August 26, 2024 | 2.5 Minute Read
Here is a creative strategy for selling real estate deals, specifically the use of Contract for Deeds (CFDs) as opposed to traditional buying methods. This approach not only enables you to generate a lump sum of cash but also creates ongoing cash flow.
A Contract for Deed is a financial arrangement where the buyer agrees to make payments to the seller until the full purchase price is paid off. At the end of the payment period, the buyer receives the property’s deed. In contrast, a lease option or lease-to-own contract allows the tenant to lease the property with the option to purchase it later. Lease options can be structured in various ways and are useful in commercial real estate, but for many residential investors, Contracts for Deeds are preferable.
You still hold the deed to the property until the property is paid off so if you have an existing mortgage on the property, you are technically doing a wrap. You pay your mortgage. Your buyer pays you from the contract for deed. You pocket the difference.
Contracts for Deeds often feel more like a purchase to buyers, as opposed to a lease, which can sometimes seem less definitive. This perception can be especially important in markets where there has been exploitation of non-English-speaking individuals by unscrupulous investors. By using Contracts for Deeds, you avoid the potential pitfalls of lease options, such as complicated terms that can be manipulated.
Additionally, Contracts for Deeds provide several benefits:
- Upfront Cash: You receive a down payment when the contract is signed.
- Long-Term Cash Flow: You receive monthly payments over time.
- No Maintenance Costs: Maintenance responsibilities are typically transferred to the buyer.
- Properties with Prolonged Market Time: If a property has been on the market too long and you want to avoid further renovation or repairs.
- Unwanted Rental Areas: In neighborhoods where you prefer not to hold rental properties.
- Taxes & insurance: They are rolled into the monthly PITI payment so the buyer assumes these costs.
Here’s a quick example:
- Sale Price: $139,000
- Down Payment: $10,000
- Interest Rate: 11%
- Term: 30 years
With these terms, the total interest earned over the life of the loan would be approximately $313,258. The total potential profit, if the buyer maintains the contract to term, would be around $263,000.
However, there are potential challenges, such as dealing with buyers who may struggle to make payments. It’s important to be aware of these risks and manage them accordingly.
Finally, be mindful of tax implications. There’s a difference between being classified as a real estate dealer versus an investor. Dealers are taxed on realized profits, whereas investors benefit from tax deductions related to property holding. Consult with your CPA to understand how these classifications might impact your tax situation.
Contracts for Deeds offer a powerful tool for creatively disposing of real estate deals, providing both immediate cash and long-term cash flow, while avoiding some of the common pitfalls of rental properties and lease options.