There is a strategy used by some investors who want the advantages of rental property ownership but are unwilling or unable to buy a property. The Lease Purchase or Rent-To-Own transaction is how this would-be investor can collect the cash flow from a rental home without owning it.
The Acquisition Lease-Purchase
As the investor, you seek out someone who owns a home, preferably with some equity value above payoff. For whatever reason, they would like to move but are unable to sell the home. It can just be a slow market, or it can be a timing issue, especially if the owner needs to relocate quickly for a job.
Whatever the reason, locating a distressed owner gives you the opportunity to create a win-win situation with them. You offer a lease-purchase deal where you will lease the home for a specified period, usually three to five years. At the end of the period, or at anytime before, you have the option, but not the obligation, to purchase the home at a specified price.
Before entering the deal, you’ll need to do the financial research to be sure that it’s going to work on the other end. Will the home rent for an amount over the mortgage payment, including the insurance and property tax escrow? If so, the amount over is the monthly cash flow that you can take to the bank for the period of the lease-purchase.
You offer the owners a purchase option premium; it’s a cash amount for the execution of the lease. For this example, use $1,500, and it’s not refundable. The owners can use it to help with moving expenses, and it can seal the deal.
The owner’s motivation is getting out of the home and the mortgage payment quickly to move on with their life. Your motivation is to acquire control of a home that you’re going to lease out to a tenant at a profit every month.
The Tenant Rent-To-Own
Though this section is second in this article, it’s the first situation you need to address to lower your risk in these back-to-back lease-purchase agreements. You need one or more potential tenant buyers before you cut any deals to acquire a home. You go out into the market area and advertise for renters who want to rent-to-own. Newspaper ads and Craigslist often yield opportunities.
When you locate prospective tenants, you get information about what they want and neighborhoods of interest. Knowing what your customers want, you can then go out and locate it. You lock up the home with a lease-purchase and then turn around and do the same transaction type with your tenant buyers.
You use the same period as the other transaction, for this example, three years. You execute another lease-purchase with your tenants for the same period, and they have the right, but not the obligation, to buy the home at a specified price on or before lease expiration. Of course, you’re selling to them at a higher price than you’re paying the owner if the purchase options are exercised. That’s your end profit. You’re also going to collect a non-refundable option premium, in this case, it’s the $1,500 you’re going to be paying the homeowner.
- You’re also renting to them at a price that gives you a positive cash flow every month during the lease period. One of three outcomes are expected:
Your tenant buyers will not exercise their lease but will stay the entire period. In this situation, you can renegotiate your lease with the owner and extend the tenant buyer lease if that’s what they want. If they leave, you can simply let your lease expire and give the home back to the owner, or start a whole new process.
- Your tenant buyers leave early, breaking the lease. Of course, you may take whatever remedies available for compensation from the lease-breakers. However, you can now go out and find a new tenant buyer or straight tenant for the home until your lease-purchase agreement expires.
- Your tenant buyers exercise their purchase option and want to go to closing and own the home. They can do this at any time, just as you can on your end. You would exercise your option as well and close on the two deals to take your sale profit.
This isn’t a popular strategy, and it may have to be handled differently according to some state laws. However, if it works where you invest, it can be a way to enjoy the benefits of rental property ownership with little or no money invested out of pocket. It’s often called the Sandwich Lease Strategy.
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