Life Estates
How would you feel about getting free land, and in the process you would be helping out elderly homeowners to lead a better, more care-free life? Put more "gold" into their golden years.
There are literally millions of retired homeowners in this country, and the number is growing each year as medical advancements allow people to live longer and the "baby boomers" begin to reach retirement age. However, for most of these folks, their "golden years" are all but golden. Social (in)Security is all that many of these folks have to live on, putting them in a very poor situation. They could lose their homes, or at least they may just scrape by.
For you, the investor, there is a lot of potential here. A potential to help these people while helping yourself. By and large, many of these homes are all paid for - free and clear. But property taxes, insurance plus a rising cost of living place the homeowner into jeopardy. But it does not have to be that way, because you have what they need, and they have what you want.
What they need is more income. What you want is the land that their home sits upon. The object is to obtain ownership of the land, while they keep their home and increase their discretionary income. Here is but one way that this can easily be accomplished.
We must first find an elderly homeowner who needs more income and owns his home free and clear. This should not be too difficult, but it will likely be the most difficult part of putting this strategy together.
For this example, we will say that the value of the property is $100,000 and that the land portion is worth $60,000. This is the part you want to own, but the last time you had $60,000 in cash lying around was never. What to do? How can you own that land and still help those people?
In many areas, property taxes and insurance on a $100,000 home will run around $3,000 per year. Assuming the couple may have around twenty years left, these expenses will cost them about $60,000 over that twenty year period. As you will notice, that is the exact same amount as the value of the land - $60,000.
Let's say that you offer to the homeowner that in exchange for ownership of the land only, you will sign an agreement to pay all property taxes and insurance on the entire property for the next twenty years. Furthermore, since they will still own the house to either pass onto their heirs or sell, as the new owner of the land you will provide them with a life estate on the land - it is theirs to use, without cost, for the rest of their lives, or until the property (house) is sold or transferred.
Let's break that down into just what the homeowner gets out of this deal:
- They still own a $40,000 house, which they can sell or pass on to their heirs
- They save approximately $3000 per year for twenty years on taxes and insurance, which is more income for their golden years.
- They have the security of a life estate to the use of the land. Being a life estate, their lease is binding even if you sell the land to someone else. The lease cannot be broken.
Here is what you get:
- A $60,000 piece of land that only costs you around $3000 per year. You would pay nearly this much, anyway, in taxes each year, even if you bought the place outright, so this is a real bargain
- In twenty years, you or your family no longer pays the portion of the taxes or the insurance on the house - you pay only that which is due on the land.
- When the homeowners pass on OR when they sell or transfer the property, the life estate (free lease) ends. From this point on, you may charge a lease for the land from whoever owns the house. In twenty years, for example, the lease value should be at least $1000-1500/month (even in poor economies property values tend to double every 10-20 years. A fair land lease is usually about 1% of the land value each month).
In such a scenario, you would effectively own a nice piece of land for its taxes and insurance only. The elderly folks would have an extra $60,000 in spending money over the next twenty years, and they still have a very saleable asset - the house. And remember - when the house changes hands, you have an automatic tenant paying you a lease.
As a safety precaution, your agreement with the elderly homeowner(s) could include a "first right of refusal" clause, giving you the exclusive right to buy the house if it ever goes up for sale. You would not have to make an offer - you only need to meet the best offer they get. And, being an option, you are in no way obligated to buy the house - you simply have the exclusive right to, if you wish.
It could be argued that those elderly folks are getting the poor end of the deal. But are they? Consider this: if they simply sold the land for its $60,000, they would then be forced to pay a lease for it - around $6,000 per year. In twenty years that comes to $120,000. They have lost $60,000. In addition, they still would have to pay the portion of property taxes that apply to the house, plus their house insurance - another $30,000 over twenty years. Total losses: $90,000 over twenty years, from a "straight" honest deal. On the other hand, by entering into the life estate, they lose a $60,000 piece of land, but they gain $60,000 in savings - a wash, so to speak. What is important here is that they need the savings more than they need the land.
Of course, if they just sold the land and invested the $60,000 in CD's, they would earn about $1500/year, but that's only enough to pay the property taxes on the house and their insurance. They would still be out the $6,000 a year to lease the land back.
Any way you cut it, your life estate offers them the best deal for their needs. And you get land virtually for free. That is, provided you can afford the taxes each year. If not, then you cannot afford even free land. But if the small annual cost is too much for you, remember that you now own a $60,000 piece of land, free and clear except for the life estate encumbrance. Your net worth has increased by $60,000 - surely you can find a way to use that to increase your income? Maybe as collateral (not down payment) toward purchasing another property that provides a positive cash flow in excess of $3000 per year?
As you can see, the Life Estate can be a powerful tool for obtaining land. But it can be much more. For example, you can make a similar life estate offer based on the entire property, not just the land. Granted, your annual costs wil be more, but at the end of the term you would own both the land and the house. Such a life estate would be based on the purchase price of the house versus the rental value, times the number of years. The purchase price includes what you would normally pay in interest over the term involved. For example, if the price of the house is $100,000 and the term is 20 years, based on an interest rate of 8%, your payments would equal $836.44 per month, times 240 months for a total of $200,744.60. This is what you would pay for the property if you bought it outright over 20 years. This, then, is the amount you would pay the seller - $836.44 per month. But...
And this is a big "but": the sellers stay in the property as tenants, so they must now rent the property from you. Fair rental value for a $100,000 property is somewhere around $800 per month, so this appears to be a wash. Accordingly, it looks like you should get the entire property for free if you are going to let them live there rent-free for the rest of there lives. From a numbers point of view, that may be correct, but then there is nothing in it for the sellers except they will no longer have to pay property taxes or do the maintenance (and pay for any maintenance). This saves them no more than if they simply traded the land. So, you need to provide the seller with a reason to also give up ownership of that $40,000 house as well as the land - you have to provide him with more of what he wants - money!
If you go for the entire property under a life estate, you would then have a $100,000 property. Even if you were to get the property for free, you would have over $3000/year negative cash flow for property taxes and insurance. And you would owe Uncle Sam a huge bite on the $100,000 asset you just obtained. To avoid the tax bite, you must actually pay for the property. So your agreement might read that you agree to pay $100,000 amortized 20 years at 8% interest payable in 240 monthly installments of $836.44. A separate agreement would state that the sellers agree to pay you, say, $636.44 per month in lease payment every month for the next 20 year (an unbreakable 20 year lease). You would then owe them $200.00 per month, plus you would pay the taxes and insurance on the property each year - about $5400 per year negative cash flow. Over 20 years this costs you $108,000. But if you had simply purchased the house outright, it would have cost you over $200,000. And in twenty years the property is likely to be worth at least $200,000. So, if you can afford the negative cash flow, in twenty years you would profit with a free and clear $200,000 property, and the rents would be gravy every month.
Assuming, however, you cannot live with such a negative cash flow, there are options to consider. Choose properties that include subdividable land, and your agreement (mortgage) with your seller permits it (you can add the clause that does this), you can then subdivide the land and either build one or more additional units on it, or sell the other lots. This option must be spelled out in your sales agreement as being permissible. Remember - your seller holds your mortgage, not a bank. There is no "due-on-sale" clause, and you can add that you reserve the right to subdivide and sell (or build upon) the subdivided lots.
Or look for an elder who owns and lives in a duplex or multiplex. In exchange for the property, free and clear, you will provide him with his unit free for life, plus he would be entitled to whatever TODAY'S net rents equal. You would also agree to pay him an additional $300 per month, for life. Where would this money come from? Well, let's say today's rents are $500 per unit for 3 units (besides his own), for $1500/month. Expenses are currently $200/month (he has no mortgage), so he would get a set, non-changeable $1300/month, plus $300/month from you. Within a year or two you can usually hike the rents on the three units by $50/month, providing you with $150/month (this amount is not part of today's net). Apply this to the $300/month you owe the seller. Since the property taxes and insurance are already taken care of in the expenses prior to figuring the net rents, your only cost for the property is now $150/month. In a couple of years you can likely raise the rents again, eliminating your debt altogether. And, if you can cut monthly expenses, you earn even more. As the years pass, increasing rents provide you with even more profit, and at the end of the term, you own the building - and all rents - free and clear.
Here is what the seller gets - $1600/month for at least twenty years for a total of $384,000. No management hassles (you are the new landlord), plus his own unit at no cost. This is $72,000 more than he would receive if he kept the property - and the hassles. If this is not enough, borrow $80,000 on the property that you now own and put $40,000 into a twenty year annuity. This will provide you with an addition $2500 per year you can pay him. Take the remaining $40,000 and put it into a safe investment, such as 12 month CD's. Every year, take out what you need to pay the next 12 months payments on your mortgage. This $40,000 will last you for nearly 6 years. Before the money runs out, you refinance, as your property has likely appreciated somewhat. Pull out more cash, and use it to keep you payments going. Keep doing this until the term is over and the property - and rents - are yours. With a solid positive cash flow from rents, you will be golden.
Here is a simpler life estate. Assuming the owners want a smaller, care-free more convenient home (after all, they are getting older, the kids have gone), you can make them a deal they would find hard to refuse. For this example, the property is worth $100,000. The folks want a nice $50,000 condo closer to town. Here is what you offer:
The sellers, upon getting their $100,000 would pay $50,000 for the condo, plus an association fee of over $100/month for life. So, in order to add to their income, the remaining $50,000 must bring in more than $100/month in income. At their age, it is most prudent to invest safely, so CD's are likely the solution. Assuming they set this up as a twenty year annuity earning about 10%, they would receive approximately $5000 per year, of which at least $1200/year goes to condo fees. So, their additional income is $3800/year, or roughly $316/month. If you can match all of this, you can get their property. Here is how you can do just that.
Offer 1) to buy them the condo and 2) pay the association fees for life. In addition, you will provide them with $320/month for life, no matter how long they may live. In exchange, you get their property worth $100,000 free and clear.
First, buy the condo, and give them a life estate to it. $2500 down on a $50,000 condo negotiated down to $45,000 leaves you a $42,500 mortgage. At 8% amortized thirty years, your payments are $311.85. Add the condo fee, it comes to somewhere around $450/month. Add the $320 per month you are paying the sellers and your total debt is just $770/month. And you can afford it because you own their old home free and clear, renting it out for $800/month. You have just added a $100,000 property to your net worth, minus your mortgage on the condo, so net increase to net worth - at no cost to you - is around $60,000. But that's not all - since they hold a life estate in your condo, once they are no longer with us, the condo is also yours to rent out or sell. Add that to your net worth.
You can do the same thing if the folks want to move to Florida or Arizona. The magic of this lies in providing these people with what they need most, and receiving real estate as payment for your services to them. You are solving their problems, and allowing them to live out their years in greater comfort and security. And, they save thousands each year by not having any more property tax payments to make! They are truly "golden", thanks to you.
How do you find such homeowners? Advertise for them. Fliers, business cards, ads in the newspapers. A well-placed flier that says something like,
"Attention Retired Homeowners - Put more GOLD in your Golden Years. Live better, with greater security and increased income. Put an end to property taxes and expensive maintenance forever. For more info without obligation, call XXX-XXXX."
People will call, you can count on it. The rest is up to you and your ability to give them what they need.
