, you need to follow through.  Take care of the house, make sure it’s livable, keep open lines of communication.  You have to view it as if your sellers and your tenants are your customers.  I’m tougher on the tenants because they screw up deals more often, and that’s not really an issue with the sellers, but I still always keep my end of the bargain. 

Tenants

Make sure that you’re keeping your Realtors, lenders and others informed at all times. Communication is key!

My goal is to get people to buy and I’ll do whatever I can to help them, but I can’t make them a responsible person or tenant.  I can’t even make them close the deal.  Only about half of my tenants ever get to the closing table, and many will walk away from their option fees after only a few months of tenancy.  I have stopped trying to figure it out. 

Excerpt from Investing in Real Estate with Lease Options and “Subject-to” Deals.

Finding and Working with Buyers – An Overview of Selling on Options

The weirdest thing about prospective tenant-buyers is that you can’t tell who is going to exercise by looking at their application.  Some people are borderline potentials for me but then end up paying perfectly and exercising.  Others seem like great potentials, they pay on time then don’t exercise at the last minute.  You just never know.

I had perfect tenants in an 18-month lease option and everything was going so smoothly I was sure  that they were going to exercise the option.  Then came month 17 and “We got a problem.”

The wife called in tears saying that she and her husband were getting a divorce and that she couldn’t pay the rent.  She was very embarrassed and wanted a way to work things out in any way possible.  Thinking she wouldn’t be able to stay, I asked if it would be possible to start showing the house right away, and she said, “No problem.  By the way, I do have some jewelry.”

My ears picked up.  “What kind?”

The wife said, “Diamonds and emeralds.”

I said, “What kind?”

She replied, “Well, I have my wedding ring and an emerald ring that my husband gave me for an anniversary present.”

Diamond Ring

I asked how soon I could come over, and she said, “Come on over now.” I immediately went over to the house and she showed me the two beautiful rings and then gave them to me.  Now that just tugs at your heart a bit so I said, “Tell you what, I’ll keep these for you.  I’m a free pawn shop. I’ll keep them a couple of years even, whatever.  If you ever want them back, just pay that rent, no late fees, nothing.  Just take them.  I don’t want your rings.”

Emerald Ring

The wife responded, “Oh no, I’m not coming back for those.” 

I said, “Well you never know.  You might work it out.  I want you to work it out.” 

She said, “No no, you don’t understand.  I’ve been divorced twice now.  From him.” 

She never came back for the rings and I still have them.  Maybe one day I’ll have them reset for my daughter.  You just never know what you’re going to get in this business.

Other considerations: 

Forget everything about a tenant’s personal life.  Judge only based on what is on paper.  If we were all blind and deaf that might be the best way to evaluate a potential tenant properly.    Just look at the facts.  Personally, I don’t look too much at the credit score number but at what the accompany credit data says. If you do a background check on one person you have to do it on all applicants in order to be fair.   Regarding Fair Housing issues, you need to have in writing what your qualification requirements/standards are for credit scores, income, etc. for prospective tenants.    You can always have it in your contract, however, that if you find out any of there information is untrue that it is grounds for eviction.

Two of my best tenants ever – I was 21 and not even into options yet.  I was just a landlord.  I bought a house in a lower end area, and I had an open house.  So these two huge guys with tattoos everywhere roar up on Harleys and park them on the front lawn.  I ended up renting to them.  They were the best tenants, perfectly clean, always paid their rent on time, and when they moved out, they left it spotless.  If I had judged on the way they looked, I probably would have rejected them because I found them a little scary.

Excerpt from Investing in Real Estate with Lease Options and “Subject-to” Deals.

Everyone likes to negotiate! We may say we don’t, but we all do. Think about this: If you were to offer a price for something and the seller said “Yes” right away, how do you feel? Good you got your price, but you are feeling bad because maybe they would have accepted less. Negotiating is key to getting any good deal in real estate also. Here are some ideas to help with negotiation:

1. Check your ego at the door. The best negotiators either don’t care or don’t show the opposite side they care about who gets credit for making the deal a success. The talent is in making the other side feel like it was their idea to finalize the agreement.
2. Summarize and confirm. At the end of any negotiation it is best to always summarize the points covered and any areas of agreement that you and the opposite side agree on. Be sure that both are in agreement. Do not leave behind loose ends. Wrap the deal up and take your next steps. 

There are many good books and CDs on the market to learn more about negotiation skills.  I encourage you to buy some and study different ideas. It will help you in all areas of life, but is essential in real estate investing.

Excerpt from Top 10 Negotiation Techniques for Buyers and Sellers – Tips for negotiating Real Estate, By Wendy Patton.

Negotiation Tips

Everyone likes to negotiate!  We may say we don’t, but we all do.  Think about this:  If you were to offer a price for something and the seller said “Yes” right away, how do you feel?  Good you got your price, but you are feeling bad because maybe they would have accepted less.  Negotiating is key to getting any good deal in real estate also.  Here are some ideas to help with negotiation:

1. Offer and expect commitment. The bond that keeps deals from falling apart is the commitment to deliver on both sides. This should be offered as a level of comfort to others. Avoid deals where the other side does not show commitment to deliver. Also, if they are not motivated, move on.  I like to say, “NEXT”, if the owner is not willing to negotiate on anything.
2. Don’t take on the other side’s problems. In a negotiation you will often hear all of the other side’s problems and reasons they can’t give you what you want. It is a tactic to get their problems to become yours. It is best to deal with each problem as they are spoken about and suggest ways for the opposite side to solve them.

Negotiating

Excerpt from Top 10 Negotiation Techniques for Buyers and Sellers: Tips for Negotiating Real Estate, Written by Wendy Patton.

Rent-to-Own, Your Lifesaver in a Drowning Market

Here are some reasons rent-to-own can be beneficial for you:

• Higher Purchase Price – Rent-to-own sales typically command a price premium over traditional saes.  The buyer is paying extra for the flexibility he recieves by not having to do an outright purchase immediately
• Higher Rent – You may be able to charge more for monthly rent in a rent-to-own than you would for just a straight rental.
• Cash Flow – If your monthly payments are less than the monthly rent, the difference goes into your pocket.
• Option Fee – This upfront fee paid to you by your buyer is what secures the purchase price down the road.  If the buyer closes on the home, it would be applied towards the purchase price.  If the buyer elects to not purchase the home, the option fee is forfeited and still remains yours.  Eitehr way you win.  If you were to just rent the home, then the tenant would put down a security deposit.  The option fee is different than a security deposit.  A security deposit is owned by the tenant and can’t be used by the owner, except for repairing damages, unpaid rent and other provisions as mandated under state laws.

Rent-to-Own

Excerpt from Rent-To-Sell: Your Hands on Guide to SELL Your Home When Buyers are Scarce.

Your Standards

It is federal law requirement that landlords put their rental standards in writing.  If you don’t have your standards in writing (and, unfortunately, few landlords do), you are liable to end up in a pickle if someone accuses you of violating this rule.  Your standards do not have to be complex but should be able to be produced if someone at a local or federal agency, or anyone off the street, requests a copy of them.  Written standards can be as simple as this:

Qualifications for Tenant Selection for Majestic Realty, LLC—Lease Options

• No landlord tenant judgements unpaid.
• Ability to pay all outstanding judgements/collections.
• Good landlord reference.
• Gross monthly income equal to three times monthly rental rate.
• If any bankruptcy, it must be discharged.
• Option fee available or must be negotiated/financed.
• Prefer they have spoken with a mortgage representative.

Landlords

On my lease option standards I don’t put a credit score, but I do state that if they have a bankruptcy it must be discharged.  I also don’t put length of employment, but you can.  These are only my standards for lease options—my standards for my regular rentals are stricter.  You must establish your standards and they must be in writing.

Excerpt from Investing in Real Estate with Lease Options and “Subject-to” Deals.

Setting a Budget – How Much House Can You Afford?

The first step is talking with a mortgage broker.  Even if you can’t get approved for a mortgage right now, he can still help you determine how much you can get approved for later.  He has formulas that calculate the maximum amount you can qualify for in a mortgage.  These formulas are based on your income and debts.  Most mortgage lenders use a debt-to-income ratio (DTI) of 28/36 and FHA limits are typically 31/43.  Let me explain what those numbers mean.

Budget Planning

The first number in the debt-to-income ratio (DTI), 28 (or 31 for FHA) is called the front ratio.  The front ratio is the percentage of income that can count towards housing costs, or PITI, which are Principal, Interest, Taxes and Insurance.  That means that 28% (or 31% for FHA) of your gross income (before taxes are taken out) can count towards these costs.

The second number, 36 (or 43 for FHA) is called the back ratio.  The back ratio includes the amounts from the front ratio (PITI) plus any other recurring debt payments, such as car loans, credit cards, student loans, child support, alimony or legal judgements.  This does not count things like groceries, utilities and so forth.  Again, this means that 36% (or 43% for FHA) of your gross income can count towards these costs.

Let’s take a look at an example.  Suppose your annual household income is $60,000 per year.  You divide that amount by 12 months, which equals $5,000 per month (before taxes).  Here is how we calculate DTI.

Front Ratio

$5,000 gross monthly income X .28 (the front ratio) = $1,400

$5,000 gross monthly income X .31 (FHA front ratio) = $1,550

Back Ratio

$5,000 gross monthly income X .36 (the back ratio) = $1,800

$5,000 gross monthly income X .43 (FHA back ratio) = $2,150

Excerpt from Rent-to-Buy: Your Hands-on Guide to BUY Your Home When Mortgage Lending is Tight.

Matching Motivated Sellers with Lease Options

As discussed previously, subject-to sellers are usually, but not always, motivated by bad debt and desperation to restore their credit.  Conversely, lease option sellers have good credit, and the sellers that would even consider a lease option fall into two categories:

1)      Sellers who don’t need their cash out of the home to move on.

2)      Sellers who have no equity in their home—they are financed 100 percent.

I prefer a seller in the first category.  Why?  This seller has some cushion financially if problems arise later.  The second category of seller does not have a cushion, and therefore if they get into financial trouble, they are more likely to botch up the deal—either permanently or for a period of time until things can be resolved.

Motivated Sellers

Excerpt from Investing in Real Estate with Lease Options and “Subject-to” Deals.

My Market isn’t drowning—Is this Still Useful for Me?

Scenario 1 – No Equity

If you need to sell your home and you have no equity, how do you do it?  In other words, you owe as much on your home as it is currently worth.  How can you pay the real estate agent a commission and also other closing costs?  Sometimes we don’t always have the option of waiting until we can afford to sell, even in good markets.

You can try the “For Sale by Owner” route, but even in good markets that tends to have only modest success and, let’s face it, is fraught with pitfalls.  Selling on a rent-to-own basis can allow you to get a higher purchase price than a conventional sale.  This can help give you some room to cover the cost of selling.  Plus, having a tenant-buyer in place for a year or two paying your mortgage can help pay down the principal giving you some equtiy as well.

Excerpt from Rent-to-Sell: You Hands-on Guide to SELL Your Home When Buyers are Scarce.

How the “Credit Crunch” Affects You – the Buyer

While this housing slump is making it tough for home sellers, there is a balancing factor that’s making it tough for home buyers. I call it the “Credit Crunch”.

With the severe tightening of the mortgage lending industry, buyers are having a harder time getting mortgages. The subprime mess we’ve all heard about means that many buyers who could qualify for mortgages before are no longer able to. This may be your situation.

Credit Crunch

This “Credit Crunch” directly impacts you as a potential homebuyer. Unless you have A+ credit or a very large down payment, getting a mortgage may prove difficult. If you haven’t already spoken with a mortgage broker, you should do so to find out if you can currently qualify for a mortgage. If you have already spoken with a mortgage broker and you know you can’t qualify yet, you know about this “Credit Crunch”.

Many would-be buyers despair after talking to a real estate agent and a mortgage broker who tell them that they can’t help them because they can’t qualify right now. This is why you, as a buyer, would need to do something like a rent-to-own. It gives you the opportunity to get into your future home now, before you can qualify for a mortgage.

Credit Crunch cereal

You can get your next home NOW without having to qualify for a mortgage until later.  This is the solution you need until you can qualify for a mortgage.  This is the solution home sellers need because they can’t find mortgage qualified buyers. 

For more information on the “Credit Crunch”, read Rent-to-Buy: Your Hands-on Guide to BUY Your Home When Mortgage Lending is Tight.