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I have a potential property coming up that I could buy creatively, but wanted to get some opinions on the best way to handle it…
A friend of mine from childhood said he has an aging aunt in poor health whose is now a widow and needs to sell her house she can no longer afford. The house is worth about $180K and she owes $99K on it, but it needs some work. She is willing to sell the house to us for what she owes ($99K). The monthly payments are $950 per month (PITI).
Here’s the catch. She can’t afford to stay there with these payments. She really can only afford about $700 per month, but doesn’t want to move. Even if she refinanced, which she did a couple of years ago with the current taxes and insurance plus the payment she still can’t afford it. So, she is willing to deed or sell it for the amount owed as long as she can continue to live there for $700 per month max until she can’t any longer due to health reasons.
It is in a local hot suburb on an acre of land, which is unprecedented in this area. With the level of appreciation, if the house were fixed up, it could easily sell for $200K or more in 2-3 years or could rent for $1,500 or more per month.
My buddy wants to partner on it. If we take it over we will get into a negative cash flow ($250 per month) plus any repairs/expenses for an undetermined amount of time. We would split the negative cash flow and expenses each month, which wouldn’t be terrible. Our deal is in the upside potential when she no longer lives there, which could have equity of $100K or more by then. We can do a lot of different things with it over the long run, but in the short run obviously we are on the hook with a negative cash flow property for an unknown period of time. Whatever we do in the future would be split 50/50 (expenses and profits) between my buddy and me.
We could probably just have her deed the house to us and take over the mortgage (my preference) or we could refinance her out of it and pay that, which I don’t really want to do for a variety of reasons.
So here are my questions:
Would you do a deal like this with a big upside, but an unknown time frame on the negative cash flow?
Would you just take it over subject to the existing mortgage or refinance to make it “clean”?
Any other approaches someone would consider that I may not be thinking of?
It would be better to buy a life estate that is well written to include exactly what you will do. It should state that if she moves out of the house to go to assisted living, then the house is deeded to you.
If she has children, you need to get them to sign off on this whole thing.
ONLY do this one with an attorney involved in writing up the agreement.
@Jackie Lange I am not familiar with that term, life estate. If I understand the context would it be a situation where she is leaving the house to our LLC if/when she goes into assisted living or upon her passing and title doesn’t actually transfer while she is living there?
Second question in this arrangement does the life estate spell out the arrangement, i.e. she pays what she can afford ($700) and we pay the difference and any additional expenses (furnace, roof, etc.) is our responsibility?
I would definitely have an attorney draft this, but I want to make sure I know what I am asking for and how I would propose it be structured to get the effect we want.
I think what Jackie meant was the owner would sell/convey the property to you subject to existing mortgage debt and reserve a life estate for herself. I.e. , she owns and uses the property for as long as she is alive. Her life estate terminates when she dies or when she goes to assisted living. Additional covenants of the Deed would be she continues to make payments of her mortgage when due, pays taxes and keeps the property insured up to a certain value. The life estate would terminate if / when she breaches these covenants.
Additionally you would execute a note payable to her at $250/mo to make up the difference between mortgage payments and the $700/mo she can afford. The note could be secured by your interest in the property, the balance on the note would become zero at the same time when her life estate terminates for any of the reasons above.
With regard to ongoing maintenance – you’d have to discuss it with her and agree on something that makes sense to both parties. Perhaps, you pay her a little extra each month on the note and make her responsible for maintaining the property during her life estate. Then ongoing maintenance sufficient for preservation of the property would also be a covenant binding on her recorded in the Deed for her life estate reservation.
Definitely have an attorney draft the docs. I’d suggest extensive disclosures.
@Alex Gurevich thank you! that is exactly what I needed. I wondered when Jackie suggested that if that is what she was talking about. My buddy said he wanted to do that for her when we first starting talking about this, but I thought this was something different.
So, I haven’t done a subject 2 deal before, which is what this is minus the life estate component. Does the person that conveyed the property usually still make the mortgage payments? I thought that was a function we would do. I was thinking she would pay us the $700 per month, we would add the $250 short fall and pay it. I figured this was how you would do it since technically we are the owners of the property once this happens. Am I incorrect about that?
>>> I figured this was how you would do it since technically we are the owners of the property once this happens. Am I incorrect about that?
Yes, you are incorrect about this. The lady still owns the house as long as she is alive and in compliance with covenants in the Deed reserving her life estate. That’s what life estate is – ownership for the duration of one’s life. You have a deeded future ownership (remainder estate) but it only starts when her life estate ends.
>>> Does the person that conveyed the property usually still make the mortgage payments? I thought that was a function we would do. I was thinking she would pay us the $700 per month, we would add the $250 short fall and pay it.
There are no “rules” for it. You could do it in any way you both agree. However, in your scenario I personally prefer the owners still make these payments to the lender since they still own the property and it’s their name on the mortgage. They are used to it already. To make it affordable for the owners you’d supplement the owner’s income by making the payments to them for the difference you agree on.
The owner would want to be sure you do make these payments on the Note. So when you secure the Note with a deed of trust or mortgage against your future interest, you HAVE TO make them, or your interest could be foreclosed out. The arrangement cuts both ways. She has her obligations to fulfill (loan payments, insurance, basic maintenance) or she loses her life estate. You have your Note payments to make to support her lifestyle, or you can lose your future interest. Your Note could alternatively be secured by something else of value that she would consider a good security for your obligation to her.
@Alex Gurevich, a sincere thank you for this great information! I thought I understood what life estate was, but it turns out I really had no idea 🙂
This makes a lot of sense and I think other than drafting the documents this would make it a relatively easy deal to manage. We simply pay her each month and just monitor that payments, insurance, etc. are all being paid on time so our interest is protected whether we do it or she does it. I will talk to my friend and see what he feels more comfortable with.
I like that we are only out of pocket on this deal a small amount of money each month. One more question if I may. Who is typically responsible for repairs during this life estate arrangement? I could see where she might be, but as discussed she is financially strapped. So a roof or furnace going out could put her over the edge and to protect our position we would have to step in and pay for that. Is this how it is typically handled? Is that something that is put in writing in the beginning in some type of agreement?
>>> Who is typically responsible for repairs during this life estate arrangement? I could see where she might be, but as discussed she is financially strapped.
Boy, what a loaded question this is. If you listened to Jack Miller’s courses he told a story of a woman in France who sold the future interest in her apartment to a man 43 (!) years yonger than her, and retained a life estate for herself. She was 90 then. 30 years later she was still alive while the man who received “future” estate died. Here is the exceprt from Wikipedia:
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In 1965, aged 90 and with no heirs left, Jeanne Louise Calment signed a life estate contract on her apartment with notary public André-François Raffray, selling the property in exchange for a right of occupancy and a monthly revenue of 2,500 francs (€380) until her death. Raffray died in 1995, by which time Calment had received more than double the apartment’s value from him, and his family had to continue making payments. Calment commented on the situation by saying, “in life, one sometimes makes bad deals”.
——–My point is, your friend’s aunt may live for many years. You don’t know how long. Buying a remainder estate is a gamble in that sense unless you have a time limit on it, i.e., “for life of Mary Smith or 10 years, whichever occurs first”. If she stays there for the next 15 years, you can virtually guarantee somewhere along the way the roof and furnace will HAVE to be replaced, as well as other maintenance items attended to.
Should you enter a contract that makes you responsible for maintaining the house for the unknown number of years? It’s up to you what you think makes sense. Perhaps, you could pay a certain monthly amount extra on your note so the owner sets up a little reserve for maintenance, but maintenance becomes her responsibility. And if she gets to a point where she can’t maintain the house, perhaps, it’s time for her to move on to a place where somebody else takes care of the building.
In the end it’s all negotiable. As long as parties see it to their advantage.
One thing in particular has stuck in my mind from Jack’s classes. If you have a good deal, you can always sell it to another party who sees value in it. I don’t know how old you are, but I’m nearly 60. From where I stand it doesn’t make sense to buy remainder estates in hopes of outliving a homeowner, even if that owner is older than me and might appear to be fragile.
It may make sense as an estate I could leave to my kids. At the same time to an investor who is 20-30 years younger than me the same future interest could look at lot more attractive (like in a case of Madam Calment). Possibly even more valuable if it’s tucked into some tax deferred plan.
So when I buy that remainder interest, I buy it primarily with a view to sell all or part of it within a relatively short period of time to another investor. I could sell it to someone with a lot longer investment timeline than mine for cash or for a near term payment stream (lifestyle bump).
Though in an up market like we have now it makes sense to ride it a bit further to a higher equity position. It’ll be easier to sell then.
Michael,
Alex is right. You’d own the house but the owner would have a life estate. Have your attorney write in that the life estate would end when she dies or if she moves out of the house. The risk is that you don’t know if that will be 10 years, 20 years or????
if she has children, make sure they are on board with the whole arrangement and sign off on it too.
Let us know what you do/
Alex,
Thank you! I remember that story you told about the woman in France. I think she held the oldest person in the world record for a long time until a guy in Canada took it years later! You have given me a bit of a pause on this. I am 50 now and the thought that I might be on the hook for some undetermined amount of time plus repairs might be a bridge too far. However, I do like your idea of securing the deal and selling it to a younger investor who can wait for it.
I wonder if an option might fit here instead of a life estate with less risk. We create an option that has terms in it that spell out we can exercise our option if she moves out or passes away from the estate. It would renew each year to purchase at $99K and the fee for that option is enough to make up her mortgage shortfall each month for the term of the option. The option would have a renewal clause in it for each year on the same terms. This way if it starts getting too expensive or other unforeseen factors come into play we can simply not renew our option and she is free to sell, move, etc. In that scenario, our only risk is the money put in for the option fee. That might be a better arrangement than the life estate. That would also let my buddy and I part ways on the deal at the end of each option term if we want as well.
I am thinking I would be willing to risk a few thousand dollars for the next 3-4 years to see how this plays out for the potential of the huge upside and if things don’t go as expected I can always bail with a fixed amount of loss to date. What do you think of that idea?
Jackie,
Thank you for the reminder about the kids being involved if we end up going the life estate route. They are on board right now as long as their mom gets to live there for the rest of her life, but my concern is what happens when she is gone. Not having these terms spelled out and agreed to contractually have a way of coming back to bite you in the backside when the heirs suddenly realize there is over a $100K on the table when mom is gone. That kind of money has the potential of making people’s gratefulness and memories get foggy 🙂
If she has kids, they need to be involved regardless if you do a life estate or other transaction. Some states have strict laws about working with elderly people. That’s another reason you need to get a good real estate attorney involved in this one. You don’t want the kids coming back later staying you cheated them out of their inheritance.
Ideally, you could convince her to move to a different location instead of letting her stay in the house. But I understand that could be tough. Perhaps you should have the conversation again.
Michael,
You may be overcomplicating it. I try to make my deals as simple, straight-forward and most-importantly – as final as I can from day 1.
I have a couple of reservations with getting options on properties in general. My first challenge with an option has to do with laws in Texas. In Texas I can’t have a deed of trust on a homestead property securing anything except a purchase money lien (or a refinanced of purchase money), mechanics lien or home equity loan (HEL can’t be originated or owned by a private party either). So there is no way to secure the option by a DT in texas unless the property is owned by a landlord, not an occupant owner.
Second, just the mere fact I have to think about enforcing the option is quite unsettling to me. If the homeowner dies, you’ll be dealing with an estate. A probate judge could stop you from enforcing your option for some time. A bankruptcy of the owner will have a similar effect. People can disappear when you want to exercise, etc. etc.
If you’re buying a property from the owner via a Deed and he/she retains a life estate — the deal is done. You have a deeded interest that is superior to any other liens or events that may happen after that deed is recorded. All liens, judgments, IRS liens, etc. that come after your Deed will be wiped upon upon termination of owner’s life estate.
The only 3 things that you have to watch for are: liens that pre-exist your Deed (payments must be made on existing loans), property taxes and insurance of the structure. That’s a very strong legal position to be in. That said, an option might be easier to negotiate than a Deed.
With regard to your ongoing obligations to the owner. Again, structure your deal so you’re not on a hook for too much , too long. In my case I prefer to pay a lump sum upfront, and be done with it. I’ve done it this way so far. If I’m ever in a situation when the owner needs monthly income, I’d only commit to a specific number of years after which the payments would stop. Then I know the most I’m on a hook for. I wouldn’t take on more than I am comfortable with.
By the way, you can limit the duration of the owner’s life estate in your Deed. It’s called “estate for years”, look it up. As I mentioned, your agreement could be for life estate or X years, whichever is shorter. Then (a) you’re not obligating yourself financially indefinitely, and (b) you know when you’ll get the property whether the owner dies or not.
Bottom line, you want to help people if it is within your means. But you got to look after your own interest as an overriding criteria. Or you’ll end up like the attorney whose family was still paying 120 year old french lady after he was dead.
I think you’ve heard it from Jackie and I’ll second it – get a good real estate lawyer to draft the docs for you.
Alex,
Thanks, I must have missed that the first time through your original post about limiting the life estate. I have discovered sometimes I need to hear things more than once for it to sink in 🙂
You are right about the option. I have to do more research to even see if that is enforceable in my state/area, especially on homestead properties. I just assumed options always were, but some research is in order. Although I don’t think I will do that on this deal for many of the reasons you pointed out about enforcing it.
I like the idea of wording this in a way that puts an upward limit on it in terms of years and dollars and fixes my downside risk to a certain dollar figure. Same as my thought about using an option, but as you point out much cleaner and done.
I think that is what I will propose to my buddy and see what he says. Thank you for very much for all of your advice and guidance on this.
This discussion started a month ago, is it too late to take part?! If not, the $99,000 loan is current and will be paid down more each year, is that correct?! As such, there will need to be language in the agreement to allow for a lesser amount paid to the lender/owner/woman each year?! Is that correct?
Gary Swartz
Gary,
Sorry, I didn’t see your response until I logged in today to post on another forum. Yes, to both of your questions.
However, I was at a seminar with Pete Fortunato a week or so ago and was talking through this with him and he gave a great suggestion I had not thought of. He said to work with her to set up a reverse mortgage that will pay off the first mortgage. This would allow her to eliminate all payments on the mortgage until after she is gone. Interest rates on reverse mortgages for 15 years right now are about 3% so very little of the equity would be chewed up by mortgage payments.
The second step would be to have her deed the property to a trust and we give her a quasi life estate, i.e. the terms will be she can live there until she passes away OR moves out permanently. In return, we would become responsible for taxes, insurance, repairs, and maintenance. Once this step is complete she would have no expenses to live there at all and the removal of monthly mortgage payments and expenses would free up her limited budget to live on instead.
The obvious risk here is she suddenly has a burst of good health and lives another 20 years and we pay a lot of taxes, insurance, etc. However, I am not sure that is a real possibility under the circumstances.
I would be doing this deal with a buddy of mine and we would split all expenses, so unless a roof or furnace go (both relatively new) I am figuring our out of pocket expenses would be around $6K per year or $3K each with the upside being that we get a $220K house for $99K plus our out of pocket expenses once the life estate ends.
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