How to Properly Manage Your Income Property  

There are many ways to acquire an income or rental property. However, the trick lies in properly managing that property once you have acquired it in order to maximize your profits and minimize your liability and exposure. There are many popular ways to manage your property, all with drawbacks, some serious. For instance:

Lease Options - Very popular, but are lease options a violation of the Due on Sale Clause? The answer is YES, they are ALL a DOSC violation. Would a lender call the loan due for that reason? I don't know, it would depend upon the circumstances. Is it a violation none-the-less? Yes (See 12USC1701-j-3) re: any lease for more than 3 years or a lease relating to an option to purchase is a due on sale violation. One's violation of a lender's due on sale admonitions is not against the law or even underhanded or devious: doing so merely allows the lender, supported by federal law, to call the note if they choose to do so.

In addition, lease options are susceptible to a tenant claiming "equitable interest" in the property and forcing an expensive foreclosure rather than an eviction. Lease options are considered among the most litigious of all real estate transactions gone awry. Many of the major brokerages (Coldwell Banker for one) no longer allow L/Os by their agents. State legislatures are beginning to take an active role in legislating against small investors and lease options are now no longer legal in Texas unless you own your property free and clear.

I used lease options as a Seller for more than 20 years. I don't use them anymore. Here is why. Here is a list of five things that may violate the law and cause the judge to classify the transaction as a "disguised sale". This is not my list, but the list prepared by a Judge in Arizona who actually co-authored Arizona's landlord/tenant laws:

1. Collection of more than 1.5 times the monthly rent as Option Deposit.

2. Collection of an Option Deposit or Rent Credit to be credited to a Purchase, or to discount the Purchase as in a Down Payment.

3. Predetermining a Purchase Price, as in delaying or disguising a sale.

4. The Lessee also holding an option on the same property they are leasing regardless if it is one document or two separate documents.

5. The Lessee being responsible for maintaining the property.

If the lease is not recognized by the court as a lease, it doesn't get the benefits that go along with a legally recognized lease. If the judge feels a sale has taken place instead of a lease, the rules governing foreclosures will apply. For this reason, possession of the property will be decided by a judge in position to decide matters of title and the process can be extremely expensive. Costs can run $10,000+, not including having to pay the back mortgage payments during the life of the suit.

Land Contract (Contract for Deed) - Is a CFD a due-on-sale violation? Yes. Will a lender call its note because of one? Yes...if they want to. Do they ever want to? Yes. Countrywide Funding, Washington Mutual or Nationwide Funding, just to name three, have tried to equate our program (land trust) with a CFD and had to be taught that it wasn't one, and that they had no grounds for foreclosure. With a CFD or L/O or Lease Purchase, it's not the relinquishment of title that is at issue, it's the conveyance of an "equitable interest in the property" (ownership of the lender's security) that lenders don't like, and which generally requires hefty legal expense and judicial foreclosure to ameliorate the situation and and dispossess the unauthorized resident-buyer.

So what is the best way to manage an income or rental property? A recent US Government survey showed that 44% of homeowners are actually LOSING MONEY on their First let's address what our needs are and the potential headaches we want to avoid.

Headache #1: Maintenance & Repairs A safe estimate is about 1% of property value per year for maintenance and repair costs. Do you hire it done or do it yourself? What is YOUR time worth?

Headache #2: Management & Collections What about property management? Do you collect the rent payments yourself or have you hired a collections company to do this for you? How much time do you spend on managing your property? What if the rent payments are late? What do you do?

Headache #3: Vacancies It is a well documented fact that when people have no vested interest in their home, they are far more apt to move from place to place. It's always safe to allow one month per year in your budget for unexpected vacancies

Headache #4: Legal & Professional Expenses Are the rental contracts you are using favorable to your interests? What if your tenant goes into default? Do you know how to handle an unlawful detainer action? Do you know how to properly serve your tenant? Do you have a CPA handling your accounting and collections?

Headache #5: A Tenant with No Incentive This is your biggest problem of all. People with nothing invested in their home are far more apt to neglect it or move than someone who takes pride in his home.

What is the solution? A prudent landlord would be well advised to consider making his rental tenant a Co-Beneficiary in a North American Realty Services PACTrustT in which the rental property's title is vested. This will give the landlord an ideal opportunity to trade such items as * mortgage interest write-off, * property tax write-off, * existing equity, * equity build-up, * future appreciation

and the psychological peace of homeownership benefits, for such commodities as * free maintenance, * repairs, * upkeep, * management... and * much higher rents.

Using this system, we can easily achieve the objectives of a traditional property holding and management methods WITHOUT the pitfalls and drawbacks associated with these methods.

The Trust can meet the objectives and functions of any of these arrangements without the many risks associated with them. In addition to the Triple Net Lease which I employ, the Trust can function:

AS A LONG TERM LEASE: A Co-Beneficiary Trust can be set up for up to twenty years, with a Lease of the property to a Resident Co-beneficiary for 2 years, eleven months and twenty-nine days. The lease with the trust will stipulate that at the end of the original lease term, the tenant may "hold-over" in the property until the end of the trust period, unless evicted sooner. Since an eviction would have to be by mutual direction by ALL beneficiaries: the tenants being one of the beneficiaries, protects him and effectively continues his/her holdover until the termination of the trust.

AS A LEASE OPTION: The property is placed into a Trust with the understanding that, at the end of the Agreement, the property will be sold to the Resident Co-Beneficiary for Fair Market Value, minus any and all sums owed to the Resident Co-Beneficiary. In this scenario verbiage is such that there is actually no "Option" per se; and that there is no "bargain buy-out" provision other than "...at Fair Market Value, less amounts due the respective beneficiaries."

AS AN AITD (Wrap-Around: A seller places its property into a Trust, assigning a full Beneficiary Interest to the "buyer," with the agreement that the property will be leased to the co-beneficiary on a Triple-Net basis for some specified period of time. The property is then scheduled to be sold at the end of the Agreement. Upon sale there is a distribution of proceeds to (between) parties with respect to each of their proportionate shares of Beneficiary Interest. In order to avoid reassessment for property tax purposes, and to justify mutual Power of Direction, we recommend that the shares of Beneficiary Interest remain at 90%:10% in favor of the "buyer." Then at the end of the term, the "seller" can forfeit its 10% in consideration of the co-beneficiary's prompt payment record and strict adherence to the contract.

AS A LAND CONTRACT (Contract for Deed): Benefits are the same as above.

AS A LEASE PURCHASE: Same as above, except that the Agreement provides that the property will definitely be acquired by the Resident Beneficiary at termination irrespective of market conditions, relative values, etc. The Rider in this scenario provides that the co-beneficiary has the obligation to either sell or refinance at termination.

AS AN EQUITY SHARE: Same as above, except that parties share 50:50 in the Beneficiary interest within the Trust, with an agreement to share all net profits proportionately at termination.

AS A BRIDGE-LOAN DEVICE (e.g., when a buyer can't finance, or afford a down payment for several more months or years and the seller may be willing to wait awhile): The Trust affords such a buyer the opportunity to live in the property, while paying all costs and enjoying all the benefits and incidents of homeownership, including tax write-off and waiting until financing and outright purchase is possible. In this scenario, the Trust is set up to coincide with that point in time when the property can be purchased outright by the Resident Beneficiary.

The concept of a land trust and what distinguishes it from any other type of investment or asset management strategy, is the Doctrine of Equitable Conversion. This is what enables us to convert real property to personal property. Once you have placed your property in the trust and deeded title to your Trustee, your transaction is no longer governed by mortgage law and all that goes with it including public recording of your documents. You are now governed by the Uniform Commercial Code (UCC), Article 9. This provides all the privacy and asset protection needed and sets the land trust apart from other investment tools.

The BEST feature of a land trust is ASSET MANAGEMENT when you use the land trust as the engine of an equity holding system that includes a triple net lease and equity sharing. Unlike traditional landlord/tenant transactions where you offer your tenant only the Use and Occupancy of the property, by making my tenant a Co-Beneficiary in a North American Realty Services PACTrustT, I am able to trade such items as mortgage interest write-off, property tax write-off, existing equity, equity build-up, future appreciation and the psychological peace of homeownership, for such commodities as free maintenance, repairs, upkeep, management... and much higher rents. Each one of these "items of trade" has a value, and giving up all or some of each one can double rents while simultaneously reducing the after-tax expense of renting for the tenant.

This is what I tell a prospective tenant: "I own a home in trust and I need someone to live in it, make the payments, and be responsible for maintenance and repairs on a 3-yr triple net lease. There will be no bank qualifying and you will have no down payment. You will pay only closing costs (my cost of setting up the trust) plus 3 lease payments (I hold 2 in reserve in case of default). If you will agree to this, I will GIVE you an immediate 50% ownership interest in the trust. You will (although only leasing) acquire IMMEDIATE home ownership benefits and are allowed by the IRS to write off the monthly mortgage interest payments and property taxes. You will also share in the future appreciation of the home on a 50/50 basis. At the end of three years, if you want to buy the property, you can do so at Fair Market Value. If you choose not to, there is no obligation or penalty."

It has never taken more than one week to find a qualified tenant/buyer. Why? Because by making them a partner they have a vested interest in its value. I have a positive cash flow, have no responsbility for maintenance or repairs, and my Trustee's payment servicing company collects the rent.

Once people begin to understand how powerful the conversion from real property to personal property is for asset management versatility and profitability, land trust usage will become more common, especially in the face of the anti-investor legislation sweeping the country.

Copyright @ 2006 Gary Mialocq, Ph.D. All Rights Reserved

About the Author

Gary Mialocq, Ph.D. is a former self-employed vocational rehabilitation counselor with significant experience in helping others improve the quality of their lives, having worked with disabled children and adults, juvenile felony offenders, and industrially-injured workers. He has also dabbled in real estate since 1980 using creative financing strategies and techniques to acquire and manage properties and is now a Full-Time Investor, Consultant and educator.