Lease option to buy.......Why? - Posted by Cory

Real Estate Investing Real Estate Gurus
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Posted by Vee Johnson on February 01, 2004 at 23:39:55:

I find these ‘because’ answers not very nice. I can see that they might be what is considered ‘slum’ lords, so, to those who might want to lease/purchase and follow these clowns advice, please note, in a lease/purchase, in many states you have to fill out paperwork (like disclosure statements) just like when selling. And, in many states, evicting the ‘tennant’ is not the same as a renter, it has to go thru a foreclosure process. So, beat up on your ‘lease/option’ people if you want, but check your laws closely to make sure they can’t pay you back! Best to be nice and make it win/win for both parties.

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Lease option to buy…Why? - Posted by Cory

Posted by Cory on January 08, 2004 at 15:28:32:

Could someone help me out here. I am having trouble understanding why a prospective buyer would want to use a lease option. What are the benefits for a potential leasee? I have read alot of good info about the benefits as a leaser, but don’t understand why someone would chose to lease for 1-2 years before closing on a property. What does this time allow for?

Thanks!

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Re: Lease option to buy…Why? - Posted by Greg (Omaha)

Posted by Greg (Omaha) on January 10, 2004 at 07:46:17:

Probably the best way understand is to look at a real life example.

A couple of months ago I lease/optioned a property to a tenant/buyer family. They had recently moved from out of state and due to a problem w/ a business they owned they’d had to declare Ch 13 bankruptcy. They had a rental lined up but on their way here the landlord died and so they were now living in a hotel.

They saw the property at my open house on a Sunday and took possession that Wednesday (Benefit #1 - Fast Possession).

Their money out of pocket included 1.25 months security deposit (refundable), 1st month’s rent and 3.5% of the option price as option consideration (Benefit #2 - Low Down, No Bank Qualifying). In our state you can charge .25 month’s if you allow pets which most rentals do not allow. I do because I want them to think like owners (additional benefit since they had 2 small dogs).

We also agreed that 10% of each of their rental payments that I receive on time will count as option consideration (Benefit #3 - Building Equity faster then on a 30 year loan amortization).

During their time in the property, any improvements they make they can receive the equity for by exercising their option (Benefit #4 - Sweat Equity Opportunity).

I will say that this is my preferred exit strategy but not so I can take the house back (it does happen). I don’t believe in setting up my system for people to fail. If they do what they say (pay me on time), I will do everything I can to help my tenant/buyers benefit including helping them get financing, taking back seller financing, helping them sell the property to obtain their equity, allowing them to carry the equity they’ve built-up to another property I have available, etc.

While I don’t do this for charity, I have found I can make more money in the long run by treating others how I would like to be treated if the situation was reversed.

Hope this helps.

Greg

P.S. This was an older couple and not familiar with some of the “new-fangled” technology available to them so I took them to their bank and helped them get auto Bill Pay setup for their rent payment (they had no idea you could do that). This way they will always receive the 10% on time payment benefit. Just another mutually beneficial service I offer.

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Re: Lease option to buy…Why? - Posted by EH

Posted by EH on January 08, 2004 at 17:51:28:

WOW!! I think you have the wrong idea about Lease Option or a real bad experience. You can Lease Option a property and turn around and sublease it for a profit. Sometimes people are tied up with other deals, so they lease option until they can be free up some money.

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because… - Posted by jp

Posted by jp on January 08, 2004 at 15:41:44:

People, in general, are very financially irresponsible. They consistently spend more than they earn and routinely skip out on their creditors. They never save any money and would be utterly homeless and broke within a month of being unemployed. These are the people you will be profitting from with lease options. They have dorked up their credit so badly that banks will not give them a loan and therefor they must lease-option. The 2 years (or whatever timeframe) is their dream time. They dream and wish during that time that their credit will improve, but they don’t do anything real to fix their credit. They probably even charge up another credit card to furnish and adorn the house they are leasing. At the end of the option period they will try to get a loan for the purchase price (usually unsuccessfully) and then get really mad when they get denied again. That’s ok because you just kick them out and get on with the next sucker. Your biggest challenge will be getting a respectable down payment because they have no discipline to save.

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Re: Lease option to buy…Why? - Posted by Cory

Posted by Cory on January 10, 2004 at 10:22:00:

Thanks Greg. This was very helpful. Do you put the 10% of their on time payment in an escrow?

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Re: because… - Posted by Cory

Posted by Cory on January 08, 2004 at 15:52:18:

Thanks for your reply…too funny. As far as a down payment, the leasee can basically chose whatever amount as far as a down payment correct? but what is typical? Is it based at all on the price of the property, a certain %, or do you feel out an potential buyer and get as much as possible?

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Re: Lease option to buy…Why? - Posted by Greg (Omaha)

Posted by Greg (Omaha) on January 10, 2004 at 15:08:00:

I?ll caveat this by saying you should check into the laws of your state. That said my answer is no…because the 10% is classified as option consideration it is treated as a credit against the option purchase price and only comes into play if the option is exercised so I do not have a need to escrow it (in some states you have to escrow the security deposit). If they do not exercise the option all option consideration is nonrefundable in my agreement (this would not be the case if it was classified as prepaid rent or a security deposit).

For example, I give you a 1 year lease/option on my house (I always give them the right to renew w/ a 5% increase in rent and purchase price). The deal consists of an option purchase price of $100K, an initial payment of $3K as option consideration and a monthly rent payment of $1,000 of which $100 (10%) is counted as option consideration for each on time payment.

At the end of the year you decide to exercise your option. You have paid me $12,000 in rent during the year and all your payments were on time. This means you have built up an addition $1,200 in option consideration. This is added to your initial $3K in option consideration for a total of $4,200. This amount is deducted from the $100K purchase price which means you need to bring $95,800 to the closing table.

Now…if you decide at the end of the year this property is not for you and do not renew or exercise your option, the $4,200 in option consideration is forfeited.

Another benefit to classifying a portion of each month?s payment as option consideration is that for tax purposes option consideration is not counted towards your taxable income until the option is exercised or expires. So using our example, although I collect $1,000 which I can spend all of, I am only taxed on $900 of it in the years I collect it and the option is not exercised or expires. Hope this helps.

Happy Investing,

Greg

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Re: because… - Posted by jp

Posted by jp on January 08, 2004 at 16:04:38:

You shouldn’t try to do it unless you learn all the details. I’ve never done it and probably never will.

You need to get as much down as possible because that will represent a large portion of your eventual profit when they fail to execute. You should set a minimum that you are willing to accept as downpayment but don’t tell your lessor. Always ask how much they can afford first and if it is higher than your minimum take it. If it is lower, then beat them up about it until they find a way to come up with more.