Beginner Investing - Real Estate Investing - Lease Option Investing
Various Investment Information
Time for a Beginner Investing take on lease option investing. Last post I mentioned that a little research would be required for me regarding lease options. Well, lease option investing is definitely a viable solution to making a property pay for itself. So let’s just get right into it.
Lease Option Investing
What is a lease option? A lease option, in simple terms, is a rent-to-own contract for real estate. The buyer signs a contract to have exclusive rights to purchasing a property after a given amount of time. When that time expires, the buyer has two options: buy at the price agreed upon at signing, or don’t buy and forfeit all excess payment (down included).
How about we make this simpler by looking at it from a buyer’s perspective first.
Buyer
Why would you want to use lease option investing as your method of purchasing property? How about risk management. Say you were shopping for a home three years ago (before the market went south) and were unsure if the area would suffer from your insights into a recession. You lease option, pay monthly ‘rent’ and then at the end of the contract (three years later) you get the property appraised. As a buyer, a lease option means you are NOT required to make the purchase.
So when you examine the value of the home after three years you compare the current value to that of the contractual purchase price. If the home has appraised higher than what you agreed to purchase it for, guess what, instant equity. However, if the property was hit by recession and is now worth less than you agreed to purchase it for, guess what, you can walk with no ties to the property and are only less the down and monthly payments.
Here are some real numbers to demonstrate the situation. You sign a lease option to purchase a property for 100k at the end of a 2 year contract. You place 3% as your down for the contract, and agree to pay 100$, above market rents, towards the purchase at the end of the 2 years.
2 years later the option is up and you have the home appraised. You find that the property went up 10% over the last two years! Now you have exclusive rights to purchase the home for 10,000$ under market value! You already have 5% down plus 100/month (2400) credited for the purchase! Think about it, 10% of 110000 is 11,000 and you already have 7400+10k equity for a total of 17400 towards purchasing your home! That means, with 5% down and mild saving you have achieved a 15.8% down payment!
But what if the house went down in value? Say you get it appraised at 90k. Ouch, the house went down 10,000$. You can walk away from the contract on the spot with no further commitments. But you lose the down and the monthly excess. So, you lose 7400$. Ya that sucks. But wait, if you had purchased the home for 100k, you would have lost 10k instead of 7400! Obviously this is a bad situation, but it saves you money in the long run.
So how would a seller benefit from lease option investing?
Seller
In times like these where a recession is running rampant, it becomes very difficult to sell your home as there are lots of sellers polluting the market and adding to a gluttonous inventory. This drives prices to the bottom. But for whatever reason, be it foreclosure or reinvestment (my case), you need to sell your home or at the very least cover the payments.
A lease option does both. Here is why.
There are MANY buyers out there with shitty credit, or not enough money for a full down payment. Think about it, how many people do you know that fit one or the other of those categories? These individuals are ready and willing to buy a home but cannot get lending institutions to give them the time of day. So a lease option offering home purchase to mediocre credit or for a low down will be VERY appealing.
Lets look at real numbers to see why this is an appealing option for sellers. I have a home that was appraised at 200k on purchase. But the market took a tumble and now it is appraised at 190k. I will have to take a 10k loss plus realtor fees to sell the home. I don’t think so. But my payments are too high since I bought it 0 down. Rents for a 3/2 (like my house) average 1100 for my area, which do not cover my $1400 payments. Am I screwed? No.
I place an ad on craigs list to lease option my house. ‘Rent to own this 205k house for as little as 6k down!’ Then I detail the monthly premium for the offer. Notice I asked for MORE than the house is worth. Why? Because they are not buying the home at the current value, but at what the value MIGHT be in the next few years.
Then we look at the monthly premium. We know that regular rents will not cover my payments. So let’s take a closer look at the payments. of the 1400, approximately 200 goes to the principal, which I get back upon selling. So that 1400 is really 1200. That’s pretty close to the 1100 regular. You are doing someone a favor so asking 100 more should not be out of the question. BUT, they also will be paying extra to apply toward the down IF they option to buy. If they do not, then you get to keep the excess.
So the monthly premium would be 1100 plus your ‘fee’ of 100, plus the negotiable amount toward a future down. Let’s say its 200/month over 2 years. Then someone could have the risk mitigated purchase of my home RIGHT NOW for 6000$ down and monthly payments of 1400. Wait. Thats the exact same amount I’m paying and I did a full blown bank mortagage!! See How this could be appealing to someone ready to buy but lacking the down payment? And it’s risk mitigated!
But how does that really benefit me? Well, they agree to a purchase price that is NOT rock bottom. I adjust the purchase price as if the home had never declined in value. For example, I want an annual 3% on my home, so I offer a 1 year purchase price of 200k+3% or a two year option price of (200k+3%)+3%.
That 3% is really $6000. But, that’s the same as the down! So if they do NOT buy the home after 1 year, I STILL get my 3%!! Add in the monthly 200 for another 2400! But if they DO buy? Hell, I get 200k+3% anyway! It’s a win-win situation.
The seller gets their % regardless of market conditions, and the buyer gets mitigated risk for the same price with a potential substantial equity gain!
Conclusion:
Lease option investing is essentially a rent-to-own strategy that works by signing an agreement for exclusive purchase privileges at the end of a time period for an agreed upon price. Said agreement can EASILY work to the benefit of both parties, and allows for home sales of your asking price even in poor markets.
Lease option investing is a very shrewd procedure and should definitely be considered by both the investor and the buyer!
Tags: beginner investing, Beginner Stock Market Investing, lease option investing, Passive Income, real estate investing
