Land contract sales: helping the poor, or screwing them?
Land installment contracts provide a viable path to homeownership, but they are fraught with abuse.
In yesterday’s post, Three calculations every real estate investor must know, I discussed my personal criteria for buying rental investment properties. Everyone who actively invests has their own criteria, but nearly everyone has some criteria they use to filter out properties with problems they don’t want to deal with. Have you ever wondered what happens to those properties that fail to meet anyone’s criteria? What is the fate of those properties that are so far gone that it doesn’t pay to renovate them and bring them up to a salable standard?
Many might think these homes are demolished, and in places like Detroit, this does occur, but generally, that is not what happens. When the renovations costs exceed the after-repair value of the property, the people who invest in these dilapidated disasters often resell them as-is to poor would-be homeowners who will invest the labor and funds to improve the property for personal use.
For the would-be homeowner, this is often the only opportunity they’ll ever have to own a house. These deals usually don’t require any money down, and the occupant can make as many or as few repairs as they desire. They have to live with the results. As a consequence, many poor people who go this route pay far more than comparable rent to live in substandard accommodations. But for those few who put in the time, effort, and money to fix it up — and then make consistent payments — this is a viable path to homeownership, often the only path available to them.
For the investor, these deals offer little downside risk. The sales prices on many of these properties are far below replacement costs, and if the land contract buyer makes payments, the monthly cashflow generates returns far in excess of 10%, depending on how onerous the landlord was during the negotiation. The worst case for these investors is that the would-be owner trashes the place, but since most of these are already on the condemnation borderline, how much worse could it get?
Of course, these investors have to deal with lots of headaches and collection issues unique to the buyer profile. Although there are many decent, hard-working poor people looking to stake their claim to the American Dream, there are also a great many alcoholics, drug users, lazy, emotionally disturbed, irresponsible people who will move in, trash the place, and squat until they are kicked out. It’s not like managing a high-end rental in Irvine.
There are two ways to look at this practice. The conservative narrative is that these investor-landlords provide an opportunity for people with no savings and poor credit a path to home ownership. The progressive narrative is that these investor-landlords are gouging poor people who have no other options and making excessive profits at the expense of the poor. When these would-be owners succeed, the conservative narrative wins; when they fail, the progressives are closer to the truth.
AKRON, Ohio — Hundreds of broken-down houses still dot the streets of this onetime tire capital of the world, a scar from the financial crisis and housing bust.
The wood has rotted in some; others have black mold, broken windows or failing foundations. Many lack working electrical systems or are missing water pipes and furnaces. The unpaid property taxes mount.
Dozens of these houses were scooped up after the financial crisis by investors, who then make deals with low-income home buyers unable to get traditional mortgages. The arrangement is something like buying a home on an installment plan, with a high-interest, long-term loan called a contract for deed, or land contract.
But for buyers lured by the dream of homeownership, these seller-financed transactions can become a money trap that ends with a quick eviction by the seller, who can flip the home again. Before the housing crisis, low-income buyers got too much of a house that they couldn’t afford. Now, they are getting too little of a house that they can’t afford to repair. …
The main difference between these seller-financed land installment contracts and a traditional sale is the process for repossession. The property does not actually change hands until the buyer completes the land-installment contract terms. If the buyer stops paying, they are in default on the contract, and since they only have renter’s rights, they can be quickly and easily evicted from the property.
While left-wing housing advocates decry this practice, no seller would ever agree to a no-money down sale and allow a buyer to occupy a property as a homeowner without this protection. Since the failure rate is very high in this buyer pool, it would be far too costly to spend years trying to foreclose on them, particularly if they put no money down to buffer the potential loss.
Nationwide, more than three million people are estimated to have bought a home through a contract for deed. After the financial crisis, as banks retreated from lending to those with poor credit, this odd corner of the housing market began to draw interest from deep-pocketed investors who sometimes sell the homes for four times the price they paid.“There is this whole other way that people buy homes. It is very much under the radar and hidden,” said Heather K. Way, a professor of law at the University of Texas. “Homeowners go into this without knowing that this is such a high-risk contract fraught with perils.”
Bullshit. When their options are to take the deal or keep renting, it really doesn’t matter what the terms are, some people will give it a try. While many will claim ignorance after the fact — the housing bubble proved that — most people understand they only become owners if they make their payments.
Swimming in DebtLacking the means to fix up the homes, those who enter into contracts with Harbour often end up swimming in debt, a review of lawsuits shows.
Kevin Franklyn, 46, of Detroit said he struggled with making repairs on a $44,925 Harbour house in 2011. After falling behind on the payments, he recently agreed to forfeit the contract to the house. The roof, plumbing, electrical system and drywall all needed serious repairs, he said.
His fiancée, Lisa Micou, 46, said the home was in greater disrepair than the couple had anticipated.
“Everybody wants that part of the American dream — everyone wants a piece of that pie,” she said.
Some people don’t make a go of it. While that may be sad, I don’t see where anyone involved did anything wrong.
Fewer Protections for Buyers
Provisions in a contract for deed are enforceable as long as they do not conflict with state law. The home dweller has more limited protections than a person buying a house with a mortgage, and evictions are quicker than a foreclosure. The residents are typically responsible for repairs and paying all property taxes, but the legal title under a contract for deed does not transfer until the final payment is made — an end result that rarely happens.
One of the big problems with land sales contracts is the accumulation of equity. According to a strict interpretation of the contract, the buyer has nothing until the terms are complete. They can’t sell the property because they don’t own it.
If they live in the property for 10 years or more, the property may have significant appreciation equity, but the buyer has no valid claim to this equity. There have been cases where unscrupulous sellers tried to break the contract in order to obtain this equity at the buyer’s expense. Most often the courts side with the seller.
Robert Doggett, Texas RioGrande Legal Aid’s general counsel, says contracts for deeds “take advantage of people’s desperation” and can worsen neighborhood blight.
Spoken like a true left winger.
Sometimes It WorksNot all contracts for deeds are as contentious.
One Minnesota nonprofit program called Bridge to Success sells homes using contracts for deeds.
Pete Flom, an executive with the program, said the contract was “just the vehicle to get someone in the house.” …
Many people have obtained their houses through a land contract sale. My grandfather sold an investment property on a land contract sale in rural Friendship, Wisconsin. The buyer made payments for 20 years and got the house. I know first-hand that these contracts can work. However, I also know human nature, and these contracts are also rife with slumlords who really do want to find innovative ways to screw poor people.
Land installment contracts provide a path to homeownership to a segment of the population that has no other means. They will always be a part of the real estate landscape.