30th March 2011

The Lease Option Landlord – Part 1

posted in Real Estate Investing |

Down markets create amazing opportunities for the investor.  However, a landlord who is sitting on one or several properties might be real estate rich, but cash poor, and unable to tap into those current market buying opportunities.  In those situations landlords would traditionally sell one of their properties and apply that money to a new purchase, preferably one that offers a higher return than the property previously sold. The only problem is, as mentioned before, the down market might be forcing you to sell your property for less money than you originally expected, or worse- for a loss, and neither of those situations is ideal.  What’s an investor to do?

Enter the Lease Option Landlord!

The lease option has been a valued purchase and sales technique for single family residential investors for years, and the process is applicable to small multifamily properties as well.  It perfect for the investor who doesn’t want to sell at rock bottom prices, but who wants to tap into some cash for new purchases.

The method works particularly well in down-markets where buyers are low on lump sum cash down payments, but have good credit and decent monthly cash-flow. A landlord can also perform a lease option using standard template paperwork without the services of an agent or broker and save the hefty commission that comes with those services.

Essentially it works like this:

●     Seller Landlord puts his property on the market under a potential lease option transaction, marketing to buyers (existing or potential landlords) who can put some money down.  He offers it with a small down payment, and a subsequent monthly option payment, part of which accrues toward a purchase price to be exercised at a later date.

●     Seller and buyer agree on terms like future purchase price of the property, length of the lease-option, monthly lease payment, and how much money (if any) will be put toward the future down payment for the buyer.

●     With the transaction complete, the seller retains title to the property and continues to hold the deed.  If there is a mortgage on the property it remains in the seller’s name and under his credit.  The buyer makes monthly option payments to the seller landlord (that’s you!) until the lease option is exercised and the buyer purchases the property outright (at the pre-negotiated purchase price), and takes title to the property.  At the time of purchase, you will convert the buyer’s down payment, and any sum accumulated for that purpose, and the buyer will bring the difference in cash or bank loans.  Essentially, at the exercise, the buyer is taking you out completely for that pre-negotiated price.

Advantages to the Lease Option Landlord Seller

In addition to getting a down payment to put toward another property purchase, the seller remains on title of the current property, controls the deed, and should the buyer on the lease option default or breach contract, the seller pursues eviction rather than foreclosure.  The seller receives a great sales price at some future date, avoids capital gains tax until then, and receives positive cash flow in the meantime.  If the buyer decides not to exercise the option all the monies paid up to that point remain with the seller-they are not refundable to the buyer.

Advantages to the Lease Option  Buyer

Right to use the property, collect rents and enjoy cash-flow.  Buys a property with relatively low down payment, and defers a larger purchase expense until a later date. If buyer has arranged for a portion of the lease payment to build toward the down payment at lease exercise the buyer has much less cash to bring in later.

Disadvantages for the Seller

If there is currently a lien on the property it will remain in the seller’s name and payments must continue to be made by the seller or his representative.  If buyer defaults seller will have to step back in to manage property.

Disadvantages to the Buyer

Already stated before, in most lease-option transactions it is standard for the seller to keep all payments made on the deal, therefore if the buyer walks away, defaults, or elects not to exercise the option, he loses all those payments and any down payment/ option consideration made at contract signing.

How Much of a Down Payment Should You Collect?

The answer here is easy: as much as you can get!  There is no right or wrong in this case, but the more you get the better.  At the same time, you don’t want to cash-strap the buyer because she should have some money left over to cover any expenses that might creep up unexpected.  Getting a higher down payment in that case may jeopardize the option, and that doesn’t make much sense in the long run.

Start by asking for a down payment equal to the down payment you need on the property which you are looking to purchase. If that’s not feasible, ask for 15% of the purchase price of the property and negotiate down from there. Fifteen percent is less than any bank will require from that buyer as a down payment, and much less than private lenders would ask for.  Also, you aren’t charging financing on the remaining amount, like the bank would, so there’s a benefit for the buyer to get the deal done at that level too.

Check back for Part 2 of this article next week…

For more real estate and personal finance tips, visit the Direct Lending Solutions credit library at www.directlendingsolutions.com.

About the author, Craig Grella

Craig Grella is an expert writing on real estate and personal finance topics. He has worked for large national banks, and for several Fortune 500 companies.  He invests nationwide, and his articles can be found online at www.directlendingsolutions.com.

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