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Investing for Residential with Lease or Purchase
One of the most efficient ways to invest in residential real estate is to do a lease/purchase. The reason a lease/purchase is so effective, is because it provides a win-win situation for both the seller/landlord and the buyer/tenant. For the owner, it provides a potential buyer and a tenant that will be willing to take care of the home. For the buyer, it provides the right to purchase the home for a fixed price, and time to save money and improve their credit. Here is how it works.
The owner and the buyer enter into a contract whereby the potential buyer agrees to lease the home for a set amount of time. At the end of the lease, the buyer then has the option of buying the home for the price agreed upon in the contract. In order to secure that price, the buyer pays an option fee up front. If the buyer chooses to buy the home at the end of the lease, he can apply the option fee and any other money saved toward the down payment. If they choose not to purchase the home, the owner keeps the option fee.
For the owner, the lease/purchase offers several different ways to make money from the home:
- The goal is to buy the home for 10-20% below market value.
- The monthly rent you collect will exceed your mortgage payment.
- You can right off mortgage interest and other expenses on your taxes.
- You pay down the principle on your mortgage and build equity in the house.
- The price of the home will appreciate.
- If the potential buyer decides not to buy, you keep the option fee.
This is just a basic outline of how a lease/purchase works and the opportunities it presents. It is still a real estate investment strategy that is unknown by many and discussed by too few. For more detailed information, a recommended read is "Buy Low, Rent Smart, Sell High" by Scott Frank and Andy Heller.
If you have an investment property, should you rent it or sell it? The answer to that question is that you should do both. If you have lots of time on your hands and are handy with tools, you can choose to rent out your property. However, if you have several properties for rent, maintaining them can consume lots of your time. You can choose to hire someone else to maintain your properties, but it cost you money. And higher expenses mean lower profits. In addition to investing your time, finding good tenants for your properties is not easy. Tenants that choose to rent usually do it for a reason. They are usually having credit problems. In addition, most tenants do not take good care of your properties like they would their own homes. And when things go sour, they can mess up your house before they move out. Your goal is to find good tenants to rent your property, transfer the maintenance responsibility to them, and create incentives for them to eventually buy your property. Including the option to purchase to the least contract can eliminate most of the headaches associated with maintenance and dealing with bad tenants. There are several other benefits to the lease and purchase option.
Because the rent is usually higher when you include an option to purchase, this can eliminate most tenants only wanting to rent. People looking for the lease and purchase option are those usually in the process of rebuilding their credit, or are saving money for their down payment. To be fair, the duration of the contract should be between 2 to 3 years, long enough for your tenants to rebuild their credit.
This contract also transfers the maintenance responsibility to your tenants. Not having to worry about maintaining the property frees up your time for you to continue to expand your business. Giving your tenants the option to purchase your property create an incentive for them to take better care of your property. You may also choose to apply some of their rents toward the down payment if they decide to buy your property. This is another incentive for them to pay the rent on time, and eventually buy your property at the locked in price.
During the contract, you cannot sell the house to anyone else other than your tenants. However, you charge your tenants a fee (usually 1 to 2 percent of the purchase price) for the option to lock in the price of your property. If your tenants do not purchase the property before the purchase option contract expires, you get to keep the option fee. However, if your tenants utilize the option to purchase anytime during the contract, you must return to option fee to your tenants. Either way, you are making money whether your tenants buy the home or not. If your tenants decide not to purchase your property and the contract expires, you can begin the entire process all over again.
The important points about the lease and purchase option are that you are looking for good tenants to rent your property, create a constant cash flow from the rent, transferring the maintenance responsibility to your tenants, which frees up lots of your time, and eventually sale the property. Your ultimate goal is to sell the property to good tenants at a price that is fair. The deal should be fair enough that both parties come out feeling like winners. This is important if you want to be in this business for a long time.
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