As you become more educated in different techniques, you find more and more ways to structure your offers. All of which will have an impact on how much you can get paid. One way to maximize your profit and generate three paydays in the process is to use lease-purchase options. Lets start with some basic textbook definitions:

What is a lease?
A lease is a grant of the use of lands or property for a specified term of years in exchange for the payment of a monthly or annual rental. 

What is an option?
An option is an agreement or contract in which the owner of property agrees to sell it at a specified price, within a specified period of time, at the option of the buyer. The buyer is not obligated to buy, but the seller is obligated to sell if the buyer chooses to exercise the option. During the option period, the seller cannot sell to anyone else.

In light of the definitions above,
what is a “lease-purchase option?” It is the ability to lease the subject property (homes, land, apartments, etc.) for a set monthly or annual payment amount. During the course of that lease term, you have the option to purchase the leased property for a set price at any time during the lease period.
In the investing world the term lease-purchase can go by a lot of different names. “Rent to own,” “lease with option to purchase,” “purchase options,” and “lease options” are the most common.  The names may vary, but essentially all these terms can mean the same thing.

There are a lot of reasons to buy property using a lease-purchase strategy from an investor’s point of view. One of the main benefits to lease-options is the ability to control an asset with little, or even none of your own money. Talk about leverage!  You mitigate your downside risk even further because you are not the one that has qualified and is financially liable on the loan. Yet you can control the asset. You have locked in upside profit with limited downside risk. That’s just plain smart!

EXAMPLES
Before we get too far into the details, let’s look at a couple simple examples. The first example is a straight option, the second is a lease-option with a sandwich lease.


As we discuss some of our creative strategies, you need to understand how it will work within your state. You need to get educated on the strategies and then you need to find out how you can execute them in the state where you choose to do business.  I have done a fair amount of real estate deals in three different states. All three have similarities, but certain “procedures” are different. You will still find ways to do creative deals, but you may have to alter the strategy somewhat to work within the real estate laws in your state.

One example is the issue of “simultaneous closings” of escrows. I did this all the time in Idaho at the title company. However, in Utah, “simultaneous closings” are against the insurance commission’s guidelines and are not done.

But in Utah I can do a “wrap-around mortgage” on an all-inclusive trust deed and even get title insurance.  In Idaho the title companies wouldn’t touch them because they typically had loans on the underlying wrap that had due on sale provisions.  Go figure.

As a general perception, we also discourage you from talking to Realtors about creative strategies, unless you have an open-minded agent. You need an agent with a good 10 years in the trenches, because in our experience, they think everything an investor does is illegal anyway.

You have to understand that a Realtor has a responsibility to the Seller to point out all the things that can go wrong with your creative offer (especially if they have to wait for a commission). Even if your offer solves the seller’s problem, they may discourage it because they feel it too risky for the seller.  Since risk is subjective at best you may get discouraged fast.

With many agents their primary emphasis is the retail market, getting listings and/or buyers. It is a different game and emphasis for them. Our real estate agent interview questions in Chapter 3.3, Professional help, are a great tool for you in this area.

We’ve looked at the basic structure, now let’s look at some of the benefits to you, the investor, as well as direct benefits to the buyer and seller.
Everyone Benefits:

Investor Benefits

As an investor you can earn maximum leverage with minimum cash outlay. You can put property under contract to lease-purchase for little or no money and then find a buyer that will put up the option consideration. You can usually control a property for a 1-2 percent down payment that would normally require a 10-20 percent if you were buying. We will get more into that later.  You also don’t have any maintenance on the prop-erty if you shift responsibility to the new buyer, and any major problem would fall under the seller’s homeowner policy.

ADVANTAGES TO YOU, THE INVESTOR MAXIMUM LEVERAGE

·    Small percent of cash allows you to control entire asset MINIMUM CASH OUTLAY
·    Target is 0-3 percent of purchase price

NO PROPERTY MAINTENANCE
·    Major repairs insured through homeowners insurance policy
·    Minor repairs assumed by tenant/buyer

CASH FLOW
·    Your make the spread between what you lease it for from the seller and what you lease it for to a new tenant/buyer (sandwich)

The last benefit listed above is also the most important - cash flow. You are not a charity. Unlike a classic buy/sell strategy, lease option transactions, if structured correctly, can give you three and sometimes even four or more paydays on the same property.

Dealing in lease/options is a great way for new investors to get into the real estate business with-out having to go out and qualify for new loans and worry about big cash down payments. You can also test out your ability and desire to manage proper-ty.  With all these things going for it, you can see why lease options are a great way for investors to get started.

As an investor there are a host of good reasons to create lease options, but why would a seller ever go for it? Let’s look at some reasons why a seller would want to sell a property on a lease-purchase option.

Seller Benefits


Lease-purchase is a great way to sell a property.  The advantages we discuss apply to both you and the seller. In some cases, you may be the seller as well as the investor.
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 with-out haggling, and you, the investor, can still make money.

ADVANTAGES TO THE SELLER GET A TOP SALE PRICE
·    At or above market for good condition property BETTER QUALITY TENANT
·    They look at occupancy as an “owner” not as a “renter” HIGHER RENT
·    Buyers will pay more monthly to avoid a big down payment TAX ADVANTAGES
·    Interest deductibility (See your accountant)

NON-REFUNDABLE OPTION CONSIDERATION
·    Bonus money can be paid at signing, monthly or yearly NO MANAGEMENT HEADACHES
·    Defer repairs to the tenant/buyer (home-owner mentality)

When people own property, they typically have pride of ownership, and usually take better care of a property. In several instances I have actually had thousands of dollars of improvements done to a property, and the buyers didn’t purchase. You know what? It wasn’t a problem. I then re-rented it and was paid the option money all over again.  This could go on forever. Even if a tenant defaults on the option and moves out, you can re-option-lease the property to a new tenant/buyer at a higher price. In an appreciating market this is easy to do.

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 toward the purchase price. For instance, market rent is $800/month but you can get $1,000 a month because $200 each month goes toward the purchase price of the house, and $800 goes to the rent. (See the example at the end of this section).

The seller can also retain all the tax advantages associated with offsetting income (NOTE: Check with your accountant as individual tax situations vary). Often, a seller receives a non-refundable option consideration up front, usually a lot more than a typical rental deposit. The seller may not have to realize that income (option consideration) until the option is either exercised or expires.

There may also be tax advantages with interest deductibility and depreciation factored The option money received, if structured correctly, can be NON-REFUNDABLE. That means it is theirs to keep, even if the buyer does not buy the property.  You can write up your transaction where the tenant/buyer pays rent and an option payment each month. Just have them write 2 checks, one for rent, and one for the option money. On the option check, have the tenant/buyer write “non-refundable option consideration” in the memo line so there is no question if there is a dispute down the road.
As a seller, when you set up your transaction one of the things that you want to get away from is the day-to-day management of the property. Nothing is worse as a landlord than getting called late Sunday afternoon with the basement flooding sewage because the sump pump is not working. There are a million reasons you can be called if you are the one responsible for the property.

I like to shift the responsibility to the tenant/buyer if at all possible. I find it easy to do when they are getting into the property and make it clear that they handle all routine maintenance, like clogged lines, leaky faucets, annual inspection of furnace, filters, etc. I ask the tenant buyer to handle any repair under $200 or so and have them agree to it in the contract. Since they view this as a purchase, they are usually happy to.

I agree to handle any major structural repair like roof leaks. Many times, a repair of that magnitude will be handled in your home owner’s policy anyway.  So, essentially I am able to release myself from any day-to-day management headaches.  If you have certain items that require continual maintenance, like yard maintenance, have a provision in your agreement that allows you to step in and pay when necessary. Just make sure the expenditures can be reflected in the final purchase price so you don’t lose out. Sometimes tenant/buyers can be slobs and it is in your best interest to keep the property up. If they are trashing the place or violating the agreement, don’t hesitate to evict them. We’ve looked at benefits to you, the investor, as well as some for the seller, but what’s in it for the buyer?

Buyer Benefits
Buying a property with a lease-purchase strategy is great for buyers because they can usually get into a house with a nominal down payment. In many cases only 0-5 percent down. It is frequently hard for buyers to come up with a big down payment, for various reasons. However, many buyers can come up with an extra $500 a month if it means the difference of getting into a house today verses waiting to save the elusive down payment.

ADVANTAGES TO THE BUYER LOW DOWN PAYMENT
·    Usually 0- 5 percent of the purchase price
·    Make the down payment over time RENT MONEY WORKING FOR HIM
·    Get part of rent going toward the purchase price OPTION CONSIDERATION IS CREDITED
·    Accumulate down payment over time

PRICE IS USUALLY LOCKED IN
·    Gives you time to arrange the best long term financing package APPRECIATION
·    If market appreciates you win. Increase equity position without ownership TIME TO EVALUATE HOUSE AND NEIGHBOR-HOOD
·    Live in area before you commit to a mort-gage

CONTROL AND FLEXIBILITY
·    If you like the home and neighborhood, exercise your option. If not, move when the lease/option period expires. You decide.

Today there are many low or no down payment loan programs on the market, but there is still a percentage of good people that cannot qualify. They may be self-employed or starting a new business and do not meet the underwriting guidelines for a loan with a minimal down. For this reason there will always be a pool of buyers for properties that are in good condition in nice, well kept neighborhoods.  Buying a home on a lease-purchase is also a good way for a buyer’s rent to start 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. For example, with a $2,000 monthly payment, $1,500 is rent and $500 goes toward the final down payment, build-ing their down payment each month.

Buyers love this. It’s a much better deal for them than interest on a mortgage those first few years.  Run an amortization schedule for them so they can see for themselves. You’ll find a sample amortization schedule in Appendix A, Forms and Work-sheets.  If you do go this route, it is important to have them make their payments to a third-party escrow company, attorney, or management company so you have independent verification that payments are made on time. It could help the buyer when they exercise their option and the lender is qualifying them for a new loan.

A word of advice here, do not write up your agreement so that the tenant/buyer gets an exorbitant amount of rent credit. The lender won’t go for it when the tenant/buyer tries to get his loan. You want to keep the numbers logically within market rents.

For example if the market rental rate for a house like yours is $1,800/month, you would have a hard time passing off a $2,000/month payment as $1,500 for down payment and $500 for rent. The lender would be much more likely to accept $1,500 for rent and $500 toward the down payment.  One of the main benefits of doing a lease-purchase from a buyer’s perspective, is that it is a great way to check out the neighborhood. This is especially true if they are moving across country or into an area they know nothing about. Face it, some communities are nicer to live in than others.
The Buyer may also want to check out the property, see what it is really like. The best way to know that is to live in it. You will know where water pools, how the lot drains, how the summer sun hits the back deck, all kinds of things that won’t come out in any inspection report.