Purchase Option Investing

I have beenreading the book by Conti & Finkel on Purchase Options. We hear a lot about rehab, subto, and other forms of investing but I have heard next to nothing about this venue.
IS anyone out there using this form and what is good and bad about it?

Here is a real basic outline.

Basically it involves a motivated seller, your taking over the payments to the home(5-6yrs contract), and putting a option price on the home at the outset (200k which is todays full value). The example has you giving the seller $2,000 when you occupy or find a tennant.
Then the same as Sub To, you get a "rent to owner" in place. The R.T.O. then gives you option money of 5-10K (creditable towards purchase price, otherwise non refundable) and you pay the owner/seller/option grantor 2K out of that
You add a couple of hundred to the rent (because of the easy terms you are offering) and set a price 2 years to three years down the way so.. if the house is 200K and property appreciates 7% a year then say 228K. and you collect the spread (28K) when they refinance and the extra rent money all for $1 out of your pocket paid to the seller to make the deal legal.
On the face of it it doesn't sound like a bad plan though it doesn't offer the tax benefits of Sub To.
I would be interested in any thoughts or experiences in this venue. I am always learning and try and take new courses every year and read new material so I can stay current.
Surely someone has done or heard of this?

Randall oh oh [ Edited by Stockpro99 on Date 03/03/2004 ]

Comments(3)

  • Mitchell3rd March, 2004

    Randall,

    I still advocate doing Puchase Options and it is a central technique that I use to control property that I will flip, however, in my opinion, in the way that you are utilizing it, the Purchase Option technique, although easier to impliment, is not even as good as Sub To.

    I have done 100's and 100's of Purchase Options. For an extended period of time, I took control of 4-5 homes a week and I closed on one a week, using the Purchase Option.

    Conti and Finkle are giving good advice, just as they did in their Forclosure book. Each method of REI has it's place, but there are better ways to do REI. That is the central point.

    I use Purchase Options to flip. I have used the Long Term Purchase Option, which I then Leased with an Option to Purchase. Each time that I did the Lease with Option I got burned. It did not fail and for very predictable reasons.

    The main problem with Purchase Options is that they run out and you have a new set of circumstances to deal with when Reoptioning. The owner is in the position to demand things and they do. Typically, their situation is changed for the better and they no longer are in the vulnerable position as when you first took control of their property.

    Consider - if the owner gets rid of you then they are left with the property and the renter. You, the middleman, are no longer a factor. What was your profit can now go to the owner or at the very least it can pay for local management. The owner is back in charge of his own property.

    My average rental stay is 3 years. If you have been involved with long term rentals then you know that the "blush has worn off of the rose". Tenants are no longer straining to buy your home at a higher than market value or even at market level. They know the deficiencies of the home and want a discount to purchase it. Any loyalty they may have felt toward you for having taken a chance and given them a home, is out the window, along with their rent money. Just as the "grass is greener", any other house is better. Especially now that they are in a better position to get a normal interest rate mortgage.

    In my experience, I have never been able to find tenant/buyers who have had any more than the standard monies needed for a rental, one or two or three months rent. I always tried to collect three months, however at least 50% of applicants have not had it. No one had $10K as non-refundable option consideration. If they did have that amount, they would never have put it up and certainly would not have let it be non-refundable. Not a chance.

    This leads to a topic that no one ever talks about, i.e. what type of tenant/buyer will you attract? In a hot real estate market you won't find houses to Option or get Sub To. In a slow real estate market, those applicants with $10K will typically find a mortgage banker who will take a chance on them because they need to fill their quotas. Thereafter, you are left with those applicants who cannot get a mortgage, usually because their credit is very bad or some other circumstance limits them. Your tenant/buyer applicants are not good choises, but that is all that is showing up because better candidates are getting mortgages. All in all, not a good situation to put your financial future into. Especially, since the Tenant/Buyer/Optionee only buys the property 20% of the time. Be prepared to have the property for a long time.

    A very big Sub To guru told me that his turnover ratio is 25%. Do the numbers. That is a very scary percentage to make up. You had better have a significant number of consistantly paying tenant/buyers in very profitable properties to offset that amount of vacancy. And let us not forget that, according to Murphy's Laws, your first several properties will turn bad and you will need to go into savings to make the monthly lease payments yourself.

    One time the owner was going to go bankrupt. The judge, looking to sell the house and capture the asset, would have voided out my option and the lease. The tenant would have sued me and would have won. Certainly, at the least, the tenants option consideration would be needing to be refunded.

    This leads to another concern that is never spoken of. You as Buyer/Optionee are vulnerable if the Seller/Optionor gets into financial trouble and has a tax lien or mechanics lien or judgment placed against him. These liens attach to an owners property, wherever it may be, providing that the lienholder has recorded the lien in the county that holds the lien debtors property. All of a sudden, any equity that you may have is wiped out. Any profit that you may be making upon sale could go to the lien holder. Now how good does the transaction look?

    Then there is the issue of having long term tenants. I have been a landlord since 1972 and for the most part it has been a good experience. However, with todays tenants, even if you can afford to spin off the management, I am hesitant to get into long term landlording. Flipping is so much easier. By investing via your Self-Directed IRA, the tax consequenses are no longer an issue, so why put yourself at risk with tenants and toilets? Yes, if doing real estate investing you will, of necessity, be a landlord. If flipping, you will be a landlord for only a relatively short time so why look for it?

    From the stand point of someone who is knowledgable about tax deeds, why are you looking at another way to do REI? Readers of this forum know that a tax delinquent house can be gotten for 10% to 50% of FMV if buying for cash or it can be Optioned for $1 if you do not have the money to purchase. That is the best deal in REI. Why look to do any other type of investing technique? Just concentrate your energies on tax deed investing.

    Hope this helps,
    Mitchell Goldstein

    [ Edited by Mitchell on Date 03/03/2004 ][ Edited by Mitchell on Date 03/03/2004 ]

  • Stockpro993rd March, 2004

    AN interesting and candid viewpoint. I am constantly trying to broaden my knowledge base and keep abreast of new techniques. YOu brought up what I percieve to be some of the shortfalls of PO investing.
    As to tax deeds, not familiar at all with them. I have done RE in Utah and Oregon and they don't do that here. I hear that TX is good.
    The closest we get is at auction either sherrif sale or foreclosure. If there were a good way to do them from afar I might give it a try.
    I am going to hae to get into self directed IRA for real estate. I guess I have gotten comfortable with 100+% returns on my money through my options and stock investing. Time ofr a new pony. Thanks for all the great info!

  • Stockpro994th March, 2004

    wouldn't recording a Memo or "Option to Purchase" cloud the title enough that the original owner couldn't pull a second on it etc.?

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