All types of seller financing are extremely popular right now. Given the current market – inflated prices, higher rates (compared to the start of this decade), and slow job growth – buyers of all stripes are interested in seller financing. This includes both investors and typical home buyers.
But as a real estate investor looking to grow your wealth, what strategy should you employ?
Should you lease your properties, or sell them on long-term installment contracts? You have probably heard of the popularity of the “contract-for-deed” strategy in Oklahoma… everyone is talking about it, and our office is seeing more examples of it – both good and bad – than ever before.
In this article, I will go over some common myths and provide real information so you can make an informed decision. If you should ever need assistance, our office can help. We specialize in helping real estate investors like you.
Should I lease my property in Oklahoma, or use a Contract for Deed?
The answer to this question depends on your goals. Here are some basic questions to consider:
- Are you looking to scale your rental portfolio, or off load your portfolio over time?
- Do you see yourself buying more properties over time?
- Do you want to capture the long-term appreciation?
- Are you strictly looking for cash-flow with minimal participation in management?
Consider how you feel about these questions, and think about your long term goals over the next 20 to 30 years.
The benefits of leasing a property in Oklahoma
If you lease your property, then you maintain ownership of the asset. This is important if you care about net worth, long-term appreciation, and maintaining legal control of the asset. You also have more efficient (and less costly) legal remedies when the tenant defaults.
Benefits of Being a Landlord in Oklahoma: Efficient Eviction Process
The best part about being a landlord in Oklahoma is the efficiency of our eviction system. If you have a default, your legal remedies are inexpensive and quick.
Because you are leasing the property – not selling it – you get to use Oklahoma’s eviction process. As you will see later in the article, this is much faster and predictable than the legal process involved in foreclosing a contract for deed.
You also have multiple ways to evict a tenant, such as for
- failure to pay,
- failure to comply with the lease, or
- simply to terminate a month to month lease.
You also have a definite start and stop for the tenant’s possession. A written lease provides a start date, and an end date. If the tenant stays past the end of the lease, you can evict the tenant.
As we explain in other articles, the eviction process in Oklahoma generally takes less than two weeks.
Benefits of being a Landlord in Oklahoma: Ability to leverage the Asset
Another benefit of being a landlord is that you can take loans against the property, pull money out, and use it to buy other properties. This access to financing can help you scale, or can save you when the time comes for capital expenditures (CapEx), like roof replacement, plumbing and electrical upgrades. As we explain below, a Seller on a contract-for-deed has fewer financing options.
Benefits of being a Landlord in Oklahoma: Ability to sell the Asset
Similar to the advantage of leveraging your property, you also have the right to sell it. Landlords can sell properties, even with tenants residing inside the home. Investors will often purchase properties with tenants, and the leases are simply assigned. Contract for Deeds are a much different in this regard.
The downside of being a Landlord in Oklahoma
Now, there are other aspects of leasing property that may not appeal to some investors. For example, in a residential lease, a Landlord is responsible for maintenance and repairs to the property. While commercial landlords can excuse themselves of this responsibility, residential landlords cannot.
The same reasoning applies to taxes and insurance. In commercial real estate, a landlord can bind a tenant to a “triple net” lease, which means the tenant is responsible for insuring the property, and for paying taxes. Because those expenses increase every year, a commercial tenant’s total overhead will increase every year along with the rent.
The benefits of using a Contract for Deed in Oklahoma
Now that we have covered the benefits of leasing property, let’s examine why some investors might want to amass a portfolio of properties that are all conveyed using long-term installment contracts.
Maintenance and repairs
Because the purchaser is buying the property, they are considered “equitable owners” of the real estate. That is a fancy legal way of saying they get the right to live there but they also are responsible for fixing anything and everything. The buyers in a contract for deed have all rights to use and possess the property, but that also means they are responsible for maintaining it.
Because you are selling the property, it is no longer yours to fix and maintain. You also do not have a right to enter the property or use it in any way. Because you have given up equitable title, you are also relieved of maintaining the property.
Taxes and Insurance
In a contract-for-deed, the responsibility for maintaining taxes and insurance can be delegated to the buyer. The buyer is now the equitable owner, and they are responsible for paying the taxes. They are also responsible for insuring the property.
If the house burns done, the loss is to the buyer, who is still obligated to pay the remainder of the installments. However, a seller has a substantial interest in maintaining insurance on the property. If the house burns down and the buyer disappears, the seller is left with the legal expense of filing a lawsuit just to get the property back, and then has an asset that is no longer worth what it originally was when the contract was signed. The Seller will likely lose a major investment.
For these reasons, a Seller in a contract-for-deed is advised to maintain the insurance, and then bill it back to the buyer.
Leverage and Scaling
Real estate investors care about leverage. It is a primary benefit of real estate investing. Taking a loan against the property, and then using “other people’s money” (OPM) to repay the loan is a key feature in real estate investing. Investors who utilize a contract-for-deed approach have access to this strategy, but it is different than that of the rental property investor.
Because a seller in a contract-for-deed situation holds legal title, he or she can claim it as an asset on a balance sheet. Of course, they will also have to disclose the contract, which depletes the seller’s equity in the asset over time. But it is still an asset none the less.
With a balance sheet of a large amount of properties, an investor can leverage those properties, either one-by-one, or by cross-collateralization (which means getting one loan but mortgaging multiple properties).
The contract-for-deed can authorize the seller to carry other loans on the property, while the buyer makes its payments. Be forewarned: you must be ready to convey title upon receipt of the buyer’s pay-off in full. If the buyer finds another lender, and brings the lump sum, you better be ready to accept that pay-off and convey title free of all other liens. That means that you cannot be over-leveraged or hold more debt on the property than is owed by the buyer (unless you have substantial reserves to satisfy your loans on the property). Failure to convey title upon pay-off by the buyer can expose you to substantial liability in a lawsuit.
Therefore, an investor can still use debt as leverage to scale a portfolio, but the risks are much higher.
The disadvantages of using a Contract for Deed in Oklahoma
It’s not all sunshine and rainbows being a lender. Just because you don’t have maintenance responsibilities doesn’t mean you can be asleep at the wheel. The financial responsibilities are arguably much greater. And the legal remedies are slower, more expensive, and less predictable.
Default remedies
You cannot use the eviction process with a contract for deed. Because you are selling the property, your contract is treated as a mortgage under Oklahoma law. See Okla Stat. Title 16, Section 11A. This is a big deal. Whatever additional cash flow your CFD generated as compared to a lease could easily be wiped out with the legal process.
The other factor is the equity in the property. Your buyer will be entitled to the equity. So if the property appreciated substantially, the buyer reaps that reward, not you, the seller.
The foreclosure process is much different than the eviction process. In an eviction, there is a notice requirement, and the buyer can only cure the default during the notice period. After that period expires, the buyer can no longer cure, and the eviction is inevitable.
Mortgages are treated much differently. A buyer has a right to redeem a mortgage up until the day of the sale. That means, you can go through the entire legal process and the buyer can bring a cashiers check at the very end. The buyer has many more options to cure.
Taxes, Financial Bookkeeping, and servicing a loan
When you sell a property on a long-term installment contract, you essentially become a lender. Your responsibility is now to maintain a loan servicing office, ready to collect payments, issue annual interest statements, and be ready to produce updated financials upon request to your borrower. If this sounds like a lot of work compared to collecting rent, you would be right in making that conclusion.
Contract-for-deed lenders must be more sophisticated than the average landlord. They must maintain amortization schedules, and they must be ready to close in thirty days if the buyer desires to pay-off the loan early. (Yes, you may require pre-payment penalties in your contract).
Then there is the issue of taxes, which goes far beyond the scope of this blog article. Rental payments are income. Principal payments are not. But interest payments are income. Then you have the issue of tax basis and capital gains. It is safe to say that the accounting requirements are more sophisticated. You are advised to consult with your CPA before diving in to contract-for-deed ventures.
Leverage and Scaling
Leverage is not always available to an investor with a property sold on a contract for deed. Yes, earlier in the article I said that you could use leverage and now I am saying that might not be possible.
There are different scenarios how this plays out. Let’s take scenario 1, where you buy a property with a conventional loan, then find a buyer for your contract-for-deed (CFD). A conventional lender will consider your CFD to be a conveyance to another party, and will have the right to treat it as an “event of default.” So conventional financing is out.
Scenario 2: you own a property outright, enter into a CFD with a buyer, then you refinance the property. If the CFD is recorded, the lender will consider the CFD-Buyer to be a first-position lien holder. Most lenders will not want to be first-position lien holders.
If the CFD is not recorded, you may be able to get away with the refinance. But you would then be in violation of the financial disclosure requirements that are contained within the terms of the loan. Which means if the bank found out, they could hold you in default.
The best way to handle this is to be open and transparent with your lender. Which means you won’t be able to use conventional lenders, but you may be able to find alternative lenders, commercial lenders, or small local banks you may believe in your strategy and will be willing to participate in it.
The bottom line: you can’t just use a big bank with a conventional loan. Those loan products are out. You must develop a tight banking relationship with a commercial lender who approves of this strategy.
OKC Real Estate Lawyer for Investors and Landlords
If you are a real estate investor in Oklahoma City, you need counsel. Contact my office schedule a 15-minute call. If you like want you hear, then we move to the next step of scheduling a strategy session.
Who am I? My name is Travis Charles Smith, and since 2009, I’ve been involved in commercial real estate. I’ve handled evictions, foreclosures, commercial leases, seller-financed purchases, and both trials and appeals involving zoning and condemnation. And that’s just the litigation side.
Today, my focus is on asset protection: keeping you out of court, and stopping legal problems before they happen. I love real estate and I love working with real estate investors.