Real Estate Acquisition Tips

A Management/Option Contract To The Rescue

by Marvin Levin

This idea comes from my friend and colleague, Bob Kagan.  Bob has been teaching real estate development and real estate finance at San Francisco State and Golden Gate University for more than 25 years, and is a treasure house of really great real estate ideas.

Bob reported a transaction from the early 1980s when real estate and general inflation was rampant. If you could control a real estate asset for a nominal down payment, the chances were pretty good that you would prosper.  However, if the same asset at the same price required a large down payment, you might have a bad experience if the market turned down (which it certainly did after the Tax Reform Act of 1985).

In the transaction Bob cited, the seller of an apartment was adamant about getting a price that seemed high.  It was the sort of property that you would buy for 1% down, but very few sellers will go for the “cup of coffee” down payment.

Well, Bob had a pretty good reputation as a property manager, and he made the following offer to the seller.  He would manage the property for a competitive fee of 2% of gross income, and he would guarantee that the net income would not fall below a certain number.  Bob calculated that it would fall below that number in the first month and a little bit less the second month, but by the sixth month the property should earn the minimum that he had agreed to provide.  If you were to add up the cumulative loss as a result of that guarantee, you wouldn’t be surprised to learn that it would be about 1% of the purchase price.  However, Bob also added in an option to purchase the property at approximately the seller’s asking price, and the deal was done.

This management contract plus option gave Bob everything he wanted.  Fundamentally, he needed a nominal down payment, but he also needed some time to put the equity capital together.  After he raised occupancy and rental rates to market, it wasn’t hard to obtain a new loan and some equity partners.

If you know of a value-added or problem property, please contact me.