Leasing Back to Sellers -- The Prostitute Principle

[Alan Brymer]

I’ve done it a number of times successfully, but have grown weary of it (as you will see) and will never do it again because of when it has blown up in my face despite my best efforts.  There are more than enough other ways to make money in real estate without having to defend your very existence on the planet.

Because what tends to happen when you lease back to sellers is what I call the “Prostitute Principle.”  This law is defined as this: “The value of your services completely diminish as soon as your service has been provided.”

I have seen this happen to real estate investors time and time again who lease back to sellers.  As soon as they ethically and legally help a seller avoid foreclosure, and do everything they promised to do on time, the seller will turn on them and start complaining about some perceived injustice, calling them a con artist.

If you can live with being treated like garbage by the very people who would have been thrust out on the street like vagabonds in the middle of winter without two pennies to rub together were it not for you bending over backwards and risking your butt to save them with an overly generous arrangement that’s better than 99% of other investors would ever consider doing, then by all means, go ahead.

If the irony of explaining something multiple times in clear, direct language, and having them read and initial every paragraph of a painstakingly understandable, notarized CYA letter, contract to SELL, and Lease Agreement, only to be threatened with legal action because they claim they didn’t know they were selling their house does not make you ashamed to belong to the same human race, then proceed.

If you’re going to do it, just know the following things:

1) No matter how intelligent, sensible, and responsible you believe a seller to be, they will mutate into something else entirely the very second you advance funds and solve their problem, to the same extent, and with the same speed and ferociousness as Bilbo Baggins in the first Lord of the Rings movie.

2) You will go from benevolent savior to despicable con artist within 1 week after closing.

3) They will almost always stop returning your calls once you have solved their problem, which makes collecting rent or qualifying them for a loan more difficult.

4) They will understand the terms of the sale and lease with 100% certainty, until the closing has occurred, at which point something which scientists do not yet comprehend alters the chemistry of their brain and supplants their true memories with false ones.  From then on, they will either forget A) That they agreed to sell their house, B) That they agreed to pay rent, or C) Everything else they promised to do, or D) All of the above.

5) They will miss 2-3 rent payments per year, on average.

6) Having a good CYA letter is not enough to prevent a lawsuit.  They will always find an attorney to represent them no matter how clear it is that they are wrong.

7) A good CYA letter is not enough to keep you out of a long, exacting, and expensive court trial that could last 2 years and cost tens of thousands.

8)A judge has it within his power to completely ignore the paperwork and everything the seller signed and undo your transaction from having happened.  It is all based on his whims and fancies.

9) Your transaction might be considered predatory lending even when it’s plain to see that they sold their house and are renting it back again (which, interestingly enough, is done all the time with commercial property by business owners who wish to raise capital without relocating).

10) You will have to have a ton of equity in the house when you buy it, if you ever plan on selling it back to them, because they will only be able to get a loan (if at all in today’s lending market) for 70-80% of the market value, which will probably be lower than it is now if you’re in a declining market.

11) If you buy it subject-to, their credit will improve quite a bit from you making the payment on their loan.  If you pay their loan off, there will be a verification of rent to qualify them for a loan, so kiss their chances goodbye if they miss even one payment in the next 12 months (which they will).

So if you can live with all of this, go ahead and do it.  If you’re like me, you’ll miss the good old days when two people could make an agreement, shake hands, and both do what they promised.

Am I just bitter?  Or has anyone else had or known anyone with similar thoughts or experiences?  Post a comment below and let me know if it’s just me or not.

[tatertot]

I hear a lot of investors complaining about troubles with the sellers if they rent back to them.  So no, it isn't just you.

I simply wouldn't consider it. They don't meet my written criteria for tenants. They have been unable to make mortgage payments for months. There is no reason to believe all of a sudden they are going to be able to make rent payments, just because it is rent and not mortgage.

I don't rent to people being evicted and just because they are being evicted by the bank from my new purchase doesn't somehow change them into a good risk as a tenant.

I have enough problems with tenants who can't quite understand that they don't own the house they are living in.  I can imagine what sort of problems would come from someone who did own the house and can't understand that they don't own it any more.

[salsadunes]

I have not heard of it being done with residential, but my first REI experiences were doing the seller lease back to commercial properties and wasnt to sure about it then. Do you have more then this one or two bad experiences with it or has it always been the same outcome? Does the same problem exist with commercial properties? Or do you know?

Im curious because the guy i learned it from had alot of inquiries for the seller lease back for commercial and i was thinking of it as a source for my REI.