Mention “real estate investing strategies” and the first thing that typically comes to mind is buying and selling. But a strategy often overlooked and underutilized is the option—and the smart use of options can generate some fast and impressive profits.
An option gives the buyer the right but not the obligation to buy—but the seller is obligated to sell. Combine the option with a lease, and you have an excellent tool to use when you have a motivated seller with little or no equity in the property, or one who doesn’t have time to wait for the traditional sales process to run its course. Instead of buying, you lease the property with an option to buy. That gives you control of the property and lets it generate cash for you—but you don’t have to own it.
The rate of residential foreclosures in on the rise in many parts of the country. A pending foreclosure for any reason is just one of many situations where lease option strategies can be used. Other situations include sellers seeking debt relief or facing personal situations such as a divorce.
“Lease options are a great way to get started investing in real estate, especially if you have little or no cash,” says Michael Van Horn, an advanced trainer with Wealth Intelligence Academy™. “Options let you control property without having to buy it, and you can profit at every step of the process.”
Why do people use lease options instead of an outright sale? Owner/sellers are likely to consider a lease option when they need to get rid of the property but do not have enough equity to sell immediately through traditional methods. For example, if the property has mortgages of up to 95 and even 100 percent of its market value, the seller would have to come up with cash to pay a real estate agent’s commission. On the other side, buyers who have flawed credit, who may need time to come up with a down payment, or who want to “test drive” the house or the neighborhood are all candidates for a lease/option deal.
One of the most common option strategies is the sandwich lease option, which works like this: You lease a property with an option to buy in three years. You find a tenant/buyer who leases the property from you with an option to buy in two years. When the tenant/buyer is ready to close, you exercise your option, buy the property and sell it to the tenant/buyer.
There are, of course, possible variations. You can use different time frames. You can assign your option to the tenant/buyer or to another investor. You can buy the property instead of leasing it, and then sell it with a lease option arrangement instead of putting a traditional tenant in the house.
“Tenant/buyers are much more attractive than traditional renters,” says Van Horn. “You can set up your lease so that the tenant/buyer takes care of a lot of the routine maintenance. Also, because tenant/buyers expect to eventually own the property, they are much more likely to take good care of it and make their payments on time.”
Van Horn recommends focusing your lease option efforts on desirable neighborhoods—generally, working-, middle-, and upper-income areas. These are the areas where potential tenant/buyers want to own homes. Also, remember that lease options can work on multi-unit buildings as well as single-family homes. “If someone wants to get rid of a small apartment building and is having trouble finding a buyer, he may be willing to lease option it to you,” Van Horn says. “You get into the property for a smaller-than-normal down payment and you benefit from the cash flow while you’re working on the financing over a year or two or more.”
Laws regarding real estate options vary by state and it’s a good idea to check with a real estate attorney in your state to be sure are in full compliance with all applicable regulations when you put together a lease option transaction.