In this article, I am about to discuss what I believe is the best investment strategy for the new investor’s success. It is the lease with option to purchase strategy. Of all the investing techniques I have tried, the lease with option is my favorite.
I have been using it since 1995. It has brought good tenants to my properties, provided good up-front cash, positive cash flow, and acceptable back end profit. This technique has several variations.
I will briefly discuss each one to show you how versatile the strategy is, in terms of ways you can implement it. Due to the amount of information presented in this article, I will compose it in three separate posts.
3 Ways to profit
The lease with option to purchase technique can be implemented in at least 3 variations, the sandwich lease option, the cooperative lease option assignment, and the consulting lease option. Each one is a great strategy. I would encourage the new investor to learn them all, since there will be times when he may be in a situation where if he knew how to use them, he can profit from the deal.
The Sandwich Lease Option
The sandwich lease option is best described with the word control. The investor has the opportunity to control an expensive piece of real estate with little or no money out of his pocket. He uses his knowledge of home values and rents to secure a nice home in a nice neighborhood.
Locating such a home will be similar to the methods we discussed in the previous articles. He will be looking for a motivated seller. This will be someone who needs to sell, rather that someone who wants to sell or is testing the market.
The investor will be looking to lease the property with an option to purchase. The length of the lease can vary from one to three years or more. The investor will be making an agreement with the seller, then going out into the market place and finding another buyer who he will sub-let the property to. In effect, the investor will be sandwiched in the middle. Once the property is put under contract, the title should be checked to see if there are any hidden or unknown liens and to be sure the legal owner is the same person who signed the contract.
The investor will be looking to profit from three revenue streams. The first will be the up-front option deposit. This will be an amount of money the tenant/buyer will put down on the house for the opportunity to lease now and buy later. This deposit is usually non refundable. Next, with his knowledge of rents for the neighborhood where the house is located, he will set the rent high enough to produce a positive cash flow. Homes offered to lease with the option to purchase command a higher rent than straight rentals.
He will do his best to cover the seller’s mortgage payment, and then increase the rent above this figure. Finally, with his knowledge of home values he will calculate the home’s future appreciation and set the selling price. This will be a number above the mortgage debt, and any seller equity. The difference will be his profit.
The investor will be looking for prospects who want to own a home rather than rent. It will need to be someone whose credit is good enough to qualify for a loan in the near future. I would suggest that the investor place the tenant/buyer in credit repair and monitor his progress.
Once the tenant/buyer is found, screened and accepted the paper work is reviewed and signed. The investor will usually give the tenant/buyer a one to three year lease, depending how long it will take for him to qualify for a new loan. The tenant/buyer will usually be responsible for maintenance and minor repairs on the property during the term of the lease.
As an incentive for paying the rent on time and taking care of the maintenance and minor repairs, the tenant/buyer will receive rent credits. These credits will be redeemable when the house is actually purchased. The amount of the credit will be subtracted from the final sales price.
Since the investor has taken the position of landlord, he will need to manage the property. As discussed in a previous article, he will need to develop people skills and at the same time run his business successfully. He should inspect the property regularly to be sure it is being maintained and any repairs that had been scheduled were completed.
Property management is an important consideration. There is a chance that the tenant/buyer may not buy the property or due to unforeseen circumstances, the investor may want to give the house back to the seller. It will be important that the property is returned in good condition at least the same condition as when the investor took possession of it.
There will be times when tenant/buyers will not perform according to the agreements. If this happens, remember the investor has the responsibility to make things right. To avoid any negative surprises, keep in close contact with the tenant/buyer.
Getting to the Closing
If the investor has been monitoring the tenant/buyer’s progress in credit repair, he will know when he is ready to make application for a new loan on the property. At this point, a new purchase and sale agreement is completed and presented to the lender, along with any other supporting documents.
This process should go more smoothly due to the tenant/buyer being in credit repair. If all went well through the lease term, it was probably not necessary to have much contact with the seller. Now, however, the seller will need to be contacted to discuss the closing.
Be sure to keep in close contact with the closing agent. You don’t want any last minute snags to develop.
When the closing day arrives, you will be rewarded for all the hard work you put into the deal. Up to this point, you have profited with the up-front option deposit and you enjoyed a positive cash flow on the property. At the closing, you will have your biggest pay day, the back end profit.
In this strategy, everyone wins. The seller has closed on his home; the tenant/buyer is now the new legal owner and you the investor has the satisfaction of a job well done, while being well paid for your services.
We will continue this discussion in the second part of this article as we talk about the cooperative lease option assignment and consulting. I hope you will stay with me.
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