Hot Sheet - Buying on Lease Option (you are the Optionee-Lessee)

Lease Options

If you cannot get a seller to deed you the property, another way to buy it is with a Lease Option, where you lease the property from the seller with the option to buy.

What Is A Lease Option?

A Lease Options is a "Rent To Own" arrangement, which is simply a lease where the tenant has the option to purchase the subject property. This tenant is commonly referred to as a "tenant-buyer" or as some investors like to call them, "Homeowners In Training".

The Lease Option agreement itself can be one agreement, or it can be a lease agreement with a separate option agreement. Basically, Lease Options are another form of seller financing, similar to an Agreement For Deed.

Control Without Ownership

With a Lease Option, you as a buyer can control a property without actually owning it yet. The lease part of the agreement gives you the right to occupy the property. While the option part of the Lease Option gives you the right to buy. As part of the lease, many times a portion of the rent payment is credited towards the purchase price or down payment. This means that you are occupying the property, the seller cannot resell it to someone else, and a portion of your monthly payment is going towards what is owed on your option to buy.

Once you stand back and look at what you are getting as a tenant-buyer, there is very little difference between a Lease Option and a seller held mortgage or Agreement For Deed. In fact, Lease Options are so similar to a seller held mortgage that many banks consider it as an "installment sale" and will actually let you refinance.

There are several benefits to getting a refinance loan rather than a regular purchase loan.

• First, you don't have to put a down payment down because down payments are made on purchase loans, not refinance loans. The purpose of any refinance loan is to take an existing debt and roll it into a new loan. As part of most refinance loans, you can also roll the closing costs into the balance. The same is true when refinancing a Lease Option.
• This means that you can move into a property and make monthly payments (which are partially credited to the amount you are purchasing the property for), without being required to put money down or having your credit checked. You can later exercise your option to buy and refinance without being required to put up any money and your closing costs can even be included as part of the loan.
• This is why Lease Options are so popular among real estate investors for both buying property and for selling them.

Why Sellers Will Do A Lease Option

There are many reasons why a Seller would consider a Lease Option. Most homeowners don't know the difference between a contract for deed and a Lease Option. But most are more familiar with the terms "Lease Option" or "Rent To Own". Because a seller is somewhat familiar with what a Rent To Own is, they are more apt to consider it as a solution to their problems.

Sellers Can Get Debt Relief

The key factor to getting most sellers to do a Lease Option is debt relief.

Your objective is to Lease Option the property for the amount owed on the mortgage and give the seller the debt relief they need.

You are going to solve the seller's problem by taking over the monthly payments, living in the house and maintaining it until you actually close the purchase of the house. In the meantime, the seller receives enough money to pay for their mortgage payment, taxes and insurance, and they no longer have to worry about maintaining the property.

Also, some sellers may need to correct their "debt to income" ratio when buying a new home. They may be moving to another home that they have already contracted to purchase, or they have built another home and are now faced with the prospect of having to make two mortgage payments. This may cause the seller to have a debt ratio problem when qualifying for their new home because they are still liable for the payments on their old home.

When you as a buyer Lease Option the house from the seller, the lease payment they receive is considered income and this offsets the debt of the monthly payment on the old home. Thus, helping to correct the seller's debt ratio problem.

No Due On

Sale

Clause Violation

Also, when structured properly, a Lease Option does not violate the due-on-sale clause on the sellers underlying mortgage.

The fact that a Lease Option does not give rise to the due-on-sale clause, may be a determining factor for the seller to do the deal. It may also help you as the buyer feel more comfortable too.

If you Lease Option the house, the title does not transfer until after you exercise your option to buy; therefore, the bank cannot call the loan due. Many due-on-sale clauses do state that the seller cannot give a lease to someone for more than a two-year term. However, this does not mean that you can't create a Lease Option with a term of one year where the tenant/buyer has the right to renew for nine times. In essence, you would have a ten-year Lease Option that does not violate the due-on-sale clause!

When To Lease Option A Property

It is important to know when to offer a Lease Option to a seller so that you don't short change yourself. You should only offer to Lease Option a property when you cannot get the seller to deed you the property "Subject To", give you an Agreement For Deed, or give you a sales price so cheap that you can pay cash. The reason for this is that both taking a property "Subject To" and getting an Agreement For Deed, give you a much higher level of control and ownership than a Lease Option does.

You'll also want to consider doing a Lease Option if the due-on-sale clause is a major concern to either yourself or the seller. If the seller truly cares about their credit, they most likely will not deed you the property "Subject To" and leave it up to you to make the payments on the mortgage. If they deed you the house and you don't make the payments as you promised, it is going to show on their credit and not yours. This is where a Lease Option can save a deal.

What To Do With A Lease Option Deal

There are four things you can do with a property after you Lease Option it.   

You can:

• keep it to live in,
• make it a permanent rental,
• sell it under a Lease Option, or
•  retail it to a homebuyer outright.

Keeping the house for you to live in, retailing the house and making the house a rental, are all pretty basic concepts to understand. However, when you get into sub-leasing the property to another tenant with the option to buy (Sandwich), things can get much more detailed.

Making Money With Sub-Lease Options (sandwich)

As part of your lease agreement you can have the right to sublease the property. This is commonly referred to as either a "Sub-Lease Option" or a "Sandwich Lease Option.”

This allows you to Lease Option a property and then sub lease it to your tenant. It is up to you whether or not you give your tenant an option to buy. You could keep the property as a regular rental or you could give the tenant an option to buy and eventually end up retailing the property for full value.

Don't misunderstand the title of Lease Options though. This does not mean that you have to buy properties and rent them out to tenants and have the responsibilities of being a landlord. As you'll learn in this course, Lease Options are a great alternative to regular rentals because you can eliminate almost all of the hassles that come with being a landlord.

Finance Terms Create Value

When you make it easy for a buyer to purchase a property, that property is worth more because of the terms under which you are selling it. A house is worth more because it has non-qualify seller financing than an identical house next door that requires you to qualify at a bank. It's ironic though that most appraisers ignore financing when determining a properties value.

Properties that are for lease with an option have a higher perceived value by the tenant-buyer because they are getting the opportunity to lease a property, build up a down payment, and have an opportunity to buy the property without having to qualify.

Because of this, when you can create a no qualifying situation for a homebuyer, you will have no problem selling the property fast. Not only that, by knowing how to structure deals, you'll be able to get a higher sales price than you paid the seller and a higher down payment.

Get Up To Three Paydays

When you sub-Lease Option the property to a tenant-buyer, you can make money at three different times. You get money today, monthly payments coming in every month, and money at a future date when the tenant-buyer refinances.

1. The Option Fee

Your first profit center is the option fee you get from your tenant-buyer because you'll be getting a larger option fee from your buyer than what you gave the seller (if you gave the seller any to begin with). This is why you need to get into the property with the least amount of money as possible.

2. The Monthly Payment Spread

Your second way to make money is in the difference in the payment spread. When Lease Optioning from the seller, your objective is to buy the property for what is owed on the mortgage. However, when selling, you'll want to sell the property for as much as you can.

Usually, rent payments on a house are more than what they are on a mortgage and of course, when selling, you're going to charge what the rent rate would be or even higher. You can also add an extra $100 or $200 that will be due in addition to the rent that is credited towards the tenant-buyer down payment.

We did say earlier that a tenant-buyer could refinance a Lease Option and not have to put up a down payment. However, there is no guarantee that the tenant-buyer will qualify for a loan high enough to cover the full purchase price or that the bank they qualify with won't require them to pay some type of money. This is where this money can come in handy. Also, this money will be non refundable. So if the tenant-buyer fails to exercise their option for any reason, the extra money above the regular lease payment would be extra income to you.

3. The Equity Spread

The third payday you get is when your tenant-buyer exercises their option and buys the property. At that time, you'll collect the difference between your purchase price with the original seller and the sales price with your tenant-buyer.

If however, you bought the property from the seller at a high price and there is not much of a payday coming to you, you may hope that the tenant-buyer never exercises their option.

Types Of Properties To Invest In

As for the types of properties you should target when doing lease options, single family homes in desirable areas are the best candidates. It is not too hard to find pretty houses in pretty neighborhoods with sellers that have little or no equity and are looking for a way out.

Pretty Houses Offer More Profit, Less Hassles And Less Competition 

Your best bet is to deal with pretty houses in pretty neighborhoods that are owned by private individuals. The better the neighborhood is, the more likely your tenant/buyer is to exercise their option and purchase the property. The buyers that are looking for nicer houses also have more money than those buyers looking for moderate to low income houses; therefore, you'll tend to get a larger up front profit on nicer houses.

You will also usually get a larger spread on the monthly payment and many times a larger back end spread as well, because of the higher property values. If you are dealing with larger valued properties, it is only logical that you could get larger spreads.

You will also have fewer problems collecting payments from buyers in nicer neighborhoods than when dealing with buyers in a lower income bracket. And because you can get more of the buyer's money up front, you'll tend to have fewer problems with tenant-buyer walking out on the deal.

To really make things easier, as you get into the even nicer and more upscale homes, you will tend to have less competition from other investors because many other investors are less sophisticated and may be scared of the larger numbers.

Properties Needing Little Or No Work

You should be targeting properties that need little or no work. In a minute, we'll talk about doing sandwich Lease Options on properties that need work. However, most of the time you'll want to Lease Option properties that need virtually no work. You don't want to be doing a lot of work and putting a lot of money into a house that you do not technically own yet and by the property not needing work, you'll have more potential buyers.

Also, properties that you have planned to sandwich lease option should be in good to excellent condition because one of your main profit centers is the difference between the down payment you give the seller and the down payment you receive from your tenant-buyer. If the tenant/buyer has to spend money on doing repairs, that is money they won't be able to give to you as a down payment.

Furthermore, you want to put in as little money as possible going into the deal. This not only includes the down payment, but also any repairs that need to be done. It is cheaper for you going into the deal if the property does not need any repairs, as this would add to the out-of-pocket cost if you plan to fix things yourself.

Investing In Properties With No Equity 

Lease Options do work well on properties with little or no equity. There are nice houses everywhere that are leveraged to the max and owned by sellers looking for a way out. Some real estate agents will even turn a seller down if they don't have enough equity in their house to pay the listing fee. The only solution would be for the seller to come to closing with a check. Most sellers are very reluctant to do this and would try to sell the home themselves, only to find out that selling a home at full price wasn't as easy as they thought.

Properties To Stay Away From

If you plan to do a Sub-Lease Option, the properties you should probably stay away from would be two bedroom houses because they are not as easy to find buyers for as houses with three bedrooms or more are. You'll also want to stay away from lower end properties, or properties in war zones, because you will most likely end up with tenant/buyers who cannot qualify for a bank loan. This would mean that the tenant/buyer would almost certainly not exercise their option.

You'll also want to stay away from bank owned properties when it comes to doing Lease Options all together. Ninety nine times out of a hundred, banks aren't going to want to deal with a Lease Option. The bank took the house back once already and the last thing they want to do is become your landlord. It's also not a good idea to try and create seller financing with bank owned properties. While the bank may finance a property they own, you probably wouldn't want the financing they would offer. When dealing with banks, you get the best deals when you pay them cash.

No Real Estate Agent Listings

Properties listed with real estate agents are also not good candidates for Lease Options as well, for several reasons.

First, you want to get into the deal with as little money as possible and of course, the agent is looking to get paid. This means that you would have to come up with their commission. Sure, you could offer to pay the agent if-and-when you exercise your option, but this is many times a complicated hassle that most agents don't like to get into.

Also, agents tend to try and protect the seller they are representing. Therefore, many times they will try to shoot holes all in your deal, especially if they see you are trying to control the seller's property while putting little or no money down.

Lease Option With Repairs

Earlier we said that you should look for properties that need virtually no work and for the most part you will. However, you can still Lease Option and then Sub-Lease Option properties that need a fair amount of work, without ever doing any of the repairs yourself.

Advantages Of Lease Optioning With Repairs

Let's take a look at some of the advantages of Lease Optioning properties that need work.

Do More Deals Faster 

First of all, you can do more deals faster and with less hassle. Therefore, because the deal does not take up too much of your time, you are able to do more deals.

No Dealing With Repairmen 

One of the reasons that the deal won't take up as much of your time is mainly due to the fact that you won't be spending a lot of time supervising or dealing with repairmen.

Have More Potential Buyers 

You also don't have to wait for the perfect buyer with a lot of money to put down and good or prefect credit. Buyers with less than perfect credit and little or no down payment, many times will be more than happy to do a little of the repair work for the opportunity to own their own home. Realize that these buyers are not A+ buyers and are not picky like an A+ buyer would be.

Less Holding Costs 

Also, because you'll be selling the deal faster and won't be getting slowed down by repairmen, you'll have fewer holding costs. The fact that you don't have to come up with the money to pay a repairman reduces your holding costs as well.

Make More Money 

Because you have fewer expenses, you can make more money as well.

The buyers that you will be dealing with won't be as concerned about the price as they are about the down payment and monthly payment. What is important to the buyer is that they get the opportunity to own a home. Therefore, even though you might not be able to sell the property for full price, your sales price won't be far from it. Again, what is important is that the buyer can do the repairs and the amount of the down payment and monthly payment work for the buyer.

Even though you will usually sell the property for slightly below full retail, you can still make as much as fifty percent more money than if you fixed the property up and retailed it. This is mainly due to the fact that repair costs and holding costs eat up a lot of your profit when doing a retail deal.

Get The Property Back Needing Less Work 

Finally, if the tenant/buyer does a portion of the work and then bails out on you, you

get to take the property back with it needing less work. This means you'll have an easier time getting the property resold and you'll probably end up making more money in the long run.

Disadvantages Of Lease Optioning With Repairs

The disadvantages of lease optioning with repairs are that you may have to wait longer to get all of your money because the property must be fixed up before it can be financed by most banks. This means that it may take a year or more before you can get cashed out.

You also get less money down. Even if the buyer has plenty of money to put down, the buyer will want to use some of that money to do repair work. The money they put towards doing repairs is that much less money you put in your pocket.

Advantages Of Lease Options

There are of course a lot of benefits to lease optioning properties, even when the property doesn't need work. That is why Lease Options are very popular among investors today.

As an investor there are three different positions you can be in.

• You can be the Seller (selling your own property),
• you can be the buyer (lease optioning from a home      owner), or
• you can be the investor in a      Sandwich Lease Option where you are sandwiched in between the owner and      your tenant-buyer.
        

Because there are advantages to being in each of these three positions, we'll take separate look at each of them.

• If you are simply a homebuyer, looking to buy a      property with no down payment, you will be mainly interested in the      advantages to the tenant-buyer only. However, it is a good idea to know      the advantages the seller gets so you can inform the seller of these      advantages when negotiating.

 

Advantages To The Tenant/Buyer

• The first set of advantages      we're going to take a look at are the advantages to you as a homebuyer or      to your tenant-buyer if you are selling.

Sellers Don't Have To Be Very Motivated

One of the biggest advantages when Lease Optioning property, is that the sellers don't have to be very motivated. They just need to be a little flexible.

Quick To Do

Lease Options are also very quick when it comes to getting you into the home. If the house is vacant you can actually start moving in the same day. This is due to the fact that you are leasing the property and there is no closing until you exercise your option. 

Control With No Money Or Credit

You don't need credit or a lot of money to put down to do a Lease Option either. The most money you should be putting down is the first payment and even then, this first payment could be due and payable when the next mortgage payment is due on the underlying loan. 

The buyer has the right to occupy the property and the seller does not have the right to sell the property to another buyer. This gives the buyer a lot of control not only over who lives in the property but whether or not the property can be sold. 

Furthermore, the buyer is not obligated to buy and can walk away if they decide at the end of their lease term. A Lease Option only states that the tenant/buyer has the "option" of buying. It does not state that the buyer will buy or has to buy. This is different than an Agreement For Deed which states that the buyer "is buying". 

Rent Credits

Depending on how the Lease Option is structured, the tenant/buyer could also build up equity while they are leasing. This is because a portion of the monthly lease payment can be credited towards the purchase of the property. 

Refinancing A Lease Option

Another key benefit is that the tenant/buyer can refinance the Lease Option agreement as if it were a seller held mortgage. As we said earlier, many banks will even let the tenant/buyer get a refinance loan based on the actual value of the property and not on the purchase price (if the value is higher than what they are purchasing the property for). Most banks will also roll the closing costs into the loan. 

Refinance loans are much easier to qualify for because chances are, the Lease Option payment the tenant/buyer has been making, is more than what their mortgage payment would be to a bank. This carries a lot of weight with the bank when the tenant/buyer can show they have the ability to pay consistently on time every month. 

Future Discounting

As the tenant/buyer, the terms of your Lease Option may be very favorable.

Therefore, there may not be much to gain by refinancing. If the seller has money coming to them if you do refinance, you may be able to talk the seller into taking an even lower price in exchange for you refinancing sooner.

In fact, any time you can payoff someone you owe early, you should ask for a discount. 

Advantages To The Seller

The next set of advantages we're going to take a look at are the advantages to the seller who actually owns the property. This may be yourself, selling your own property, or this may be the seller that you are buying from. In either case, it is important for you to know and understand these benefits. 

More Potential Buyers

The biggest advantage to selling a property under a Lease Option is that you have more potential buyers.

When selling a house, you are looking for a qualified buyer. However, there are more people out there who cannot qualify for a mortgage loan than there are those who can. These people who cannot qualify for a loan do not have a lot of houses to choose from and are very interested in buying a home under a "Rent To Own" arrangement. 

The right buyer is one who has the money needed to put down and the ability to repair their credit (or build the necessary credit), so that they can qualify for a bank loan. During the option period, the tenant-buyer has time to repair or build their credit, save up for a down payment, and even make repairs to your property if needed. 

Don't forget, the buyers that can qualify for a mortgage loan can still buy under a Lease Option and the more you limit how much a buyer has to come up with, the more buyers you will have as well. 

No Title Transfer

You only deliver the deed when the agreement has been fulfilled. This has many benefits within itself, including easier remedies in the event of default and you can retain many of the tax benefits of still owning the property. 

No Due On

Sale

Clause Violation

Again, as we said earlier, because the title has not transferred, a Lease Option does not give rise to the due-on-sale clause if structured properly. 

Eviction Rather Than Foreclosure

Lease Options also give the seller more control in case of default by the tenant-buyer than if the seller had given the buyer a seller held mortgage or Agreement For Deed.  This is not only due to the fact that the title has not transferred yet, but also because a Lease Option creates a landlord-tenant relationship. 

Under a Lease Option, you can evict the tenant whereas under an Agreement For Deed, most states require that you file a foreclosure, which is much more time consuming and costly. Evictions, on the average, take thirty to forty-five days depending on what part of the country you live in, whereas a foreclosure could take up to six months or more. 

It is important to remember that as a tenant/buyer, it is much easier to talk a seller into doing a Lease Option because of the fact that the seller can simply evict you in the event you don't follow through. 

Judgments Against Buyer Will Not Attach To Property  

Remember also, under a Lease Option, the title to the property is not in the name of the buyer, therefore if the buyer gets a judgment against them, the judgment will not attach to the property. 

Tax Advantages

The seller also retains the tax benefits of owning the property. Because the property is technically still just being leased, it is still a rental and can be depreciated on the owner's tax return. The seller can also write off their taxes and insurance on their mortgage.  And lastly, the option money a seller receives is tax deferred.

Advantages To The Investor - Sub-Lease Options

The last set of advantages we are going to take a look at are the advantages to the investors under a sandwich lease. As an investor who Lease Options a property from a seller, then sub-Lease Options to a tenant/buyer, you not only get both the advantages as a buyer and a seller, but you also have other advantages as being the investor in the middle of the sandwich Lease Option.

More Paydays

One of the best benefits of dealing in Lease Options is that you have the multiple paydays we talked about earlier.

When flipping property wholesale, you get one payday and it is usually in the amount of several thousand dollars or more. But, when dealing in Lease Options you have multiple paydays, some of which are dramatically larger than the payday you get when you just flip a property. It is great to do a deal once and get paid several times.

By using Lease Options, you can keep control of a property, have a monthly income, and later realize a profit when you sell it. 

You also realize immediate cash from the tenant buyer’s option fee. 

Future Discounting

One important payday is when your tenant/buyer exercises their option and purchases the property. At that time, you'll be paying off the seller, and where are you going to get the cash to pay them off early? .. From your tenant-buyer who is paying you off. 

If the seller has any money corning to them, it is a perfect opportunity to ask the seller for a discount if you pay them off early. The important thing here about negotiating the discount with the seller, is not to let the seller know that your tenant-buyer will be paying them off anyway. 

By getting the seller to discount in exchange for the early payoff, only adds to your payday and creates additional income for you. 

Deal In Nice Properties

Best of all, when doing Lease Options, you get to deal with nice houses, in nice areas, in beautiful condition, and you get to deal with quality buyers. These will be houses you would be willing to live in yourself. 

Less Repair Work

Of course, because you're dealing in nicer properties, there will be less repair work. Even if the property does need work, you can reduce your repair work by having your tenant-buyer do some of the minor things after you have repaired any major problems. 

Avoid Seasoning Issues

There may come a time in which you purchase a property outright and you decide you want to retail the property. By only owning a property for a short period of time before you try to resell it, you many times will run into what investors and mortgage brokers call a "seasoning" problem when the new buyer applies for a bank loan. The word "seasoning" simply means how long the title to the property has been in your name.

The problem is, many banks don't like to do loans on a property in which the seller recently purchased the property for a lower price and is now reselling the property a couple of months later for a higher price. While there is nothing wrong with buying a run down property at a good price, and then fixing it and selling it for full value, banks are not always comfortable knowing the property recently sold for a much lower price than you are selling it for now. This is because banks think that if they have to take the property back, the original lower sales price is an indication of what they might get on the foreclosure market. Banks also don't like to see investors making money at what they feel is their expense. 

By doing a Lease Option, the extra time you own the property during the lease period allows you to overcome these "seasoning" issues with lenders. 

Can Do A 1031 Tax Deferred Exchange

Lease Options also buy you more time so that you can still do a 1031 Tax Deferred Exchange if you own the property for eighteen months before the tenant/buyer exercises their option. 

By Lease Optioning the property out for the necessary eighteen months, you can save yourself from paying any capital gains tax on the deal. Remember, a dollar saved is a dollar earned. If you bought the property, owned it for a few months, and then retailed it, you would not be able to do a 1031 Exchange. 

You Have Multiple Exit Strategies

Another advantage to you as an investor is that when you Lease Option a property from a seller, there are a lot of things you can do with the deal. 

· You can either keep the property as a rental and not give the tenant an option to buy, or

· you can Lease Option the property to a new tenant/buyer with a higher down payment, deposit, a higher monthly payment, and a higher sales price.

· You also have the option of performing any repairs needed and then retailing the property without sub-leasing it to a tenant.

· Or you can keep the home for the purpose of making it your residence without having to qualify for bank financing or having to put any money down.

· You can even combine strategies by purchasing a property "Subject To" and then reselling on a Lease Option to your tenant-buyer.

 

Selling With Lease Options Vs. Renting Out Properties

If you like having the monthly cash flow that comes from owning a rental, but you don't want the hassle of repairs and dealing with tenants, you may want to consider Lease Optioning houses out rather than doing straight rentals or straight retailing. 

By doing so, you are basically combining Rentals and Retailing into one. 

By selling under a Lease Option, you as the landlord avoid much of the hassles you would have if you had just made the property a regular rental. 

· You cut out a lot of the disadvantages of being a landlord while at the same time, keeping almost (if not all) of the advantages.

· Plus, Lease Optioning has its own advantages that you can't get as a landlord, such as a higher up front deposit that is nonrefundable.

· You can also get a higher monthly lease payment, and the tenant/buyer takes care of the maintenance. 

This means that tenants won't call whenever they have a repair problem, the property appreciates, you get a cash flow, the tenants pay down your loan for you, and you get the tax benefits of depreciation. It just can't get much better than that! 

Disadvantages Of Lease Options

We have covered a lot of advantages that come with doing Lease Options. So, there are bound to be some disadvantages, yet there aren't very many.

No Ownership Yet

Of course, you don't yet own the property in your own name when buying under a Lease Option. This isn't much of a disadvantage because you do control the property. However, you don't get the tax advantages that corne with ownership.

Judgments Against Seller

Furthermore, because the title to the property is still in the seller's name, you do have a slim chance that the seller might get sued and a judgment could attach to the property. If you feel you have a seller that you should be concerned about, you can solve this problem by having the seller put the property into a land trust. 

Tenant/Buyers That Default

As a seller under a Lease Option, you always have to consider that your tenant/buyer may not be able to qualify for a bank loan. The tenant/buyer may not improve their credit and even if they have somewhat good credit now, their credit situation may go down hill.

No mater what, you always have to plan for the tenant/buyer not being able to qualify, or if they walk away for one reason or another.