Understanding the Benefits of Selling with Lease Options
During my early years as a real estate investor I heard the words lease option quite frequently. Upon further inspection I realized that the reason I was hearing the term so often was because the technique is one of the most powerful ways to sell a home. It is important to note that while selling on a lease option is probably the best way to sell in most situations, it probably should not be your first choice as far as creative buying techniques are concerned. The reason for this is simple...when you buy on a lease option you do not have full ownership of the subject property until the deed has changed hands. As you are probably aware, that does not happen until the original owner is paid in full. A much better way to buy is “subject to” an existing mortgage, which is a fascinating subject that will be addressed thoroughly in a future article. This article will deal with selling your property using the lease option technique. I will start by walking you through a typical lease option sale and then go into further detail on how to increase your monthly cash flow and back end profit using this powerful technique.
After I have acquired a new piece of property, whether it has been purchased subject to an existing mortgage, bought outright or I have entered into a lease with option to purchase with a seller, my single most favorite way to sell the property is on a lease option. There are many reasons I prefer this technique of selling over others. The first reason is that I retain ownership of the property while increasing my monthly cash flow without having to deal with minor maintenance issues. The second reason is that I know I will get a price higher than the current market value for the sale of the house and I will also receive a monthly payment that is higher than if I were to rent the house to a tenant. For discussion purposes, I will begin illustrating this technique with marketing the property and take you through moving the tenant/buyers into the home.
I prefer to run an occasional ad on a regular basis to locate potential tenant/buyers and build my buyers list. The advantage to doing this is that as soon as I get a new property I can send a simultaneous fax and/or email to the prospects on my list. Doing this usually gets the house occupied quickly with minimal effort. The standard ad should read something like the one below:
HOUSES FOR SALE
RENT TO OWN
Down Payment Assistance
(407) 555-1212
After placing the ad, my phone begins to ring. I recommend using a voice mail system to prequalify all callers. I explain on the voice mail that I often have houses available to purchase using my rent to own program. I continue to explain that I need them to leave there name, phone and fax numbers, email address and how much can they afford to put down and pay monthly. I also explain our wonderful down payment assistance program (which will be explained to you in the next paragraph). After collecting names and building a buyers list, I send each prospect a description of the house along with directions so they can take a look. I always have them look at the house by themselves because I do not want to waste my time showing houses to prospects all day. I would rather let them look themselves while I am out finding new deals. After they have seen the house, they contact me to discuss terms. At this point they have usually already mentally moved there furniture into the house and the kids have picked there bedrooms, so you are operating from a position of strength. The benefit to you from setting up your transactions this way is that you are working smart instead of hard and you can use the time you saved to locate new deals.
Now for the exciting part. This down payment assistance program can dramatically increase your monthly cash flow. The way the program works is simply any amount of money the tenant/buyer can afford to pay on a monthly basis beyond the minimum payment will be applied toward their down payment when they go to purchase the home. So for example, if I have a home that I am selling on a lease option and I need to get $800 per month to cover my underlying payment and give myself $150 per month positive cash flow, I will ask $800 per month with the added incentive that anything paid by the tenant/buyer over that amount will not only be applied to the down payment to be used at the time of purchase but my company will also match the amount that is paid over the minimum payment dollar for dollar with our money. It is important that you realize I am not actually using money out of my own pocket, but I will adjust the end purchase price to make it appear as if I am contributing funds on a monthly basis. I always make the end purchase price negotiable based on there down payment and monthly payment. For example, if I was asking $800 per month and the tenant/buyer elected to pay $1000 per month, I would raise the end purchase price by $2400. This is the amount that my company would have contributed had we been matching the extra $200 per month dollar for dollar. The beauty of this is that the tenant/buyer is actually getting a $400 per month credit toward a down payment should he exercise his option to purchase the home (on paper at least). The key to making this work, however, is making sure you do not commit to a purchase price until after working out the down payment assistance plan. This down payment program creates a win-win situation. The tenant/buyer is building a down payment which will make it easier to purchase the home and you have increased your monthly cash flow significantly.
Fortunately, or unfortunately, depending on how you view this, the tenant/buyer often will not exercise there option to purchase the house and you will get the house back. The good part of this is that you get to repeat the process, only with higher numbers this time. The downside, if there is one, is that you do not get your back end profit yet. However, no matter what happens, you will be in a good position.
In closing I would like to note that lease options are probably the most powerful and advantageous ways to sell a property. I have touched briefly on a few of the reasons why they are so powerful in this article, but this is only the tip of the iceberg. Selling on lease options is a topic many authors have written entire books on. They can not possibly be covered from A-Z in one article, but I hope I have at least sparked your interest enough to make you realize that this is a topic that can be used to generate HUGE profits!!
Thanks and happy investing!!
Sean Flanagan
Great thread
I have a comment regarding inflating the rent and the price to give the future buyer a golden bonus. I have sold with the L/O method and in fact wrote one deal so that the option buyer could buy me out any month after month 24 at a price that was set forth and agreed on when signing the contract. ( The price went up every month.
I leased hIm the house for $1200 a month and agreed to apply $200 a month toward the down payment. Problem was, when it came time to finance, the mortgage companies would allow monthly ammounts to apply to the down payment ONLY TO THE EXTENT THAT THEY EXCEEDED MARKET RENT.
So you must be careful when applying portions of the rent to downpayments.
I have sold other Lease Options but must say that in most cases the option is not excercised. I get the property back.
I agree. The article is geared towards charging over market rent to increase cash flw, not the other way around. Thanks for the input.
Best wishes,
Sean Flanagan
Don't tenents who don't excercise the option want thier "down payment" overages back?
Generally the Down Payment is non-refundable. It's all in the wording of the agreement.
how do you get around committing to a sale price.
what if thats the first thing the 'buyer' asks?
I'm confused. In your article, you're telling people to inflate their asking price compared to what the tenant/buyer's willing to pay extra each month to artificially create a golden "discount" (which I won't get into the problems with this), yet when asked about this, you say that you only increase the price by the expected appreciation rate (much better answer BTW). So is the article a shame or the comment?
Personally, I disagree with the voice mail system. People like to talk to other people, not machines. You're losing more leads than getting by doing this.
Ditto, for the showings, though you can still limit your time and effort by holding open houses to all who are interested (and create demand, too).
"the tenant/buyer will not exercise there {sic} option to purchase the house," Sadly, sometimes this is true, but if it's happening more times than not, then you're not doing your job. As an investor, your goal should be to actually sell the property, and that includes helping the tenant/buyer get financed.
Roger
Sean Flanagan,
Glad to meet you.
I am certainly no beginner nor am I confused.
Of the 500+ Subject To deals I have done not one was a Lease Option deal on the sell side. I found through experience of my own and hundreds of my students that Contract for Sale is the preferred method of selling if you want to receive the full dollar potential out of a Subject To deal.
The buyer is more apt to improve the property, feel the pride of ownership and actually re-finance within the time period of the Contract for Sale.
We have 3 profit centers built into the Subject To deal, the down payment which is considerably more than Lease Option option money, the increase in the monthy payment from increasing the interest rate for passive income and the backside which includes a two year appreciation on the property when the buyer finances the property.
Voice mail has proven that if you do not answer the phone the caller will call the next deal. The first thing I ask when a student calls me and say they are having trouble selling a property is "are you using voice mail".
If they are then I know immediately this is the problem. When a buyer calls me I ask them questions about their life style, or do they have children, then I point out all the benefits of buying that particular property and then set up the appointment to show the property and sell it.
I admitt I learn everyday, but I do it from the many phone calls and 5000 emails I answered personally over the past year from investors and students who need help, so this keeps me as a course writer on top of what is really happening everyday in the investing community.
I wonder how many emails and phone calls your Guru's answered from their students over the past year to help them keep up to date?
So, I would say Roger is right on tartget and if I were you I would use caution in who you refer to as a beginner. His answers were correct to help the beginner.
John $Cash$ Locke
I have a question. How do your potential buyers get into the houses to visualize where their furniture is going to go if you do not show them the property? You didn't mention using a Realtor, and I doubt you are foolish enough to leave the houses unlocked.
Also, there is a law in most states that says if someone lives inside a property and and has power turned on in their names, then they are a resident of that property. To me, allowing people into your houses unattended would allow them to exploit this law, as the power company rarely checks to see if you are legally able to turn it on. How do you deal with this danger?
Jon