There are rules of the road. Sometimes we call these laws and regulations but not always. The rules don’t tell you so much what to do but rather what not to do. That leaves the investment road wide open to creative ideas as long as you do it responsibly. The single largest hurdle regarding creative investing deals is the level of business acumen or sophistication that all participants in the deal possess. By definition, creative financing (or creative deals) are nontraditional. The average consumer or Joe Q. Public does not use these techniques. The result is there are fewer rules and regulations governing them. Creative deals contain more complexity.
Bad apple investors use this lack of rules and higher complexity without scruples to defraud others. When this happens enough times, new rules and regulations are put in place to prevent it. Legitimate investors don’t benefit from more rules. For the sake of your own business reputation and the industry as a whole, it is always best to create ethical deals and even build in protections for less sophisticated investors and/or Joe Q. Public.
This is just plain good business sense. If the other person in the transaction has a deep knowledge of the type of deal you’re involved in and is unethical, you could be the one holding the short end of the stick. But that isn’t what I’m referring to here. This is about you being ethical when you encounter people that are unfamiliar with the type of deal that you are trying to put together. There are times when it’s better to walk away from a deal even if you could have made a killing. At times, sandwich lease options and seller financing can be these types of deals.
I’m a firm believer that sandwich lease options need to be win-win-win deals. For the seller, for you as the investor, and for the tenant/buyer. You are the sophisticated investor in the middle of the deal. Most of the time, the seller and the tenant/buyer are Joe Q. Public. They are depending you to put the creative transaction together. You MUST be sure everyone in the deal fully understands what the intended outcomes are and what the unintended outcomes could be.
The seller should be relatively secure in the deal since he/she holds the property title until the deal completely closes. However, this person could be highly dependent on the rental income until the deal closes. As an ethical creative investor in the middle, you have a responsibility to understand how dependent the seller is on that income and assure they receive the income – even at your own expense if your tenant/buyer doesn’t make the monthly payment. An unethical investor could force the seller to miss several payments until he/she is forced to sell for pennies on the dollar that was never the stated intention of the deal. As the investor, you should enter the deal prepared to keep the seller “whole.” If you find yourself in a position of not being able to do this, you should unravel the deal even if it means no benefit to yourself.
Understanding the sophistication of the tenant/buyer carries at least the same amount of responsibility for the investor. Failing to work earnestly with tenant/buyers is most the common cause for sandwich lease options to be considered unethical. It happens when an investor churns the large option fee. The typical lease-option buyer struggled to save most of the down payment needed (lease option fee) and is an entry-level buyer with a limited salary. But he/she can’t quite qualify for a mortgage at this time. This is an unsophisticated buyer. Investors have an ethical responsibility to assure these people fully understand the terms of the deal. Investors have a responsibility to strongly urge that the tenant/buyer seek outside legal advice. Investors have a responsibility to be sure the tenant/buyer has a reasonable opportunity to obtain a mortgage within the lease option period. This often means working with a mortgage broker and/or a respectable credit repair service. An ethical investor wants the tenant/buyer to succeed. There is no better word-of-mouth advertising than a tenant/buyer who has succeeded in purchasing the home.
I was once involved with a person who grievously took control of a small portion of valuable land through adverse possession. It involved 11 feet of expensive lakefront property owned by an elderly man with Alzheimer’s. The standard lot had 60 feet of waterfront. The man with Alzheimer’s and the adjacent property owner both had double lots or 120 feet of waterfront.
The trespassing neighbor planted a hedge that angled from the common upper property line to cross over the line 11 feet at the water’s edge. This happened at about the time the elderly man was diagnosed with Alzheimer’s. He verbally complained several times about the hedge but never took legal action. Following his death, the heirs filed for the property title but the neighbor clouded the title by filing for adverse possession of the 11 feet. The heirs could not afford to pursue a legal challenge.
I purchased the contested lot for fair market value based on the 49 feet of waterfront the heirs could deliver and a promise to legally pursue the adverse possession. At a cost of about $8,000, I did pursue the case in court but lost. The legal requirement to obtain adverse possession in Washington s State is to have active possession for a minimum of 10 years. The trespassing neighbor was able to show photographs of a family event partially on the disputed property. The date of the event exceeded the statute by 3 months.
Although the trespassing neighbor received legal title to the 11 feet, he paid a dear moral price. He too was retired, elderly, and living in a small rural waterfront community. The entire community took great exception to his actions and fully shunned him. His social life ended for the remainder of his lakeside retirement. Such is the price paid for being unethical.
Please comment with your thoughts and experiences about ethical real estate investing.
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