There are literally dozens of ways to purchase a property with little or no money down. These tend to work well with real estate investors that are just starting out or the experienced investor that is reaching the limits of their available cash and/or credit. For these investors, a lease option (also known as rent to own or something similar) can be a great creative financing option. We aren’t going to go into the specifics of how to do a lease option in this article, but instead, are going to dwell on the advantages of a lease option. Once you have convinced yourself that this is a great way to go, you can load it to your arsenal of real estate investment strategies to help you on your road to success. They key is being educated and having someone to guide you along.
For those of you that are totally new to this concept, a lease option is merely a contract between a buyer and seller. The buyer then has the option to purchase that property at an agreed-upon price at a specified time. (There may be other terms and conditions involved) Many investors act as a master tenant or middleman. The master tenant leases a seller’s property from a motivated seller and agrees upon a selling price when they exercise their option. The investor then finds an end buyer/tenant. This end buyer will normally rent the property for a specific period of time (12-24 months or more) and then choose at the end of the option period to move away or purchase the property at a pre-agreed upon price. Obviously, this price is higher than the agreement between the seller and investor.
The Lease Option strategy works well in my home state of Colorado as well as most other states. However, in some states such as Texas, there are some restrictions. It’s a great idea to check your state and local laws regarding lease options.
Here are 10 great reasons that a lease option can work well for a real estate investor:
1. Little Outlay of Cash. With lease options, you are normally dealing with decent looking properties that require minimal fix-up. The sellers are normally pretty motivated. (Relocation, divorce, illness, late on payments, etc.) In most cases, the sellers don’t require a ton of cash upfront. The cash they do get, if any, can come from your end buyer’s option fee.
2. Doesn’t Go on Your Credit Report. Because this is a private transaction, you don’t need banks and it won’t go onto your credit report.
3. You Can Usually Pay More for the Property. On lease option properties you normally have as an end buyer, someone that has income but can’t yet qualify for a standard loan. Because you have several profit centers on a lease option (see item #10) you can afford to pay a bit more ordinarily. Please note that you still have to do your numbers to make sure that they work.
4. You Can Normally Sell at a Higher Price. Once again, this goes back to the type of buyer motivation. The buyer isn’t as interested in “How much?” but is more pointed to “How much down and how much per month?” Please note that your goal is to get the end buyer to eventually qualify for a standard loan, buy the home, and then cash you out. With a standard FHA or conventional loan, the house will have to appraise for that eventual selling price.
5. You Can Normally Command Market Rents. Because you have a motivated buyer, you can normally get market rents. Some investors propose that you can charge a lot more, but we haven’t found that to be the case. That being said, you can normally charge at the high average end of the spectrum, within reason.
6. Good Cash Flow. Lease options tend to produce good cash flow if you do your due diligence and get the right properties. The option fee plus your monthly rent (less paying the seller’s mortgage) can be substantial over a year or more.
7. Minimal Risk. With a lease option, you also have the right to exercise your option or not. If things aren’t working out, you can always give the property back to the seller. That being said, this scenario should be the exception rather than the rule.
8. Fewer Repair Issues. A lease option buyer is going to be hopefully, a future homeowner. In that regard, a strong lease option contract will stipulate that the end buyer is responsible for the small repairs. The original seller is then responsible for the large repairs such as furnaces, water heaters, etc. Be aware that this is great in writing but as a practical matter, you still may have to work out something with one of the parties if there are repair issues.
9. End Buyers are Normally Higher Quality. Your standard end buyer is normally more stable both financially and as a future homeowner than a standard tenant. In that regard they normally, but not always, take better care of the property and pay more promptly than a standard tenant. You have to qualify them just a diligently, if not more than a standard rental tenant.
10. There are Three Ways of Profit on a Lease Option. This is the strength of a lease option when done properly. First, you have an option fee that is paid upfront that can be anywhere from a couple of grand to 3 to 5% of the eventual selling price. Second, you have your monthly net cash flow after paying the mortgage. The third is the final selling price of the property, which can net you a nice bundle!
Hopefully, this article has convinced you that lease options can be a great investment strategy! They give you, short-term, medium-term and long-term cash flow. Remember though, that for a lease option to work out, it has to be done correctly. We highly recommend getting as educated as possible on the techniques and paperwork. In addition, a mentor or experienced associate can be priceless in ensuring that you have done it correctly.
Finally, be sure to check your local laws. Please be aware that there are a couple of states, which either outlaw lease options outright or have strict rules and regulations regarding them. The Lease Option strategy works well in my home state of Colorado as well as most other states. For most areas, however, lease options are an opportunity to help a distressed buyer, help a challenged potential homeowner and to put a little cash, both legally and ethically, into your pocket. It doesn’t get any better than that!
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