If you are plunging forward with your career in the real estate investment industry, you may have already discovered the difficulty in acquiring the financing necessary to fund your first property purchase, especially through the more conventional channels. Yes it is true the credit crunch we are experiencing today may have led to some tighter lender practices, but at the same time it has also opened the way for the creative investor to control a property without using any of your own money. Let’s look into this a bit more.
The tightening of the credit markets has reduced the number of buyers that will qualify to purchase a home, while simultaneously, the foreclosure fallout has also left a large number of former homeowners wondering where they will next reside. The end result of this financial tsunami is a significant amount of people looking for a place to live.
Do you see an opportunity where you may be of help? Your purpose as a real estate investor is to see solutions where others see obstacles. What I see are a number of homeowners with unwanted property and a large number of potential buyers looking for a place to live, hmmmm.
But how can we put the two sides together if the seller is in some type of personal/financial distress, the buyer cannot qualify for a mortgage, and heck, I already know I don’t have any money now what?
This, my friend, is where you earn the big bucks and use a little of that innate investor creativity! Let’s pull out our Lease Option tool kit and explore in detail how we can be of assistance and create a win/win/win real estate transaction.
So let’s set up a scenario and see how this might work: you get a call from a homeowner who has seen one of your “We Buy Houses” signs, let’s call him Bob. He is relocating to another state because of a job transfer. His house was listed for 4 months and it didn’t sell. Now Bob needs to leave and he needs a solution fairly quickly – he has given up on his agent selling the house, and he doesn’t want to carry 2 mortgages.
The Lease Option is an agreement that allows you, the investor, to take control of the property without actually purchasing the property. In essence, you will have an agreement in place with Bob for an agreed upon option payment, monthly rental amount, and a purchase price at the end of the lease agreement. All of these figures will vary upon what the seller needs to cover the cost of the property, and from your prospective, what the local market will support. Your up-front option payment that you pay to Bob for the right to exercise your option to purchase the property will be subtracted off of the end purchase price, and if possible, some percentage of your monthly rental will be credited towards your purchase price principle. As you can see, these figures will require some negotiation. The lease option agreement you sign with Bob will be anywhere from 2-5 years, and naturally, you would prefer your option payment, rent, and purchase price to be as low as possible yet still make sense for Bob the seller.
But you will not be living there – and you have disclosed this to your seller! Now let’s go find someone that wants to live in Bob’s house…
The tenant/buyer: Mary contacted you off of one of your postcards. She is indeed interested in purchasing a home and would like more information about your credit repair program. She is currently renting an apartment close to her place of employment for the past 3 years. While she has put some money away in hopes of purchasing a home, her FICO score still reflects a splurge of credit card debt racked up a few years back. The poor FICO score and the tightened lending policies have prevented Mary from qualifying for a mortgage today.
You meet with Mary and go over the many benefits of the Lease Option and also get her in touch with your mortgage broker to get going with the credit repair program. The terms of your agreement in the Lease Option with Mary will be higher than the terms you have set with Bob, the seller. I usually make the Option payment 3-5% of the end purchase price and non-refundable. I do not credit any portion of the monthly rent because the tenant buyer can then claim an equitable interest in the property. As far as the end price goes, I check the tenant’s qualification potential (forecasted impact of successful credit repair) with my mortgage broker and the current market price of the property. All three of these variables, the option payment, monthly rent, and purchase price are negotiated to a point that makes sense with your buyer why would you want to put someone into a property that they cannot afford?
On the other hand, if the buyer chooses not to exercise the option to purchase at the end of the lease agreement, you have the right to keep their non-refundable option payment and then find yourself another tenant buyer. You can continue this process until one of your tenant buyer’s chooses to exercise their option to purchase the property.
This is a scenario that works for everyone involved: Bob the seller has someone else paying down the principle of his mortgage (and perhaps enough to put a little in his pocket) while receiving the tax benefits of home ownership; the buyer improves their credit score while “test driving” a property they will soon be qualified to purchase; and the investor maintains a positive monthly cash flow while earning a tidy profit on the option payment and end purchase.
Because of your skill in seeing outside of the obstacle, you were able to broker a winnable real estate solution for all sides of the transaction! If it weren’t for your involvement, Bob may have had to carry two mortgages and Mary may have continued paying rent when she really wanted to purchase!
The Lease Option is just one of the tools you will have at your disposal when you look to find a solution to an otherwise sticky real estate issue. Stay tuned as we will be discussing another real estate tool you will find helpful in solving common real estate issues: Options…