Lease options

Would you like to be able to make money on deals that other people avoid? Would you like to make money on deals without risking your income or credit? Would you like to get some money now, make money each month, and get a large chunk of money in a few years? You might be ready for Lease Options.

Lease Options are actually two separate functions; the lease, and a separate option to purchase. You are also, as an investor, going to securing the right to sublease to a tenant buyer for a larger monthly payment and/or a larger non refundable option fee. We will also explore three levels of sophistication in this article; a basic option, a more advanced option, and a sophisticated user option. Choose your comfort level.

Why would you consider lease options?

Advantages to you:

No purchase, therefore no income or credit needed.
No risk to you, other than the monthly payment.
Each month your equity in the property increases.
You can do this with properties that have very little equity…as LONG AS YOU HAVE POSITIVE CASH FLOW.

Advantages to the seller:

If there is no equity, they can walk away from the mortgage without having their credit destroyed.
They get to write off the interest, and depreciation, on their income taxes each year.
They don't have to worry about double payments, maintenance, or repairs.
They still own the property so their perceived risk is lower.

Advantages to the tenant buyer:

They can lock in a price amid escalating appreciation and know what their purchase price will be in the future.
They can work towards acquiring a down payment through the non-refundable option fee and the additional payments applying towards non-refundable option fee plan, (Which shall be converted into a down payment if they execute the option to purchase.)

How does it work?

1) You must find a seller that NEEDS to sell, but does not necessarily need cash. (People that are in the early stages of pre-foreclosure, divorce, moving, transfer, tired landlord, etc…)

2) Make sure that the house doesn't need ANY repairs.

3) Negotiate with the seller to buy the house in a lease option where you will:

· Take over the payments

· Negotiate with the seller so that the purchase price shall be the mortgage payoff/or the declining mortgage balance, whichever is less.

· Have the seller pay the payments for the next three months while you find a suitable tenant buyer.

· Have an option period of AT LEAST five years, hopefully for the duration of the mortgage.

· Add your name to insurance policy as an "additional insured" payee.

4) You will take care of all maintenance, repairs, and you send the payments through an escrow company so that each month the seller will see that the payments are being made.

5) When you execute the option to purchase (when your tenant buyer executes- you execute) you will purchase the property at the declining mortgage balance and sell it to your tenant buyer at the agreed upon purchase price.)

6) You are looking for a tenant buyer that has: good income, good cash, but had a hiccup in their credit. (Your ideal Tenant Buyer just had a bankruptcy and can't qualify to purchase for two years.

7) They will give you a NON-REFUNDABLE OPTION FEE of 3% to 5% of the purchase price that will be applied 100% towards the down payment if they execute. (If they don't buy it, you keep the money. It is non-refundable. DO NOT REFER TO IT AS A DEPOSIT OR A DOWN PAYMENT.) On a $300,000 property, that would be $9,000 to $15,000. The more money you receive, the fewer problems you will have with the tenant buyer.

8) They will purchase it at a future value price.

Example: If the property is now worth $300,000 and you have historically had 6% appreciation over the last 10 years, multiply $300,000 X 1.06=value after year 1. Multiply that figure X 1.06 to get value after two years. (In this case your $300,000 property would have a contracted purchase price to the tenant buyer of $337,080 at the end of two years.)

9) The rental payment will be at market rental prices. If they choose to make an additional payment, give them a two for one credit. For every $100 they make in additional payment, give them a $100 credit towards the non-refundable option fee, as well as a $100 reduction in the purchase price. (Lenders will want to have that money verified, and be on a separate check. They will also want to verify market rent. Get as much market rent as you can, and don't be stingy with giving up the two for one credit. If they pay an additional $100 per month for 24 months that is an additional $2400 in cash flow for that time period. You are going to be giving up $4800 in total credits…but you have inflated the purchase price to account for that. If they don't execute the option to purchase, you keep the $2400.)

10) At the end of two years, if they decide to execute, they will have their purchase price locked in, and their non-refundable option fee will be credited towards their down payment. (You keep copies of their check; you do not keep the money in escrow.)

How does it work for you?

1) You are able to control a property without using any of your income or credit.

2) You receive a large non-refundable option fee up front. This option fee doesn't become a taxable event until the tenant buyers either buy the property, or walk away. (At which point you can sell the property to someone else.)

3) You receive a positive cash flow each month.

4) When the tenant buyer executes the option you get the difference between the declining mortgage balance and the contracted purchase price. (If the Tenant Buyer walks away, you resell it to someone else at a higher price.)

5) The spread between the balance and the contracted price becomes larger each month. If you have to resell the property, you have the non-refundable option fee to use as cash to pay for any repairs. (The larger the non-refundable option fee, the less damage, historically, you will have on the property.)

6) This does NOT affect your debt to income ratios, it does not affect your credit score, and you can control multiple properties without excessive maintenance if you write your leases so that the Tenant Buyer handles all maintenance. (Major repairs, of course, would be covered under homeowners insurance.)

Basic options:

Find people that would like to sell their properties. Propose to do a lease option with them for an extended period of time with the right to sublease.

Advanced option: Ask the sellers to pay the first three months of payments.

Sophisticated option: Ask the seller to have the purchase price be the payoff amount…or the declining mortgage balance…whichever is less.

Basic options:

Have the seller allow you the right to sublease it. Have an option period of two years

Advanced option:

Convince the seller that it is in their best interest to not charge you an option fee, so that you can have a good tenant buyer and you will be responsible for the maintenance, repairs, and payments. Have an option period of five years.

Sophisticated option:

Have the option period with the seller be the length of the mortgage. Have the tenant buyer give you a 3% to 5% non-refundable option fee which shall be credited 100% towards their down payment if they execute the option to purchase. If you NEVER sell it to a tenant buyer, you can execute when the mortgage is paid off.

Basic options:

Have the tenant buyer pay in cash for the non-refundable option fee.

Advanced option:

Have the tenant buyer pay in part cash, and accept additional payments on a monthly basis.

Sophisticated option:

Have the tenant buyer pay cash, ask for more non-refundable option fee, and see if they can have a co-signor that can contribute additional assets. Take title to boats, planes, cars, vacant lots, or time shares if they have value.

Basic option:

Do everything you can to avoid conflicts.

Advanced option:

Do everything you can to avoid conflicts that would take you to court.

Sophisticated option:

Do everything you can to avoid conflicts that you would lose in court. Structure everything so that you have no risk of losing.

Summary:

Lease options offer a way to control large numbers of properties in a way that gives you immediate cash, residual income, and deferred income in the near future. Consider this as a way to produce income on properties that have little or no equity to increase your options in your market.