Ahh, spring is in the air here in Chicago land.  For me, spring always brings a sense of optimism and hope. 

For those of you who wish to live in Hinsdale, there are some great opportunities.  For example, you can get this two bedroom condo at 300 Claymoor #3E.   The Claymoor complex is actually very nice and is nestled quietly amongst single family homes valuing from $700k up to several million  There are four buildings with 20 units each and 1 garage spot for each unit.  There is plenty of exterior parking for residents and guests as well.  The association is very well managed (financially)  and the grounds are beautiful with an abundance of flowers and mature trees throughout the property.

If you have just about double that to spend, you might want check out this townhome in  Chanteclier.  At $319,900, this townhome has 3 bedrooms, 2 1/2 baths and is completely remodeled from the bathrooms to floors and kitchen.   At both complexes the assessments are reasonable and  under $250 per month.

For just another MILLION dollars, you can buy  a “Dazzling Creekside Graue Mill Villa” .  The listing agent Joan McInerney of Adams and Meyers decribes the home as:

3 Levels & 6000 Sq Ft of Magnificent Living Right out of Architectural Digest. Two Master Suites, Newer Chef’s Kitchen, Incredible Newly Completed Master Bath, Dramatic Loft Library/Office. Add Vaulted Ceilings, Skylights, Hardwood Floors, Crown Molding & 3 car garage. Lower Level Great Room overlooking creek & private deck access. This is one Incredible home!

There are several condo and townhome communites located in Hinsdale.  The map below gives you a rough idea of where each complex is located.  The details can be found on on our Hinsdale Market page where you can find other relevant information on the Hinsdale real estate market.

There are a few common ways that I have seen an FHA 203k loan used.  Predominantly the clients I’ve worked with use this type of loan to purchase a property that either needs some general rehabbing throughout or to finish a job that was left incomplete for one reason or the other.  As rehab loans of any other type have virtually disappeared the FHA 203k loan has been on the tip of many buyer’s tongues lately.  The only challenge is that the type of property that would motivate a buyer to seek this type of loan typically ends up in a multi-offer situation; speaking in terms of my local market.  If you had a chance to read my short article on TheChicago77.com entitled, “Short Sale and Foreclosure Multi-Offer Strategy“ or you have had any experience as a buyer or buyer’s agent attempting to purchase distressed properties then you already know that in a multi-offer situation an FHA 203k loan gets the lowest priority of any offer on the table.   For an in-depth explanation of why please visit the article mentioned above.  The long and short of it is that the FHA 203k loan has a huge amount of contingencies, outs, or reasons to fail before close, and that is very unattractive to a bank.  As banks are the ultimate decision makers in many distressed property sales it is their opinion that counts, and they want nothing more than the quickest close possible.

Clearing The Air

I’m sure there will be some of you reading this who have used an FHA 203k loan to buy a distressed property, and I do not mean to say it is impossible.  Local market conditions significantly impact the possibility that this loan will be accepted for the purchase of a distressed property.  For example, with most suburbs of Chicago and a few of the fringe neighborhoods of the city proper the competition is virtually nonexistent.  A bank attempting to sell a property in areas with low demand are often so desperate for any type of offer that on the slight chance that one comes it matters not what type of loan it is; they’ll pounce on it like a starving cat.

Back To Business

The purpose of this article is to illustrate an example that worked out very well for a buyer that I have been working with for quite some time.  As with many savvy investors my client was very particular about what he wanted in a property.  His goal was to find a distressed building, preferably a multi-unit, and convert it into a beautiful modern single family home for himself.   As such it took us quite some time to locate the perfect property.  When we finally did it was a gutted two unit that had little more than the bricks, the studs and a pile of rubble lining the floors.  With an asking price of around 180K it was ripe for the plucking.  When he asked me to put an offer in on the place, protocol demanded a pre-approval or proof of funds and I asked him for such.  A few moments later he forwarded me a pre-approval letter from his lender for an FHA 203k loan.  Knowing what I know about this type of loan and also about the desirability of this type of property to other investors I correctly surmised that a multi-offer situation was at hand.  Given a very small number of days on the market, there was little chance the seller of this property would jump on a 203K loan.  Instead, they would graciously acknowledge our offer and hold out for something more attractive; cash or a conventional loan offer with a low number of contingencies.  Given this, I called a couple lenders who I know that have their fingers on the pulse of the lending market and we came up with a solution.

The Challenge

Our challenge was how to make our offer stand out on top versus the others that were sure to come.  Knowing my client had enough cash to buy this property with some to spare, I asked him why he chose an FHA 203K loan.  He gave me the answer I was expecting, “I want to save my cash for the rehab.”  Knowing what we now know about the low desirability of this type of loan it was only natural that I council him on the unlikeliness that his offer would be considered.  As the ball was in my court to find a superior alternative I shared my discovery with him.

FHA 203K Refinance

Let me cut to the chase.  If you buy a property with cash there is no title seasoning requirements to re-finance the property with a 203K loan.  As such the refinance can happen immediately after purchase.  Combine that with the huge desirability of cash in the eyes of the seller and this significantly increases the likelihood of a win-win situation.

What If I Don’t Have Cash?

Here’s the good news for investors out there who want to take advantage of this scenario but don’t have enough capital to purchase with cash.  The FHA 203k refinance has the same title seasoning requirement (zero days) if you purchase with a conventional mortgage.  In other words, if you buy a property with a conventional loan, right after you close you can turn around and re-finance it with a FHA 203k loan allowing you to obtain extra money to do some rehabbing on the property.  So why not make the initial offer with an FHA 203k loan and why did I not recommend a conventional loan to my client and encourage him to save the cash for the rehab?  To get that answer I suggest you read my article on Multi-Offer Strategy.

Ciao for now!

Buyers often wonder what bureaucratic torture they are going to be subjected to in order to obtain a mortgage. Therefore, I asked Russ Martin of Perl Mortgage to explain the required documentation for a mortgage application.

In general, a conforming loan (i.e. conforms to the guidelines established by Fannie Mae and Freddie Mac) will require the following documentation:

• Driver’s license
• Two years w-2’s
• Two year tax returns, all schedules.  If self-employed, we will also need two years business returns
• Most recent 30 days paystub(s)
• Three month’s statements for all assets – checking, savings, 401k/investments.  The bank will want ALL pages of the statement, so if the statement says Page 1 of 4, they need to provide all four pages even if one page is blank
• If paying rent to an individual, they will also have to provide 12 mos of cancelled rent checks
• Any large deposits or movement of funds on the asset statements will need to be verified
• If not a US citizen, we will need a copy of their work visa such as an H1-b.

Keep in mind that these documentation requirements could change over time. And non-conforming loans could have different requirements – possibly even more stringent than the list above.

The list doesn’t look too onerous unless you have a complicated financial situation. For conventional financing, banks pull a 4506-t which is a request to get copies of the borrower’s tax returns from the IRS directly on every mortgage.  Most underwriters will ask about other income that is showing up on the returns if it is not documented.  For example, you may be getting a salary and w-2, but you may also have income as a minority partner in a small business.  They are going to see that on the tax returns and request information on it.  This is the primary reason I ask for the borrower’s copy of their tax returns ahead of time so I know about it before the underwriter does. That way we can prepare for the questions that are going to come up.

It used to be easier to deal with borrowers who have more complicated financial situations back in the day when we had stated loan programs which is what those loans were for.  However, they were abused so now it doesn’t matter how complicated an individual’s personal/business life is…. EVERYTHING has to be documented.

The reason most borrowers complain about the paperwork is because most borrowers never really sit down and get themselves pre-approved and truly prepare for their financing ahead of time.  This is why financing is so spotty and inconsistent on real estate transactions.  Realtors are really disconnected from how their clients truly shop for mortgages.  Most borrowers aren’t nearly as qualified as they think these days because they really have no idea what it takes to get a mortgage.  Combine that with the fact that they also are so focused on getting the lowest rate and what they perceive to be the best deal, it causes problems because they wait till the last minute to really get their financing in order because they don’t want to commit to anyone ahead of time fully until they know their rate/fees which can’t be guaranteed until a property is under contract which is when we can lock rates.   So in short, most borrowers don’t know squat [edited for a family audience] about their ability to buy a house until they are under contract.

Part of this is probably driven by big bank advertising which shows the call center monkey talking about getting pre-approved in five minutes.  No one gets approved to borrow hundreds of thousands of dollars in five minutes.

A Tutorial

Lease with option to buy (aka rent-to-own) is a viable solution for many sellers and buyers, yet it is largely under used. Browsing through the various real estate blogs there are many people asking questions that often go unanswered or receive the same type of safe/fluff answers every time. As we have navigated this process from start to finish and seen it work, We’d like to dissect this topic in hopes of shedding some light on a very viable method of transacting real estate.

A lease with option to buy is an agreement to lease a home with the option to buy it before a certain future date at an agreed upon price. This type of agreement is ideal for someone who is either not ready to buy because of a lack of assets or credit or a lack of desire to risk their assets or credit. Even though this is not a new concept it is largely under-developed and there are many things to consider for both sides of the transaction. We cannot stress enough that having an agent that is experienced in this type of transaction is something that should be strongly considered by both sides.

How much should the rent be?

The rent should reflect current market prices for comparable rental units plus additional amounts that may go towards purchase of the home or payment for the option. However, all three of these rent components are negotiable so this is a great reason to have an agent working with you who is experienced in this type of transaction. The key is for the seller to be appropriately compensated for taking the risk of future price depreciation while forfeiting all price appreciation to the buyer.

How much should the rent be increased to fund the future purchase?

As mentioned above, this is negotiable. Again, because this process is rarely used there is no standard or often used guideline to consult.  However, incorporating an extra amount into the rent to fund a future purchase amounts to nothing more than the seller operating a savings account for the benefit of the buyer. Does the seller really want to be in the banking business? And from the buyer’s perspective, how is this any different than the buyer starting a savings account and putting that extra money in there for an eventual purchase that doesn’t tie them to a particular unit? The only difference is that under this arrangement the buyer is “forced” to save money for their purchase. Interestingly, the Chicago Association of Realtors has a “Lease With Option To Purchase” rider that doesn’t even provide for such an accumulation fund.

How should the accumulation fund be managed until it’s time to buy?

There are a couple ways to go about this and it is largely affected by the profile of the seller. Is it huge profitable developer or a struggling couple that is trying to sell? First of all, if it was agreed that the monthly rent would be increased by a specific amount each month (above market price) and that amount would be put toward the eventual purchase, that money should be put into a separate escrow account by the landlord/seller until such a time as it will be used for the purchase or refunded to the buyer/renter. Another way this can be handled is for the landlord to keep a ledger to record the agreed upon amount so that when the time comes to purchase, the landlord will reduce the sale price on the home by the amount in the ledger. From experience this is the most common method, however a number of risks for the buyer present themselves. Namely when the time comes to sell will the landlord be able to sell the home at the reduced price? In addition, lack of funds for a down payment is a very common reason that buyers seek a lease with option and it is not necessarily the price of the home that is preventing them from buying. Often the amount of money accrued is a drop in the bucket when compared to the over all cost of the home and as such the highest impact of that money would be as down payment assistance for the buyer. If the landlord is not keeping the money in escrow, there is no guarantee that the landlord will be able to cough it up at the closing table.

At what point in the process should we agree on a purchase price?

In the Chicago Association of Realtors “Lease With Option Rider” there are two choices (this may differ for your local association’s forms, please consult your agent):

“Tenant shall have the one-time right to purchase the Property (“Purchase Option”) for a purchase price equal to (strike one) $_______________________________ / the fair market value (“FMV”) of the Property at the time such Purchase Option is exercised (“Purchase Price”). (Strike the following sentence if it does not apply) The FMV of the Property shall be determined by Landlord and Tenant, in good faith, taking into consideration the purchase price for properties similar to the Property, located in the same geographic area as the Property, which have been purchased in the preceding nine months. “

There is a lot to consider here. When does the renter plan on converting himself or herself into a buyer? Will it be six months or two years? What does the housing market look like at the time of purchase? Is it stable, falling or experiencing growth? Either way there is risk involved for both parties.  In a standard option there is an agreed upon purchase price, the “strike price”, established at the point at which the option contract is entered into. It is this set price that creates the value of the option for the buyer. If there is merely an agreement to negotiate a fair market value at some point in the future then the option has absolutely no value whatsoever.  If the buyer ends up purchasing the property at fair market value in the future then they have forfeited any right to appreciation of the property up to that point in time.  What if the buyer and seller can’t agree upon a fair market value in the future? This essentially provides an out for the seller. In other words, the seller is not really obligated to sell the property and the buyer doesn’t really own an option.  The existence of this second alternative in the contract is really rather pointless. It creates a situation where the seller can’t sell the property to anyone else, but the buyer is not guaranteed that they will be able to purchase it for a price they consider reasonable.

As a seller, when should I ask for a pre-approval?

This is a tricky one because in many cases the reason people are looking for a lease with option is because they cannot yet qualify for a loan for one reason or the other. Our advice is this: With the assistance of a lender you or your agent are comfortable with, get the renter/buyer pre-qualified for the purchase amount you’ve negotiated and find out what it would take for them to be able to qualify. It could be increased assets or it could be credit clean up. Whatever the case may be, this will give them a clear picture of what their goals need to be in order to eventually purchase the home. This is also very important because this will give them a glimpse of what their monthly cost to own would be. A lot of first time home buyers have no idea what their mortgage, insurance, taxes, and assessments (for condos) will add up to. It may be that once they see what their monthly cost to own will be that they realize there is no way they would be able to ever buy this in the near future. The last thing a seller wants is to waste time renting their place when their goal is to attract a buyer. Getting the pre-approval done up front is also a good way for the seller to assess the risk of a given buyer. At the beginning this will serve as a credit check, which most landlords require anyway. If you see that the potential buyer has a 300 credit score and has never paid a bill on time, it may not be a good idea to tie your home up with that candidate. If you see that they are 800+ credit, never missed a payment, and the only thing preventing them from buying is a lack of down payment or lack of income, you may consider this to be less of a risk than the former example. Obviously the buyer will need to get re-approved once the purchase is close at hand.

Will the security deposit be handled separately from the earnest money?

We recommend that these two be handled separately. Through the Landlord Tenant Ordinance (LTO) the City of Chicago requires a lot from the landlord with respected to the security deposit and noncompliance comes with some very heavy penalties. That said, we feel that the seller acting the part of the landlord should adhere to the LTO and ask for earnest money if and when a purchase comes to fruition. This will reduce the liability to the landlord who is at significantly more risk than the potential buyer.

Should I keep my home for sale during the agreement?

Only if someone will buy it with the option attached. You gave the buyer/renter the right to buy the place and you can’t just ignore that fact. Again, consider the comfort level of the buyer. Do you think a buyer would go through all of this trouble with the possibility that the rug can be pulled out from underneath them at a moment’s notice? Plus a renter who is planning on buying this home may be very put out by having “potential buyers” traipsing through the home.

What happens if the home is foreclosed during our agreement?

This situation is largely effected by the type of agreement you had. If you are paying above market rent and having that money put into an escrow account, obviously you should have claim to that excess money. We recommend that you have some verbiage in your agreement that covers this possibility no matter how remote you think it may be.

Can section 8 vouchers be used in a rent-to-own home purchase?

The answer according to the HUD website is yes, depending on your personal situation and the program that you are involved with. We advise you to consult the hud.gov website for details.

Do I have to sell my home at the end of the agreement?

Absolutely. That’s the whole idea behind an option and that’s what you are being paid for.

In Conclusion

With all of the different variables to consider it is clear why a lot of agents steer clear of this type of transaction. It is unfortunate that often the professionals that people turn to for advice are the ones that push them away from viable options due to lack of familiarity or out of sheer laziness (short sales are another example of this). In the end, rent-to-own has the potential to be a win-win situation for all parties involved. The buyer gets a chance to test out a home before buying it, continue to build credit, and an opportunity to put their money toward a home purchase prior to qualifying to do so. For sellers, they can have a renter in the short term to help alleviate some of the financial burden of their cost to own while cultivating this renter into a buyer. The situation can also be a very easy out for both parties. In a market where serious buyers are hard to come by, this has the potential to be an excellent compromise.

Home buyers in Chicago are almost always concerned about whether or not a particular neighborhood is safe or they may ask us for recommendations of a safe neighborhood. The only problem is that there is no simple way for us to provide advice on this subject so most realtors are going to avoid the entire subject – and I’m one of them. The reason for the difficulty is that there is limited objective data to begin with and opinions on relative safety are highly subjective anyway. In addition, if a realtor tells a buyer that a neighborhood is safe and that buyer later becomes a crime victim in that neighborhood then that realtor might have a problem. But let’s explore this topic a bit more.

There are Web sites like EveryBlock that provide lots of Chicago crime data, including maps of individual crimes. However, that interface leaves a lot to be desired and the different data views always seem to be either too granular or too aggregated. That’s why I turned to the Chicago Police Department Web site to provide me with an overview of crime by neighborhood. Their annual reports provide a great overview of crime in the city. 2008 is the most recent report available, with the 2009 report probably coming out in a few more months.

Reading through the report is rather educational because it highlights an important distinction between the different types of crimes. For instance, the only crimes reported by neighborhood are what the FBI refers to as index crimes. As the report says, “Index crimes are the combination of eight categories of crime, selected because of their seriousness and frequency of occurrence.” The eight categories, broken down into two groups, are as follows:

Violent Crime

• Murder
• Criminal Sexual Assault
• Robbery
• Aggravated Assault/Batter

Property Crime

• Burglary
• Theft
• Motor Vehicle Theft
• Arson

Noticeably absent from this list are prostitution, drug activity, graffiti, and disorderly conduct, which the FBI clearly does not see as being “serious” enough to qualify as index crimes. So this highlights perhaps the most subjective aspect of the concept of a “safe neighborhood” – what does “safe” mean exactly? I would guess that most people would not feel comfortable living in a neighborhood where there are lot of these non-index criminal activities going on, yet those crimes are not summarized at the neighborhood level by the Chicago Police department because they are not as serious. (They are available on the EveryBlock Web site, however.) In addition, many buyers look for other subjective clues as to whether or not a neighborhood is safe – e.g. are there a lot of adult males loitering on the street during normal work hours?

So, what do the index crime data tell us about relative neighborhood safety? You’d be surprised. I took the Chicago neighborhood index crime statistics from the annual report and normalized them for neighborhood population – i.e. what are the crimes as a percentage of neighborhood population, or what is the probability that you would become a crime victim in a particular neighborhood. The results are available in the two charts shown below.

Chicago Violent Crime By Neighborhood

Chicago Property Crime By Neighborhood

What you will notice is that some of this data runs counter to people’s intuition. For instance, I often hear people refer to Uptown or Hyde Park as being “dangerous” but according to this data you are more likely to become a victim of violent crime in the Loop than you are in either of these neighborhoods – and way more likely to become a victim of property crime. And you are more likely to become a victim of property crime in Lincoln Park than in either of these neighborhoods – because “that’s where the money is”. However, in all fairness, places like the Loop and the Near North Side have a huge influx of people every day that are not reflected in the population numbers and that invites more crime and thus skews the statistics.

By now you are getting a pretty good indication of just how complex this whole analysis is. That’s why if you ask me how safe a neighborhood is I’ll tell you to drive around at a few different times of day and visit a crime statistics Web site. But if you take that advice to heart you may just end up moving to Iowa.