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I?m negotiating the purchase of a single family property with a seller who has some unusual circumstances that has them preferring to be a tenant. I?ve long had a policy against these leaseback deals but I?m a pretty experienced investor and believe that this deal is a true and acceptable exception to the rule and I have created about 10 pages of CYA that I believe will reasonably cover the risks. This isn?t a foreclosure (the property is f&c) and they are not even remotely contemplating bankruptcy.
Here?s my problem and an area I have no good experience in. They want the equivalent of a long term lease (I still have to check the laws, if any, of my state regarding them). Subject to anything I discover under the law that would prevent this, I?m prepared to give them a conditional option to extend the lease annually for 19 renewals (conditional upon them not being in breach, etc.) or something akin to that but I haven?t yet come up with a fair way to determine rent increases over those years. They know they will have rent increases every year and they understand why they are necessary but I?ve told them it will take me a few days to come up with something equitable.
My initial thought was to apply against the then current rent some fixed percentage or the CPI, whichever is higher at the time of the increase, but I?m not sure what the % should be and ? in particular – I?m reasonably certain that neither of those percentages will cover all the rental upside that certain rental market conditions may allow and certain economic conditions may demand. 20 years is a long time and lots can happen.
I?m open to all ideas. Thanks for the assistance.
It’s not a good idea to buy someone’s house then lease it back to them unless it is for a very short term.
You sure don’t want to give them an option to buy the house back.Are you buying with seller financing? If so, what are the terms?
Jackie, thank you for the input.
I’ve always been very strongly against leasebacks. But as my post suggests, I believe this one to be the exception to the rule assuming I can structure it correctly.
Additionally, one of my strengths is documentation and while CYA docs are not quite complete, they will absolutely be very thorough and very strong and I’ll be insisting the seller/tenants be represented by counsel. If they scream “foul” 5 years from now, though you can never be certain what a court would say, I believe this transaction will be viewed as extremely well documented with very clear reasons laid out for the various components – and agreed to – by both sides.
Within the CYA docs and also within the purchase and sale agreement there is very strong, very explicit language that deals with the issue of any kind of buy-back. There will be none. No options, no LIC’s, no rights of first refusal – no nothing except the right to renew an annual lease 19 times.
That said, I’m interested in understanding the distinction you are making between short term and long term leasebacks. That is, why make a distinction at all and why do you favor a short term lease beyond the concerns I’m raising in this reply.
Regarding terms, it’s mostly a cash deal at a discounted price. We’re still trying to refine the actual terms and there may be a 20% component with 0% interest over about 9 years. For every $10,000, that’s produces a modest “savings” of about $2500 if you calc NPV based on 7%; that is, $10k @ 0% interest for 108 months has an NPV of about $7500. The 0% interest is already in place on some debt they have that my company may commit to pay over those 9 years.
The part of the deal that may have me walk is the part I asked for some help on – rent increases. I believe this deal has 2 important considerations that are not present in the vast majority of rentals (or maybe even no other rentals).
The first is the value to the tenant of an assured, very long term right of renewal (barring a material breach). That in itself, I believe, is sufficient consideration to ignore market rents as a standard. I believe they should share in the risk some way.
The second is the significant ongoing liability to the landlord that comes with not being able to refuse a renewal should it develop sometime that market and/or other economic conditions scream “sell.” While there will be no prohibition against me selling, there is only one class of permitted buyers – other investors. I believe that most investors wouldn’t be interested in this deal unless I had a very thoughtful strategy for rents that considers things that might arise like inflation or even hyper-inflation. For example, given the state of our nation’s debt and entitlements, some pretty scary scenarios are not impossible to imagine over a 20 year period. I’d certainly never buy into a deal that didn’t have a way to deal with those extreme possibilities which is why I’m trying to set up something that reasonably offsets those risks.
So, I’m all ears (I guess “eyes” since this is a forum) if you have some thoughts on the rent adjustment part of this transaction.
Thanks for your help.
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