Investors - How To Buy a House For Your Rent To Own InventoryPosted by Nick Niesen on November 8th, 2010 First and foremost, this article is for investors. As an investor, you should not (must not) have any emotional ties to any of your properties. You are in this business to make a fair and honest profit, and you will sell your home(s) when it makes sense to do so. Your goals should be to buy low and sell high, generate a positive cash flow while you own the house and use as little of your own money as possible. OK, so now how should you go about buying a house for your rent to own inventory of homes? Location: Stay in your comfort zone. If you are not familiar with the laws and regulations in other states, stay in your home state. If you must "touch and feel" (see) your properties, stay within a comfortable driving range. If you are not comfortable with certain types of neighborhoods, whether it be an urban blight area or upscale posh area, don't go there. There are plenty of opportunities in your comfort zone. All you have to do is find them and BE PATIENT. Buy low: The best way to do this is to find a motivated seller. Here are some obvious (and some not so obvious) ways to find that seller: Bottom line - If you find a motivated seller, you should be able to buy the property below appraised value. Sell high: In this scenario, sell high refers to the option price you will set with your renter/buyer. Keep this in mind - If your renter/buyer was able to qualify for a mortgage today, he/she would probably not be your renter/buyer. He/she would simply buy a house without your help. Furthermore, the renter/buyer is probably a frustrated renter who wants to be a buyer. In other words, you have a motivated prospect, and that prospect should understand that you are a business person who is entitled to a FAIR profit in exchange for the risk you will take to help them. Bottom line - your prospect is probably not very price sensitive, and he/she will probably accept any fair number. In my opinion, a fair option price should be the current appraised value (not necessarily what you paid for the property) plus an amount equal to the average annual rate of increase compounded annually for each year of the option term. Allow me to explain by way of example: First, try to keep all of your option terms to one year. It's to the seller/landlord's advantage. So, assume you own a house with an appraised value of $150,000 and prices have been increasing an average of 8%. For a one year contract, you should set your purchase price at $162,000 ($150,000 + 8% of $150,000 or $12,000); a two year contract, $175,000 ($162,000 x 1.08 = $174,960). Positive cash flow: Cash flow is defined as the amount of money you receive per month minus the amount of money you spend per month. Obviously you want that to be a positive number. 1. First let's look at how to minimize the amount of money you spend per month: The lease: Your tenant is not just a lessor. Contractually he/she has the right to become the owner of the home. As such the tenant should develop a "pride of ownership" attitude and be responsible for most of the minor maintenance issues that arise with any home. Ownership: Get a good real estate attorney and an accountant. They should be able to explain the advantages/disadvantages of personal versus LLC ownership including liability issues. This will help you determine the extent (and cost) of insurance you will want to have. 2. Now, let's look at how to increase the amount of money you receive every month: OK, here's what you should consider (by way of example). To increase your cash flow, offer the tenant/buyer greater credits in exchange for a higher monthly rent. For example, in exchange for $1,300 per month, offer the tenant a $400 rent credit for every on-time payment received. Now, it can be viewed as a monthly net rent cost of $900, and the total equity built would be $12,800. If you present this properly, you can let the tenant negotiate for higher rent payments! You will have a much better cash flow, and there will still be a nice profit if the option is exercised provided you properly purchase the house. If the option is not exercised (90%+ odds it won't be exercised), you keep all the rent monies paid. But, again, PLEASE keep this in mind; if you have a GOOD tenant who is unable to exercise his/her option, WORK WITH THEM. You should renegotiate a second year to your advantage, but not one that would force a good tenant to leave. Use as little of your own money as possible: With diligence and patience, you will be able to buy a home for less than appraised value. Rather than buying the house at the reduced amount, pay the appraised value and take the difference as an allowance for, say, remodeling. Take this money in the form of a bank check. Using the above example, assume you are able to negotiate a purchase price of $140,000 (this is possible, in fact, doable if you do your homework). Tell the seller you will pay $150,000, and they must give you a bank check for $10,000. Now you will finance 90% of the purchase price of $150,000 which equals $135,000. You need a down payment of $15,000. Your actual out of pocket cost is $5,000 because of the $10,000 allowance. Summary: We will assume the tenant/buyer takes advantage of getting additional rent credits, makes all rent payments on time and the option is exercised after the first year. Using the above example (which is based on a composite of actual deals) and not accounting for miscellaneous costs (for simplicity purposes), here is the deal: 1. Cash spent - $17,300 ($5,000 out of pocket down payment plus $1,025/month P.I.T.I.) Profit from cash flow = $6,300 ($23,600 minus $17,300) $20,500 profit divided by $5,000 out of pocket = 410% RETURN IN ONE YEAR!!! If the tenant does not exercise the option, it can only get better. Like it? Share it!More by this author |