Buying a house. Seller wants cash now and move only next year, renting same house in meantime

Question

A relative of mine found a fantastic house on the market (Canada), evaluated 750k. He knew there were 3 other buyers making offers and he was entering a bidding war. He made an 800k offer and was the highest bid, offering to take ownership 3 months from now, which is usual to give seller time to prepare and move.

The seller came up with a counter proposition. He agreed to the amount. The thing is, he wants the cash NOW and even if ownership is transferred, he included in deal that he (the seller) would rent the house and continue living in it for 12 months and pay 3k/month rent.

At that point my relative felt this person was dishonest not to disclose these unusual requests from the start and just backed out from the deal, letting the 3 other bidders fight for the house.

This seems risky from the buyer's perspective. Let's say the buyer owns a house himself, he would have to support 2 mortgages for a year. If he waits 9 months to sell his first house, the market could change. If a recession happens perhaps his first house would lose value but he would still have buy the first house at big price. That said, it could go the other way and prices could go up.

From the seller's perspective, I imagine him investing the money for a year and if the interest goes beyond 4.5%, he recovers all the money invested in rent. (3k * 12 month / 800k = 4.5%) Or perhaps he wants the first buyer to finance a new house he is building?

Is there any shady reason why the seller would use this strategy?

Answer 1

Is there any shady reason why the seller would use this strategy?

The seller has a reason for staying for many months and they want to get out of ownership now.

If I was presented with a counter-offer like this, I would worry that the seller has inside knowledge of something. They know that the city is going to seize the property for a big project, or they know that there is a big bill and by selling now it becomes the new owner's responsibility.

There can be non-shady reasons also. Their existing mortgage has a balloon payment and this is the only way out they can see. They need to cash in the equity because they need the cash for some other major expense like their 100K of credit card debt.

Even if the reason is benign, the buyer risks that the ex-owners will be terrible tenants.

One way to protect the buyer is to subtract the rental payments for the 12 months from the sale proceeds. This would make the sale price $800K - 12 months rent. Because there is also a risk of them not moving at the end of the lease or of damage to the place, there also has to be a significant security deposit. Don't go the normal 1 month's rent as a security deposit; go for 10 months worth. Local laws could limit the size of the security deposit.

Another thing that could be done is to put all the money above the amount need to pay off the old mortgage, reasonable closing costs, and the rent into an escrow account. The proceeds are only released if they move and there were no "known" surprises.

I wouldn't let the seller set the rental amount. The buyer needs to make a profit each month. They would want to make a profit if they were renting to an unknown person. So the minimum amount would be to pay the mortgage, property taxes, fire insurance, and any other reasonable fees associated with the house. But I would go a little higher just to be safe.

Answer 2

This is not risky, or dishonest. It is known as a contingency. Your relative is free to back out of this deal if it does not work for him.

Although not common, basically your relation is buying a home and becoming a landlord for a period of time. A similar situation would occur if they were buying a home that was rented to a tenant with a lease in place. The new owners would have to honor that lease.

Your relations may feel that this person may not pay the rent, which is always a risk. The rent payments could be put into escrow and doled out as the months pass.

While surprising, this may be motivated by delays in obtaining a new home by the owner. Perhaps there may be a number of project delays and paying a few months of rent in their current home is a small price to pay.

Answer 3

It's not unheard of to charge rent during a closing period, but 12 months is a LONG time. It's a year of potential missed rent payments, and 12 months of "wear and tear" that the seller is no longer concerned about. I would back out just because of that, not because of the rent arrangement. Lots of houses will come on the market in the next 12 months.

It is risky from both sides. If the market is "hot", then the price could go down over the next year, hurting the buyer, but if it continues to rise, then the seller has lost money in opportunity cost, so locking in now removes that risk for both sides.

And look at it this way - the buyer has two mortgages but also has rent coming in to pay one. So perhaps the proposed rent just isn't enough? 4.5% capitalization rate (3/800 * 12) seems a little low but may be right for that market. Could you rent a similar house in the area for that much?

Answer 4

It is not unheard of to have a delayed move out with rent being paid the occupancy time frame.

A standard rental agreement would be put in place for the rental period. The rental fee should be sufficient to cover homeowners' insurance, mortgage payment, taxes, any HOA fees, and some amount of profit.

An escrow account should be funded to be released pending move-out, third party inspection, and completion of any repairs to bring the home back to sell date condition.

The escrow account should be of sufficient amount to cover the full amount of rent for the year period, full deductible or the homeowner's policy and enough additional funds ensure potential repairs not covered by a homeowner's policy.) Rental disbursements can be scheduled from the escrow account as part of the agreement eliminating missed rent. To alleviate concern for eviction, forfeiture of a portion/remainder of the escrow account should be guaranteed if the seller has not moved out by the agreed move out date.

As all of the above are very legal issues, consult an attorney to draw up the required contracts; ensuring all items are legal in your particular jurisdiction. I am not an attorney so the above are just some suggestions that might be helpful to consider.