Lets start with some basic 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 end – 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. Their 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


You also don’t have any maintenance on the property if you shift responsibility to the new buyer; and any major problem would fall under the seller’s homeowner policy. The last benefit listed above is 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 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. You know what? It wasn’t a problem. I then re-rented it, and got paid option money all over again. You could 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 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


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 awhile to sell a property 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



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.



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 determined 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 into 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....





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