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I’m saving for a son who is 11 years old, so that when he turns 18 he has a nest egg for college. (this principle could apply to my younger kids as well, he’s the more immediate thought at the time however).
I’ve got a friend who is an investor who’s in a bad condition on some of his properties. When he started buying houses 8 years ago, he had income as a senior Delta pilot, so he purchased many of his properties on 15-year fixed rate notes. Now, he’s doing this full time, struggling with cash flow, but has tons of equity.
I don’t know how many times I’ve heard the following strategy mentioned by many of the experienced real estate mentors, but I guess it finally penetrated my thick skull enough for me to see an opportunity.
I’ve approached him with the idea of buying either an option or a second mortgage on one or several of his properties, with payments over time to cover his cashflow deficiency long enough for the first mortgage to get paid off. This first mortgage must be one that pays off in less than 7 years, on a property that has over 25% equity in today’s market. I want the final amount that he owes me in 7 years to be no more than 50% of today’s value.
I’ve worked out several different payment streams on paper for 24 months, 36 months, 48 months, 60 months, and 72 months, that all work out to either a 20%, a 25%, or a 30% return on my invested dollar, that I can scale to meet both his and my needs (the returns are dependent on what I can get him to agree to
) My goal is that in 84 months from now, I am in a first mortgage position on a solid piece of rental property. At that time, he can either pay me off, or I’ll finance the property to him, or he can give it back to me.
If we do this deal, I’m going to want him to sign an undated quitclaim deed to me that gets stuffed in my filing cabinet, in case he ever stops paying on the first mortgage.
Now, my question. I prefer this to be done as a second mortgage. However, I’ve always heard this strategy when we’re talking about options. Why? Is there any reason why, if I could get this as a second mortgage, that I would want to consider this to be an option instead?
get the best of both worlds… use an option secured by a mortgage or deed of trust. the option spells out the terms and conditions(what if’s). The mortgage is the security instrument.
I just did a similar deal. I paid a lump sum for a long term option. I took back a note to insure the Optionor’s future performance. The note I secured with a deed of trust.
Any profit will be treated as capital gain. I may use that option in an exchange in order defer taxes. The note that I took back is to insure performance not to repay any debt so usury is not an issue. It is for twice the amount of my option consideration and interest compounds at the highest legal rate. The Optionor has the future alternative of deeding me the property or paying off that note (defaulting on the option commitment).
I have better control with an option instead of a mortgage, usury does not apply, capital gain rates apply, and the option will easier to exchange.
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