THE LOST LAND CONTRACT

By Kirby K. Gordon

Printed with permission, by A+ Institute

Is it time to dust off the old Land Contracts formally known as "Long Form Security (Installment) Land Contract With Power of Sale and Assignment of Rents?" Widely used in the 1970's these once popular instruments for conveying an interest in real property should not be overlooked in today's market by sophisticated investors and real estate professionals.
Why use a Land Contract? Traditionally, Land Contracts have been used to "wrap around" a low interest fixed rate loan. They differ from the typical "All-Inclusive Note Secured by a Deed of Trust" in that no grant deed is immediately recorded. The Land Contract is an agreement to transfer the deed in the future. The Seller (known as the "Vendor") retains bare legal title in his/her name and transfers the beneficial interest in the property to the buyer (known as the "Vendee"). The IRS and most local taxing authorities consider the recordation of the Land Contract to be a transfer which triggers a taxable event for both income taxes and property tax assessments. Since you can combine an installment sale with a 1031 tax deferred exchange you could use the Land Contract as part of an overall tax strategy for sophisticated clients.
Although they do not like to publish the fact, several national title insurance companies will issue Vendor/Vendee Title Insurance Policies on the recorded Land Contract. They usually require tha Land Contract to be prepared by an attorney since it is considered the practice of law in most jurisdictions to prepare such agreements. However, the title companies will give you the required provisions that they need in order to issue their title insurance policy. Land Contracts with the Power of Sale clause can be foreclosed non-judicially by the Trustee of the Land Contract just like the typical deed of trust. Without this important safeguard of having title insurance Land Contracts would have little practical value.
The major reason to use a Land Contract is to obtain the spread between a low fixed interest rate charged by the underlying lender and the current market rate which a buyer/vendee would accept on the Land Contract. A simple example will illustrate the benefit to the seller/vendor. If the seller has a $500,000 fixed rate loan at 5.5% and the buyer/vendee is willing to pay 6.5% then the "spread" is 1% per year ($5,000). Thus, the seller/vendor makes $5,000 on the lender's money. If in the example above the seller/vendor carries a Land COntracr for $501,000 which wraps around the $500,000 then he/she is only carrying $1,000 of new loan money. When you calculate the return on the $1,000 that is being carried you can see that it is enormous! Therefore, the less you carry over and above the underylying loan the higher your rate of return.
Lenders, however, rarely want anyone else to make interest, especially on their money. Even though their focus should be whether there is an impairment of their security (there is none) they will usually try to accelerate the loan under their alienation clause contained in the note if they discover it. Since the Land Contract is an agreement to transfer the deed in the future, the lenders rarely see the recording. The smart practitioner will keep the same insurance coverage and simply add the buyer/vendee to the existing policy as an additional insured. The lender does not see a change in insureds which triggers an investigation of the loan. Payments to the underlying lender should be made by a trusted 3rd party collection agent/escrow. Many times you can have the lender impound for taxes and insurance and the buyer/vendee can simply add this impound amount to the payment and everyone knows that the insurance and property taxes are paid on time.
Obviously there are risks in using the Land Contract, and they should only be used with sohisticated clients who can evaluate the risks and rewards. Where both the buyer and the seller are experienced and knowledgable the Land Contract has benefits to each. The buyer/vendee saves the points and loan fees or assumption fees since it is a type of owner financing, and the seller/vendor makes additional interest on the spread. Structuring such a transaction requires competent legal, accounting and title professionals.
The author is a licensed attorney/broker in California with 34 years of experience.Kirby K. GordonBroker/AttorneyGordon & Gordon Real Estate760 Mattie Road, Suite A-1Pismo Beach, CA 93449(805)773-2610(800)394-2610(805)773-6050 faxgordonandgordon@charter.nethttp://www.gordonandgordonre.com/