The Rental and Sales markets

“My ex-wife and I co-own a house just north of Tampa, FL. We purchased it 2 years ago for $260K, and have just unexpectedly lost our tenant. This leaves us in a $2,000/month hole. Both the rental and the sales markets are slow down there, with a glut of empty houses providing a big challenge to our fiscal serenity.

“We are currently working with realtors to either rent or sell the house. We owe $205K, and the comps are showing sales prices of $225K, $205K, $190K, and $175K in the past 6 months. If we found a buyer at the top of that range, we could pay the mortgage and the realtor fee, and walk away with nothing. Distressingly, that has been seeming the better option of late. We had a negative cash flow of $900/month before, and IF we could find another tenant, it would likely be higher.

“My question is the obvious one. What would you do?”

Tom B.

Leverett, MA

Dear Tom,

I’ve advocated buying only cash-flow properties using fixed rate, amortizing loans. But now that you’re in this situation, here are a few things to consider:

Option 1: Look into special-needs housing – connecting with organizations that provide furnished rooms for vets or the disabled or people in halfway houses.

As I said in my article “Creating Cash Flow Without Ownership,” one of my houses is rented out to a guy who subleases on this basis. He pays me $1,450 a month. That covers my nut comfortably. Then he turns around and subleases to members of a substance abuse recovery program. He charges them $125 to $150 per week for a room, which includes utilities, Internet, and cable. If his utilities, Internet, cable, and other expenses are $650, he clears $1,500 a month.

Now I wouldn’t want to lease out the property on a room-by-room basis myself. It’s too management-intensive for me. But I could if I needed to. And if I did, I could increase my net by $1,500 or so a month. For you, this is very much worth looking into.

Option 2: Student housing – a version of the above.

Rent by the bed with “all bills paid.” If there’s a school near your property that makes this possible, try to get the parents of the students to guarantee the leases and agree (in writing) to pay for any damages. Again, managing this yourself will be time-consuming – but you could end up (at least) doubling your rents.

Option 3: See if you can sell the house on terms.

You can usually get a somewhat higher price this way than if you require the buyer to come to the table with a down payment and a bank loan. Take five percent down (or even one percent or two percent if you have to), and hold a note for the rest. Now taxes and insurance are the buyer’s concern. You take the five percent monthly payments on your sale price and pay your underlying mortgage. This is called a wrap-around mortgage. You sell the property “subject to” the existing mortgage and create a mortgage for your buyer that wraps around your existing mortgage.

You’ll want a lawyer who has experience in this kind of transaction to handle it for you. It’s probably best to structure it as a land contract, where you don’t give the buyer the deed until they’ve paid off the note. You can try to make the note for one or two years, with the buyer getting third-party financing after that to pay off your mortgage.

Note: in all likelihood, your current mortgage has a “due on sale” clause. This clause typically says the bank could call the loan if they find out you sold the property. People who do this sort of thing say the bank’s not likely to call a loan if the payments are being made on it. But be aware that they could – in which case you’d have to pay all of it or forfeit the collateral property.

Option 4: Try a creative lease option.

Say you normally might be able to offer your house for $205K on a lease option. The other party pays $1,200 a month, and $200 of it goes to equity. Maybe you can offer it for $220K with a $1,250 monthly lease payment… but 100 percent goes to equity if they execute the option to buy! This is a unique offer. At the end of one year, if they execute, they have to come up with $205,000 – about what you owe. If they don’t execute, at least you’ve pulled in another $15K, reducing your negative cash flow.

Not ideal… but keep in mind that you’re trying to make the best of a bad situation.

Last, but not least, should you stay or should you go… and walk away with nothing?

I’m afraid I can’t tell you when your market is going to bottom. I’ve never had a crystal ball – only a healthy dose of financial fear and skepticism. That’s why I only buy cash-flow properties at or below market value, fixing rates for at least a few years longer than I intend to own them, using amortizing loans. If nothing else, one day… however far down the road… my tenants will eventually pay off my properties. And the chances that I’ll be forced to sell are greatly reduced.

I could wait for the right market or just hold until the loan is paid off. But I don’t know if you can or should wait. You’re losing about $24K a year, and stand to lose about $11K a year even if you get another tenant in there. And it looks like you may have negative equity right now. Try to increase income with the first two options I gave you above. Or lease-option, using Option 3. Or sell, using Option 4. Keep getting creative: Look for ways to boost your income and reduce your expenses on the property, while seeking buyers and lease optioners and being disposed to work with them on terms.

I wish you luck.

– Justin Ford

[Ed. Note: Justin Ford is the author of Main Street Millionaire, a value-focused real estate investment program. At ETR’s recent Profits in Paradise Wealth-Building Summit, 14 of the world’s experts in wealth – including real estate specialists Dave Lindahl, Marko Rubel, and Jim Fleck – divulged their biggest secrets to churning out cash. Take advantage of their proven money-making strategies with ETR’s Profits in Paradise DVD Library.]

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Justin Ford is an active investor in real estate and global stock markets. He is also a veteran financial writer. He has published, edited and written for over a dozen international investment newsletters, including launching the US version of the Fleet Street Letter, the oldest continuously published newsletter in the English Language. He is the author of Seeds of Wealth, a program for getting children to adopt good money habits from an early age. He is the editor of the Seeds of Wealth Quarterly Investment Update Bulletin. He is a contributing editor and author to a number of books on personal finance, including Michael Masterson's Automatic Wealth and Dr. Van Tharp's Safe Strategies for Financial Freedom.