Buy Income Property With Shared Equity - Part II

WHAT TO DO? WHAT TO DO? Mr. Investor listed his property with commercial real estate broker, Charlie. Charlie, being a very conscientious & knowledgeable broker, got the word out that he had a great property available that needed a “hands on” type of investor/landlord. Someone who had the skills and drive to turn a property that was in vacancy trouble around.
Charlie received several responses to his marketing efforts. After interviewing the prospects, and selecting Mr. Eager, he proposed that he and Mr. Eager meet with Mr. Docile to see if a mutually agreeable solution could be worked out.

Mr. Eager was an experienced Landlord/Manager who already owned several income properties. He had sufficient income from his other properties to cover the “eat” on Mr. Docile’s property. A problem was that his cash resources were limited and with the negative cash flow on Mr. Docile’s property, everyone knew it would be difficult to obtain new financing from an institutional lender to pay off Mr. Eager’s loan.

Mr. Eager felt that his property had a value of $1,200,000, which might have been true with 90% or better occupancy; however, based on the current income and the current economy certainly was not valid now. After considerable brainstorming, broker Charlie proposed the following as a possible solution to give Mr. Docile his price and still make it workable for Mr. Eager.

1. Mr. Eager will Master Lease the property from Mr. Docile for a period of 5 years. (If this time length would violate the current loan terms, then lease for 2 or 3 years with options to renew.) The lease payments would be $4,800 per month. Mr. Eager would be responsible for taxes, insurance, and all other operating expenses.
2. Mr. Docile will grant Mr. Eager a 5 year option to purchase the property at a price of $1,200,000. The option consideration is $10,000. To exercise the option Mr. Eager would pay Mr. Docile $522,912 (Today’s Equity) plus 25% of the appreciation of value above $1,200,000 when the property is sold by Mr. Eager in the future.

*NOTE: The objective is to sell the property in the future when the market has turned around. To protect himself, Mr. Eager should have the option to renew or extend the option period.

BENEFITS - Let’s look at the benefits to each party of the transaction, Mr. Docile, the owner; Mr. Eager, the potential buyer; and let’s not forget Charlie, the broker. He was probably the most important factor in putting this deal together.

1) Benefits to Mr. Docile, the owner:
a – He solves his negative cash flow problem.
b – He retains all the tax benefits on the property.
c – He gets his full price plus shares in the appreciation of the property value.
d – Instead of receiving monthly interest which would be taxable, he defers the receipt
of income to the future.
e – He does not have to sell in a depressed market wherein he would not have received
a good price.

2) Benefits to Mr. Eager, the potential buyer:
a - He acquires control of excellent property without putting up much cash or having
to qualify for a new bank loan.
b – With his expertise he can get the vacancies leased-up and enjoy a positive cash flow.
c - If he exercises the option and resells the property after 5 years, he will receive $50,647
in reduction on the existing loan principal plus 75% of the appreciation above $1,200,000.
d - If for some reason he is unable to turn the property around, he can walk away.
If this happens he would lose his option consideration of $10,000 – However, better
to lose a finger than your whole hand.

3) Benefits to Charlie, the broker:
a - Receives $9,600 leasing commission (two months rent) up front.
b - Receives five percent of the sale price when Mr. Eager resells the property.
Seller & Buyer to each pay half.

These posts are the opinion of the author who is not engaged in rendering legal, accounting, or investment advice. If such advice is required or desired, the services of competent professional persons should be sought.