The Lease Option Real Estate Investing Strategy

The Lease Option is the easiest and simplest of the buying strategies I teach. Plus, it is probably the lowest-risk way to get started in real estate investing. Bare with me if you've already read the 'basics' behind the Lease Option in one of my books or courses. This is essential information well worth repeating in order to get you taking action with this buying strategy now.nnThe Lease Option SimplifiednnHave you ever seen a rent-to-own store? Did you know that you could walk into that store and buy a brand-new big-screen TV? All you need to do is make nice, easy monthly payments and, in a few years, you will own that TV. Of course, in the long run you will end up paying between two and three times more for that TV than if you paid cash up front.nnAnother good example is one of the options when getting a new car leasing to own. You simply make a small down payment and then each month you make an easy lease payment. At the end of your lease period (usually three or five years), you have the option to buy that car for X dollars more. Or you can simply hand back the keys and go find another car, if you choose. Of course, if you buy the car on these lease-to-own plans, you will end up paying much more for it than if you had purchased it for all cash up front.nnWhy do people pay more for something on a rent-to-own basis? They are paying a premium for the easy financing with which they are then able to own that item. What most people don’t know is that you can do the exact same thing with real estate! Just by controlling a property and changing the terms with which you make it available to a new buyer, you instantly increase the value of that property.nnWith the Lease Option strategy, you are going to be using the 'rent-to-own' concept, which has been around for many years, in a new way-with real estate. You are going to be a matchmaker, matching up a motivated seller and a hungry tenant-buyer. And by helping both these people get what they want, you are going to get paid handsomely for your efforts.nnRemember, your motivated seller is someone who has a compelling reason to get rid of his or her house quickly. Your tenant-buyer is someone who desperately wants to own his or her own home but for one reason or another can’t qualify to buy a home in the traditional way right now. Remember the three things you need to buy a home traditionally-a large down payment, good credit, and adequate monthly income. Well, your tenant-buyer is someone who is lacking in one or more of these key areas. Your tenant-buyers figure that while they can’t buy right now, down the road, after they clean up their credit or get an increase in salary, they will be able to qualify for a new loan and buy in the traditional way.nnLet’s walk through a hypothetical example of what we are talking about to make things easy to understand.nnSam Seller is a motivated seller. He was transferred three months ago to a new city. The job is a great career move, with an increase in pay and prestige. The problem for Sam Seller is that he hasn’t been able to sell his house yet. He tried listing it with a real estate agent for three months, and he just couldn’t sell it. Now he is faced with moving in just three weeks.nnHis options are either to slash the price of the house for a quick sale, something he is hesitant to do, or he can rent it out until he can find a buyer. But then he would have to either manage the property long distance or hire a property manager and pay him or her to manage the property-typically 8 percent to 10 percent of the monthly rent-with no guarantee that he won’t have a vacancy for several weeks or months at a time.nnThat’s where you come in. As a creative investor, you are able to help solve Sam Seller’s problem. You come in and agree to rent out Sam Seller’s house for six years for the amount of his payments. At the same time, you agree upon a price at which you can buy the house at any time you choose over that six-year period. This is called a “lease option” or a “lease purchase” and it is the foundational strategy of my Real Estate Protege Program system and the first of the seven real estate buying strategies that I teach.nnSay that Sam Seller’s payments on the house are $1,300 a month, which includes principle, interest, real estate taxes, and insurance. You will cover this amount so that Sam Seller will have no costs associated with his property over the period in which you control it before you purchase it. As for the price, to show you how you can pay the seller top dollar and still make money for yourself, you have agreed to pay the seller close to full market value for the property. In this case, the seller was asking $190,000, and you negotiated the price down to $180,000. After all, you tell the seller, he will pay no real estate commission. With Lease Option investing, you can offer the seller a healthy price and still make a large profit for yourself. As that property appreciates, you will capture the future appreciation as one part of your profit in each deal. If you are in an area with slower appreciation, or even no appreciation, you simply negotiate harder on price.nnWhat Does It Take in Upfront Money?nnWell, if you are like the students we work with across the country, you will probably be able to lock up the property without giving the seller any upfront money. Actually, you will give the seller $1 upfront as “legal consideration” to make your agreement binding.nnBut let’s say in our hypothetical example the seller won’t do the deal unless he gets at least $2,000 upfront. Wait a second, you say. You don’t have $2,000! Just hang in there because in a moment you are going to learn where you are going to find this money. And here’s a hint for you-it won’t be from your wallet or purse!nnLet’s get clear on exactly what you and Sam Seller have agreed upon. You have agreed to rent out the property for six years for the amount of the monthly payments of $1,300. You have also agreed on a price of $180,000 at which you can buy the property at any point over the next six years. In essence, you have negotiated a lease with the option to buy. nnAs for the $2,000 of upfront money, you are going to tell your motivated seller, “Sam Seller, I will give you the $2,000 as soon as I take occupancy of the property or find someone to occupy the property.” You’ll see in just a moment why it is critical for you to add this part into your agreement because it will be essential in your funding of this deal.nnThe Best Source of Funding for Your Nothing-Down DealsnnHere is the secret to doing nothing-down deals: Nothing down does not mean “nothing” to the seller. Nothing down means none of your money to the seller. The distinction is critical. Your motivated seller may get money up front-it just won’t be your money! The best way to fund any money you need to get into the deal is by using a tenant-buyer’s money. In our next hypothetical example, your tenant-buyers are the 'Byers'.nnThe Byers are a young couple with two children. They have good credit; however, because their current income isn’t high enough, they can’t qualify for the mortgage on a house this nice, yet. The Byers know that when Mrs. Byers goes back to work (she has been staying home with the children who will both be in school full-time soon) their income will be high enough to qualify for a mortgage to buy a house like this. You are able to help the Byers by letting them rent to own the house. The Byers will rent out the property from you for two years with an option to purchase at a price you have set in advance. nnThe current market rent for a house like this in the area is $1,400. But this property is a rent-to-own property. A rent-to-own property usually commands a premium over the current market rent because of the advantage of the easy financing it offers a future buyer. This means the Byers willingly pay you above-market rent. In this case, they pay you $1,500 a month in rent.nnYou also agree with the Byers on a price at which they can purchase the property at any point over the next two years. Because you want this to be a win for the Byers too, you set the price at less than the house will be worth in two years. If the house appreciates at just 5 percent per year, then in one year it will be worth $199,500. After two years, the house will be worth $209,475. (We are leaving the money-making effects of compounding out of the equation to keep the concept simple.) You are going to let the Byers have a purchase price of just $199,900. Note: Appreciation has averaged 6.58% over the last 50 years. Ups and downs smooth out over time.nnBecause of this value you are giving the Byers, they will pay you 3 percent to 5 percent of the value of the property as an upfront payment (technically called an “option payment”). In this case, you collect $8,000 from the Byers up front as their option payment on the property. This money gets credited toward the purchase price if they decide to buy. If they choose not to buy the house, it is yours to keep for allowing them to lock in their option to purchase and tie up the property for two years. It is nonrefundable.nnAfter a year or two, the Byers will be able to get a new loan from their mortgage lender and cash out both you and the motivated seller, Sam Seller. In essence, that’s how the system works.nnRemember the $2,000 you owe Sam Seller, the motivated seller? Where do you think you are going to get it? That’s exactly right! You are going to take the $8,000 cashier’s check you collect from the Byers, deposit it, and give $2,000 of it to Sam Seller. What happens to the remaining $6,000? You get to keep it. By the way, as an option payment this money is nontaxable until the year in which your tenant-buyers either exercise or quit their option to purchase.nnYou might think this is a nothing-down deal, but it’s not. It’s better than that. This is a nothing-down deal with an extra $6,000 that goes into your pocket. Let’s add up your profits. Each month you are earning $200 in cash flow. Over 24 months, that adds up to $4,800. You are buying the house for $180,000, and the Byers are paying you $199,900 for it. So you make an additional $19,900 from the spread in the sale prices. All totaled, you will earn $24,700 from this Lease Option deal.nnThe Biggest Difference between Lease Option Investing and Traditional InvestingnnImagine you were buying an investment property the traditional way. You would negotiate a price with a seller, put a large chunk of your cash down, and sign personally on a bank loan for the balance. Once you closed on this house, you would start to hope. You’d hope that you would be able to find a renter. You’d hope that you would be able to rent it out for more than your monthly payment. You’d hope that you wouldn’t have any major repairs to take care of. You’d hope for a lot of things. And then you would wait and see how you would do over time.nnThe biggest difference between Lease Option and traditional real estate investing is that you know what you are going to do before you move ahead with the deal. What we mean is: With Lease Option investing you never make a final commitment to a deal with a seller until you have presold the house to your tenant-buyer. This way you don’t have to worry about how you are going to make those $1,300 a month payments to Sam Seller. You know how you’ll do it because you’ll have already collected cash in hand for the first month’s rent of $1,500 and an option payment of $8,000 from your tenant-buyers, the Byers.nnHow can you do this? You will use a special “subject to” clause, which states that your agreement with the motivated seller is sub¬ject to your finding a qualified resident to occupy the property. In other words, your agreement is subject to your finding a qualified tenant-buyer. If you don’t find your tenant-buyer, then you don’t move ahead with the deal.nnWhat you do when setting up a Lease Option deal is to have both halves of the transaction complete before you ever fully commit to the deal. You find your motivated seller and lock up the property. Then you quickly go out and find your tenant-buyer. Then and only then, do you fully commit to moving ahead with the deal.nnHere’s the exact wording of the clause we use in our lease-option agreement with sellers that makes this possible. Clause 9: Qualified Resident: Because having a qualified resident to occupy the property is of the utmost importance to all parties, this agreement is subject to Buyer approving a qualified resident to occupy the property.nnIt seems obvious to invest this way, but traditional investors don’t. They do their best due diligence and then hope. Lease Option investors don’t leave it up to chance. They know that you can only be sure of a deal when you have already found your end-buyer for the property who has given you cash in hand to hold the property.nnCAUTION! When you use such a powerful “subject to” clause, you need to be respectful of the seller. You need to let them know right away if you are having any problems finding your tenant-buyers - within two to three weeks. Under no circumstances would you ever want to tie up a seller’s property for several months and then tell them that you cannot find your tenant-buyer. That would be both unfair and wrong.nnHow to Sidestep the Landlord TrapnnUnless you have a way to get out of the hassle of the day-to-day management of a property, you are still going to run into the Landlord Trap. Here is how you can safely sidestep the Landlord Trap and escape the hassles of tenants and toilets. When you are talking with the motivated seller, you will say to him, “Sam Seller, to make this a real win for you, would you like me to take care of the day-to-day maintenance on the property? Why don’t I take care of the first $200 of maintenance in any one month? That should take care of 98 percent of the problems. Would that work for you?” Of course, the seller will be thrilled that you will be taking over the day-to-day upkeep on the property.nn“But wait a minute,” you say, “how does that get you out of the Landlord Trap?” Next, you go meet with your tenant-buyer. You tell your tenant-buyer, “Mr. Buyer, you’re coming into this property as if you are the future owner. And we expect that you would treat the place as if you owned it. Of course, this means that you are going to be responsible for the maintenance on the property. But so that it’s a win for you and so that you know that you won’t have any major repairs that you are responsible for, let’s put a limit on it. Let’s see,why don’t you take care of the first $200 in any one month and anything above that I’ll see that it gets taken care of, okay?”nnIf a repair is needed and it costs over $200, who is responsible for the amount over $200? That’s right, the seller is responsible. If a repair is needed that is less than $200, who is responsible for it? That’s right, your tenant-buyer pays for it. What are you left responsible for? Well, you might have to coordinate some phone calls, but your tenant-buyer will be the one waiting at home for the plumber to come give them a bid. You get to sit in the middle, making money without 90 percent of the hassles of traditional rental real estate.nnOf course, you do have other responsibilities. Each month you have to collect a check, deposit a check, and write a check. The beauty of the system is that once you have set up a property correctly and you collect a chunk of money up front, for the most part you have a hands-off residual stream of income that flows to you each and every month. Then at the end of a period of time, you get a large payday when your tenant-buyer gets his own loan on the property, cashing both you and the motivated seller out of the deal.