Making Money With Lease Options, Rent To Own etc..... Let’s start with some basic definitions. definitions. What is a "lease option?" Basically speaking, it is the ability to lease the subject property (real estate) for a monthly, or annual payment amount, and have the option to purchase the subject property for a set price at the the end – end – or or anytime - during the lease period. Lease options go by a lot of different names. "Rent to Own," "Lease with Option to Purchase," and "Purchase Options" are the most common. The names may be different, but essentially all these titles mean the same thing. As you become more educated in different techniques, you find more and more ways to structure the offer, all of which will have an impact on how much you can get paid. There are a lot of reasons to buy property using a Lease Option, from an investor’s point of view.
One of the foremost reasons is that it allows you to control an asset with little, or even none, of your own money. Talk about leverage! You mitigate your downside risk further because you are not the one that has qualified on the loan yet, you can control the asset. Before I get into some of the mechanics, let’s look at some of the benefits to you the investor, as well as direct benefits to the buyer and seller, using this strategy. As I said before, as an investor you can earn maximum leverage with minimum cash outlay. You can put a property under contract to lease-purchase for little to no money, and then find a buyer that would put up the option consideration. You can usually control a property for a 1-2% down payment that would normally require a 10-20% down payment if you were buying. There are also at least 3 ways to get paid when doing lease options; we will get more into that later.
Advantages to You, The Investor Investor
•Maximum
Leverage
•Minimum Cash Outlay •No Property Maintenance •Cash Flow
You also don’t have any maintenance on the property if you shift responsibility to the new buyer; and any and any major problem would fall under the seller’s homeowner policy. The last last benefit benefit listed above is also also the most important - cash flow. You are not a charity. If structured correctly, lease option transactions can give you 3 and sometimes even 4 or more paydays on the same property. With all these things going for it, you can see why lease options are a great way for investors to go. There are several types of options: a strait option, a sandwich lease option, or an assignment assignment on an option. We discuss all of these, and more in detail. Making you money is great for you, but why would a seller ever go for it? Let’s look at some reasons for selling a property on a lease-purchase. When Sellers are more flexible on their terms, they can usually demand a higher sale price. Buyers are more apt to give them what they are asking without haggling, and you, the investor, can still make money. When people are buying a property, they have pride of ownership, and usually take better care of a property. I have actually had thousands of dollars of improvements done to a property, and the Buyers didn’t purchase. purchase. You know what? what? It wasn’t wasn’t a problem. problem. I then then re -rented it, and got paid option money all over again. You could c ould actually go on forever. If you structure a long-term lease up front, you can generate great cash flow. You can also typically get higher rent, especially if part of the payment goes towards the purchase price (more on that below). The Seller can also retain all the tax advantages advantages associated with offsetting income (Check with an accountant). Often times, a seller receives
up front, a non-refundable option consideration, usually a lot more than a typical rental deposit.
Seller’s Advantages
•Get a Top Sale Price •Better Quality Tenant •Higher Rent •Tax Advantages •Non-Refundable Option Consideration •No Management Headaches
We’ve looked at benefits to you, the investor, as well as some for the seller, but what’s in it for the buyer? Lease -purchases are great for Buyers because they can usually get into a house for only 3-5% down. It is oftentimes hard for Buyers to come up with a big down payment. They also get their rent money working for them. I like to structure lease- purchases so part of the Buyer’s monthly payment is credited each month as part of their down payment. It, thereby, increases their down payment each month. Buyers love this. It’s a much better deal for them vs. paying interest on a mortgage those first few years. I like to show them an amortization table to show them the advantages.
To avoid problems down the road, it is good to lock the price today for what they will pay tomorrow. This works well as the buyer is able to lock in appreciation without actually owning the property. Those of you in California, and those of you in some of the other hot markets know what I mean. I think one of the main
benefits of doing a lease- purchase from a buyer’s perspective, especially if they are moving across country, or into an area they know nothing about, is that it is a great way to check out the neighborhood. Let’s face it; some communities are nicer to live in than others. It’s hard to know where "the right side of the tracks" is when you have never lived in the community. The Buyer may also want to "Check out" the property. It can take a while to sell a prope rty to if it’s not in the "Right" neighborhood and in good condition. Nice Properties in Good Areas Only This is also one of the reasons why you, the Investor, only wants to do lease-purchase transactions in "Nice" areas and only with properties that are not in need of repairs. You will find out that Sellers will practically give properties away in bad areas, and there is a reason for this give away. You will end up a landlord with problem tenants if you violate the “Nice Property/Good Area” rule. Stay out of the lower and lower-middle class neighborhoods for lease options. They work best with higher valued properties, for a multitude of reasons. Now that I have shown you some of the reasons it makes sense to structure a lease-purchase transaction, let’s run through a few examples. As I do, I will explain how you can create multiple paydays using this buying strategy.
Advantages to the Buyer The Key to Making it Work Buyer’s Advantages
•Low Down Payment •Rent Money Working for Him •Option Consideration is Credited •Price is Usually Locked In •Appreciation •Time to Evaluate House & Neighborhood
• Control
Example: House on Twin Loop:
How I found the property:
A seller responded to my yellow page ad that stated that I bought houses. I gave him a FREE report which educated him on how I could help him. Motivation for Selling - Find Out "The Why" The husband had a job transfer 150 miles away, and they had purchased another house. The realtor had been by, and told them that they had to spend $5,000 to fix it up before they could sell it because the basement was not 100% completed. It was a nice house in a good area. Solve the Sellers Problem I told them I would be willing to lease the house for 1 year, for $600 per month, as long as I had at least a one-year extension. Their under-lying payment was $750 a month. I told them that in order for me to lease it, I would need them to subsidize the payment at least $150/month, so I could make a profit. You may ask why would they ever do that? Well, there are a lot of reasons.
1. They wanted to sell the house, not just rent it. 2. A Real Estate Agent wouldn’t make the payments while it was listed. 3. $150 a month payment is a whole lot easier than $750/mo. 4. They couldn’t do 2 house payments.
Pay Day #1 "Monthly Payment Spread" An Example of How it Works Your First Payday I think it also important to say that they "bought" me. We developed instant rapport, and they sensed that I knew what I was doing. They knew that I could solve their problem. People will pay for specialized knowledge. I found out the "Why", meaning: "Why they needed to sell". Then, I solved their problem. Within a few weeks, I had rented it out to a new buyer, and created a monthly payment spread of a few hundred bucks that equaled $2,400 a year.
Payday #2 " Front End" Option Consideration.
This is the difference between the amount of "Option Consideration" that you pay the seller, and the Option Consideration you charge the buyer to get into the deal. In the above example, I only had to make the property payments they owed. Since they were moving, that was $600 due in about 2 weeks. I immediately began marketing the property as a "Rent to Own." Within a few weeks, I had found my buyer a mortgage broker with a few dings on his credit. He figured he would be able to buy in about a year or so, and was willing to give me $5,000 as Option Consideration, and rent of $800 a month. I had to take the option payments over time. $2,000 to get in; $500 in 30 days; plus $2,500 in 6 months. I said, "Sure." Let’s get back to the Sellers for a moment. I had d etermined that the Sellers were payment sensitive, and credit sensitive. That was why they were willing to subside the payment. They were willing to basically give me their house for their payoff plus $5K. That equated to me, a purchase price of $85,000. This brings us to the third form of cash flow.
Payday #3 "Back-End Spread" What I mean by "Back-End Spread" is the difference between the price that I had the house under contract to purchase ($85,000), and the price that I had sold it to my new buyer ($115,000) less the option consideration to be paid by the new buyer. The reason I call this the back end is because, the money gets paid to you when your new buyer exercises his offer to purchase. You basically earn the spread between the two contracts. I will explain further in a moment. Before I recap this deal, I want to talk about the Buyer. I had sold the property to them for the option consideration of $5,000, paid over time, plus monthly payments of $800. You may ask why would he pay so much to get int o a house that he wasn’t sure he wanted to buy. You see, most Buyers in his situation will do almost anything to buy. He was a former homeowner. He knew his credit situation would not allow him to get better then an 80% loan to value in the near future, which means he would have to come up with at least $20,000. He didn’t have it, and he had to wait at least a year to get his credit scores up. Besides, when I explained that I would give him a monthly credit of $250 towards the down payment, from his rent payment, it made it a sure thing. What you are asking is a rent credit. Let me explain. His payment was $800/month to rent. I gave back to him $250/month, deducted off the purchase price in the form of a credit. Not bad, huh? Once the Buyer realized that he was basically only paying $550/month in rent, and $250/month towards the purchase price, it was a slam dunk. Structuring a lease-purchase for the Buyer this way helps mitigate any concerns they may have about paying a little higher rent payment. We all know that the bulk of the payment (99% +) during those first few years of paying on a mortgage goes to interest, and only a very small % goes to principle. I just show them an amortization chart vs. a rent credit for a lease purchase where a 1/2 or a 1/3rd of the payment goes to principle reduction, and it is easy. Finding the buyers, if you have the right properties, just isn’t that hard. NOW , LET’S RECAP....
PAY DAY #1 Monthly Payment Spread Payment Out $600 To Seller Payment In $800 From Buyer Monthly Cash Flow: $200 x 12 months = $2400
PAY DAY #2 Front End Option Consideration Option $ Paid to Seller $600 Option $ Collected from Buyer $800 Option Money Collected = $5000
PAY DAY #3 Back-End Spread Purchase Price to Seller $85,000 Sale Price from Buyer $110,000 Rent Credit to Buyer ($200 x 12 mo.) $2,400 Back End Profit = $22,600
GRAND TOTAL $30,000.00 Profit
In the beginning of this Section, I mentioned 3 or more pay days. There are actually a few more. Create "Paper" with Lease-Purchases You can use this technique a few ways. One way is you can take back part of your back-end profits from your new buyer is in the form of a note. In the before example, I could have carried a note for $10 or $15,000. If the Buyer was still going to have a hard time qualifying for the new loan. I would have actually increased my return, and monthly cash flow by earning additional interest. The second way to earn paper on a lease purchase once you get good at creating the deal, is to assign the whole agreement to another investor for a flat fee, and/or take back a promissory note. This gets you out of the deal entirely, but earns you some monthly cash flow. Certain situations may make this an attractive way to go.
Lease Purchases for Cash Flow
Done correctly, lease purchase transactions are on auto pilot. It is a good idea to use an escrow company to collect the payment from the Buyer. Use an escrow company to pay the underlying payment on the Seller’s mortgage directly, so you
know it gets paid. I feel a little stupid saying this, but the one time that I allowed the Seller to pay it, it didn't’ get paid. It’s a story for another day. All I can tell you is, that you must have control in the transaction, or don’t do the deal. One of the
reasons I like a third party escrow company to service the payments is that, when the buyer goes to get their financing, there is an undisputable payment history. Sometimes you can get that rated as a mortgage, and put it on a credit report to help with your Buyers FICO credit scores.
Bottom line....Lease options are an excellent way to go. You can control staggering amounts of property, and not have your name on one single mortgage. It’s funny. If I look back at all my deals over the last 14 years, it’s the ones I owned with bank
financing that have caused me the most grief. Lease options are by far less stressful when things don’t go your way, and market conditions change
JR'S KEYS FOR LEASE OPTION Find A Property That You Would Like To Purchase On Lease Option. Here Are The List Of Steps And Documents That I Use:
Check List Buying Real Estate With Lease Options. 1.
Optioned Property Information Worksheet,
2.
Optionor/Seller's Property Disclosure Statement,
3.
Standard Real Estate Lease Agreement,
4.
Option To Purchase Real Estate Agreement,
5.
Real Estate Optionor/Seller's Affidavit,
6.
Notice Of Real Estate Option Agreement,
.
Checklist Selling Real Estate With Lease Option Use When You Are Optioning To Sell And You Are The Seller
1.
Have Each Applicant Complete "Application For Lease/Option" To Be
Submitted With Reservation Check And Photo Copies Of Identification, Social Security Card, Pay Check Stub And Last Years W-2 Form. 2.
Complete "Application Receipt Agreement",
3.
Confirm Information On Application And Pull Credit Report.
4.
Verify Funds In Account And Deposit Reservation Money Check.
5.
Prepare And Execute "Standard Real Estate Rental Agreement"
6.
"Move-In/Move-Out Inspection Report"
7.
Prepare And Execute "Real Estate Option Agreement"
8.
Mark Your Calendar For A Date Before Which The Option Must Be Exercised
And Write A Letter Or Call To Remind Optionee/Buyer Of The Timing In Order To Insure That The Date Does Not Pass Unnoticed. 9.
Upon The Receipt Of Buyer's "Notice Of Intent To Exercise Real Estate
Option" Within The Time And In The Manner Allowed Under The "Real Estate Option Agreement", Then; Prepare And Execute Standard Real Estate Purchase And Sale Agreement" 10.
Follow Standard Procedures For Closing The Sale.
11.
If Extending Option Term, Prepare And Execute "Extension Of Option To
Purchase Real Estate Agreement"
Now those are some of the documents and steps that I would use. Depending on the deal would determine the paperwork
Never focus on just one; sellers or buyers. Focus on getting BOTH buyers and sellers at the same time.. if you had to choose, however, get educated on finding sellers FIRST! You'll be able to practice negotiating and become an expert at talking with sellers... Once you've got that down, the buyers will come... buyers will and always have been an easy thing to find... there out there...
So focus on BOTH buyers and sellers, but sellers first if you had to choose one (to prevent you from getting overwhelmed)..
You can take an option in your name then assign it to a tenant buyer and step out of the way. This does not require a closing at your transaction, contract assignments are not real estate transfers, but can be filed for record if needed. :)
I invest in real estate that has been on the market a long time or more is owed than the current value so I am dealing with sellers who are more motivated to sell so I only pay $10.00 option fee.
in order to avoid a large option fee to a seller it important to take the right approach, have the right presentation and it has to benefit the seller enough for it to have value to them
Selling lease options is actually the focus of my business. To begin with, I just tell them if they are looking for any money, it will need to be on top of my 5% assignment fee. So if they are selling a 100k house, then I get 5k so if they need 3k then we gotta find someone with 8k. Then I ask them If I should ignore a good buyer for the property that does not have at least 8k. They usually quickly come around and tell me just to get someone good.
I personally use an attorney to draw up all of my papers and close the deal at his office. I charge the buyer for this service. All checks are written to the escrow account, and checks are cut accordingly for first month rent and assignment fees.
You work with the owner to set the numbers, including the option price, rent and rent credit. When I send preliminary figures to the owner, I know that those are very likely the figures we are going with. I include in there my assignment fee, and I normally give the owner $1k of that, since there is no deposit with a LO, or at least you really don't want one.
Then, you sign the docs with the owner, giving him $5 or $10 or whatever for option consideration, and you now need to bust it to find a tenant/buyer to assign it to. You aren't assigning it to an investor, you are assigning it to the end buyer.
The rent credits should reflect on your docs as a seller concession, and I don't even use the term rent credit or show a monthly rent credit on the option to purchase, just the total concession.
The payments go from the T/B to the seller, but you can use an escrow service for this, but there is a fee of course. I don't use an escrow service. No need for it for how we structure everything, but that's up to you.
You don't need an agent to market the property, but that's up to you, and about how you structure your model etc.
You can't necessarily charge a much higher lease amount either. We normally set it at the going rent rate, or about what the payments will be at finance.
All Real Estate, like politices (LOL) is local.
It doesn't matter what strategy you want to get into, before you begin you really need to talk to a local RE attorney. IMO, you should never use a contract from some other area (state) or any site without running it past a local attorney.
As to title folks, they are in the phone book, you need to talk to these folks and see what they will do, ask, they will be a good source of information for local
requirements. Not all are investor friendly, so shop around and don't take the word of one closing agent as gospil. If you hei a dead end on any issue run it by the attorney as he or she may convince the closing agent that all will be well in some cases. Good luck
Title companies are insurance agencies basically, providing title insurance. These agencies are often owned by attorneys, but an agent does not need to be an attorney. If a title company is owned by a non-attorney agent, they will have some relationship with a local attorney to cover the bases of the business.
An escrow closing is usually done by an insured closing agent or an attorney. Lenders may also close thier own loan transactions involving sales and usually have an insured closing letter, a gurantee by a title insurance company to cover any errors or ommisssions in such closings. I use to close my own loans and obtained title coverage.
An escrow is simply money held in trust, Real Estate Brokers may have escrow accounts and may close transactions but that is rare today due to compliance issues, liability assumed and the fact that the services are affordable.
Attorneys may also close transactions and they will also have escrow accounts to hold money in trust to facilitate a closing. Title insurance will generally be afforded for an attorney closing as they are also insured and bonded as attorneys and meet such requirements.
You should look to an attorney or title insurance company in your area to provide closing services for you. You could have a situation where an attorney is willing to close a transaction yet a title insurance company will not insure the closing but
will provide title insurance. In such a case, it is the attorney's professional coverage that may cover the attorney services. This is probably rare now but could be arranged if allowed under state law.
So, as an investor, you should have choices, however, when you sell and the buyer obtains a loan, that lender may require how, where and when such loan is to be closed.
Talk to TI folks and RE attorneys in your area to see what best fits your needs.
Call the local Board of Realtors and ask them who thier attorney is for the Board, they might give other names, maybe thier past attorney if they'd rather not say. Call title companies and ask them. Call the Bar, they will give you a list of RE types. You can also ask RE Brokers. Some attorneys may say they can't help, that probably means that if they are on retainer with a broker or Board, they may feel that any matter that comes up with you may result in a conflict of interest.
Interview with several, it should be free, you'll get thier sales pitch but figure out who you click with best and assess thier experience in the area.
You can live in fear or you can step up. Talking to a RE attorney is a good idea. The best idea is call your state Real Estate Commission and meet with a compliance officer and tell/show them what you want to do regarding lease options. Then you can determine from the get go if you are in compliance or not
Originally posted by Robert Burns: I've was recently sent a complaint by my state real estate commission board regarding my lease option work. I met with them and reviewd my lease option agreement and explained to them that I was simply "assigning my rights in my lease option agreement" and receiving an assignment fee for such. It is LEGAL to assign your rights in a contract. It's done all the time in all types of businesses. Robert I love this soooo much. Face the fear. Do the right thing. This is a valuable business if you do your due diligence, and that includes investigating the local Realtor board.
This is my explanation to real estate agents and brokers.
"I have looked into this matter with my attorney. I am entering into agreements as a principal and I do not act as an agent for a fee or commission.
Anyone can assign an interest in a lease, an option, or a bill of sale for a fee, acting as a principal."
Then ask them,
"If you have a listing about to expire, for whatever reason, please call me, I may be able to help."
Lastly, I place this on my Letter Of Intent to Lease and To Option:
"Please be advised that the undersigned is interested into entering into a Rental Agreement and Option to Purchase Agreement. Please be advised that I am a real estate investor that intends to enter into the agreements contemplated for the purpose of investing in real estate as a going business concern. I now provide you with this Letter of Intent. "
There are two major problems with lease options the way they are being taught in seminars:
The percentage of tenants who fail to buy the home is scandalously high There are numerous other serious, potential ethical and legal problems High failure rate Claude Diamond runs his lease-option business in a way that I object to, although it's pretty typical. He says about 50% of his lease-option tenants are unable to exercise their options. That means that about half the people who do business with him as lease-option tenants end up thousands of dollars poorer as a result when they walk away from their large front-end payments and year or two of above-market monthly rent payments. These are people who entered into the deal in the hope of becoming homeowners and leave less able to become homeowners than they were when they first met Diamond.
That reminds me of the trade schools whose students pay thousands of dollars tuition, then a high percentage of the "graduates" of the school cannot find a job in the field for which they were trained. When I voiced my objections about the high rate of his lease-option tenants being unable to exercise their options, Diamond asked, "Whose responsibility is that?"
In other words, if a lease-option tenant pays Diamond thousands of dollars for the lease option, then loses it all because they are unable to exercise the option before it expires, that's the tenant's problem, not Diamond's, even when it occurs half the time. I disagree with that attitude toward such a high failure rate. And I give the
general advice that whenever you deal with anybody in any field of endeavor, you should make the working assumption that the person will treat you the same way he treats other people.
Other lease-option practitioners have failure rates as high as 95%. That's not right. The lease-option tenants are typically young couples who cannot afford their dream of home ownership and are convinced that a lease option is a back door to owning a home. In fact, the vast majority lose the thousands or tens of thousands of extra dollars they shell out, above and beyond what a lease would have cost. When the lease option is over, they are far less able to afford a home than when they started. I suspect many permanently lose their ability to buy a home because they fell for the false promise of the lease option.
There is no question a lot of real estate investors are making a lot of money from lease options. But most of it is dirty money earned by scamming young couples, not by finding a need and filling it, the age-old legitimate path to profits. Rather, this is the predators' way: a fool and his money are soon parted, so devote your life to finding fools and taking their money.
The tenants do not exercise the options for two reasons:
The option is not in the money The tenant's financial difficulties that prevented him from buying a home to begin with were never fixed 'In the money' An option is “in the money” when the option price is less than the current market walue of the property. You would not exercise unless that were the case. In
probably the vast majority of cases, the landlord sets the option prices in the lease option so high that the option price is never likely to be less than current market value. Furthermore, on the rare occasion when the option price turns out to be less than market value, the landlord just reneges. In the stock market, they have procedures to prevent that. No such procedures exist in real estate.
Can't qualify Lease options are targeted at people who want to own a home but who lack the cash down payment, credit, and/or income to qualify for the mortgage. In virtually all cases, there is little reason to believe that will change during the two or three years the option lasts.
So by making a lease option that is never likely to be in the money to a person or couple who is not likely to qualify for a mortgage so they can exercise the option, the lease-option scammer does a deal that he is pretty certain will result in his pocketing $10,000 to $20,000 of the tenant’s money and leave the tenant out in the street with nothing—no benefit from having paid all that extra front money and rent.
Legal problems Lease options are explicitly named in numerous laws and legal documents as triggering events. They trigger almost all mortgage due-on-sale clauses. They trigger reassessment for property-tax purposes in California, thereby wiping out the protection California homeowners normally get from Proposition 13.
Another problem is the legal doctrine of substance over form. It is possible to do a lease option that is clean. But the various gurus advocate doing lease options in a
way that arguably triggers the federal income tax doctrine of substance over form.
That doctrine says that what you call something does not necessarily determine what the law will regard it to be. Calling a lease option a lease option does not mean the court will treat it as a lease option. In fact, I believe they will treat most guru-designed lease options as land-contract sales in substance. The legal implications of such a determination are amazing in their number and seriousness. You could have a tax-free exchange invalidated. You may find that you are unable to evict the tenant. IRS may say that all your lease options were installment sales and that you must pay overdue tax and penalties on them, tax that will be inflated by the typically inflated option prices
Here are some issues that will get you in trouble, give you a bad reputation, maybe jailed as some "investors" here have been;
The SAFE Act
Tenant/landlord law
Consideration given for a valid contract
Preditory lending/financing and transactions
Fraud, puffing the deal
So far, while I know you want to make as much as you can, you're headed down the road of scammers, step back, get away from guru strategies and give yourself time to study the basics. RE is an area where you can easily get bad advice, wrong answers and be lied to by others, especially when they have a vested interest selling you crap.
