Re: ??? ABOUT A LEASE OPTION - Posted by JohnBoy
Posted by JohnBoy on April 15, 2002 at 02:31:51:
If you do a L/O with the seller then you don’t get the deed until you exercise the option and pay the seller off. The seller retains the deed. You get a lease with an option to buy at a later date.
If there is a loan against the house then you want to send the payments from your rent directly to the lender to insure the loan payments are being paid. If your rent is more than the loan payments then you can send the difference to the seller. Never send the full payment to the seller if they have a loan on the property. Otherwise you run the risk of the seller not making the payments and using that money for other things instead. Then by the time you found out about it the property would be in foreclosure and several months of payments behind on the loan.
A lease option is just what it says. It’s a lease with an option to buy the property at a later date at a predetermined price. When you get the deed then you would own the property. A lease with the seller would make no sense if you already owned the property.
As long as your lease agreement allows you to sublease the property then you can lease option it to someone else. You would charge your tenant a sizable amount up front as non-refundable option consideration, which is usually 3% - 5% of the purchase price. Lease it to them for a couple hundred or so above your rent amount to create some monthly cash flow and set your option price to your tenant at about 10% above property’s fair market value.
Typically when buying on a L/O you want to lease the property for the same amount of the seller’s mortgage payments and set your option price for the amount of the balanced owed on their mortgage at the time of exercising your option. This is assuming there isn’t a lot of equity involved. Otherwise you may need to agree to a higher option price where the seller would get any equity when you exercise your option and pay them off.
For an example:
You find a house that is worth $100k. The seller owes about $90k and their mortgage payment plus taxes & insurance is $800 per month.
You would agree to lease option the house for $800 per month with an option to buy for the balance owed on the mortgage at the time of exercising the option. They don’t have much in equity and what little they do have would all be eaten up, plus some, just in selling costs if they were to list with a realtor to sell it out right. So in this case even though you weren’t giving them anything for their $10k in equity, the seller would still be coming out ahead on this because you would be saving them from having to come out of pocket to make up any difference in selling costs!
So you are in with nothing down and taking over the property on a L/O for the amount of their payments and for what they owe on it.
Lets say rents in the area for a house like this is renting for $1000 per month.
You would then L/O this to a tenant/buyer where they would need to pay you at least $5k up front for option consideration which would be non-refundable if they don’t exercise the option later. This is money to just buy the option on the property.
Since rents in the area are going for $1000 on just a rental that doesn’t involve any option to buy, you would lease it for $1100 - $1200 per month by getting a premium rent because of giving the tenant an option to buy it.
You would give them an option to buy for $110k which would be 10% above market value. Your agreement with them would be for one year. So by the end of the year if they don’t exercise the option they would lose the option money they paid.
If they do exercise the option then you would apply the $5k option money they paid towards their purchase price. So they would owe you $105k to exercise the option since they already paid the $5k for option money.
In this deal you would make $5k profit on the front end from the option money they paid.
You would make $300 per month in cash flow if their rent was $1100 where your rent to the seller is only $800.
On the back end when your tenant exercises their option you would make about $15k which is the difference between your option price with the seller and what your buyer’s option price is with you for.
So that would be $5k + $3600 (12 x $300) + $15,000 = $23,600 total profit over one year IF your tenant exercises their option.
If they don’t exercise the option then you would have still made $8,600 during the first off the $5k option money they paid plus the $3600 in rent you got for the year and you would still have the property. Then you start the whole process over again by getting more option money from the next tenant/buyer you get, more monthly cash flow for another year and collect that back end profit when they exercise their option. You just repeat the process every year until one of your tenant/buyer’s eventually exercises their option and pays you off, at which time you will pay the seller off.
BTW, you mentioned two year term if you are buying on a L/O. Two years isn’t enough time. You may need more time to get your tenant/buyer to be able to exercise their option with you. So you should require a minimum of 3 years and try to get as many years as possible. The more years you get the better!
When selling on a L/O you only want to give one year terms. When selling on L/O the shorter the term you give the better.