Residential Lease Option Explained

Residential Lease Option Explained

Residential Lease Option ExplainedResidential Lease-Option or rent-to-own programs have exploded in popularity since the 2008 housing bubble collapsed and will continue into the decade ahead.

Who Benefits?

These Residential Lease Option programs are typically marketed to people who have bad credit with the aim of getting them into a home with the option to purchase it in the future.

Many of these people have stable jobs and pass background checks. The only thing holding them back from purchasing their own place is bad credit. This approach to investing provides good families with a place to call their home and this program helps them get back on their feet!!

In response to the economic recession and the sub-prime fiasco the banks now have tighter more-stringent lending guidelines. Resulting in tons of people who would be great Rent to Own or Lease Option clients.

This is awesome news for the investor because now we have a larger potential pool of tenants to choose from. It also means we can continue to provide excellent products for good people who need them!

Lots of different methods!

( A side note: The information in this post was learned from the book Strait Path to Real Estate Wealth by Kris Kohn which we offer for free in its entirety by requesting it to the right or in the footer of this website)

There are literally as many variations on this type of investing as there are people who use it. I’ll provide a Rent to Own Example using one of my personal properties in another post. I believe the way I have learned to do it is the best and I’ll show you why.

Before we jump into it I also would like to mention that this type of strategy has received a bad reputation.

People have used this to take advantage of others who are desperate and down on their luck. This is NOT acceptable practice in my book.

I always seek a win-win both going into the contract and exercising the option to purchase. Even with tenants who can’t pay and I need them to move out I always seek the best outcome of all parties involved.

My process of the Lease Option

I learned this perfect system in The Strait Path to Real Estate Wealth by Kris Krohn.

I start out with a plan and stick to the plan. I don’t allow emotions to dictate or skew the numbers of a good deal. I’m looking for a 3 bedroom 2 bathroom house, sometimes larger.

Preferably over 1,500 square feet. The house must be in a geographic area that I deem acceptable  based on crime, schools, neighborhood, job availability etc…

The house itself does not have to be immaculate by any means. I am looking for livable and functional. I never buy a property that needs more than $3,000 in repairs before it meets my livable and functional criteria.

This is very important because lots of people when starting out try to project their own living standards onto their investment prospects. This is not going to serve you well.

house plans

We look for this very specific type of property for two main reasons:

  1. This targets the largest market that can afford the property.
  2. The folks who are sick and tired of renting a cramped over-priced apartment with lots of restrictions and headaches are usually very eager to overlook the less-than up-to-date cabinets and landscaping.

What about the price?

We also have very specific goals. The rule is simple but specific. The property must be selling at a minimum 15% below current market value based on current market analysis (CMA) performed by our Realtor.

Each investor should know a general price range that they can afford and also one that will be affordable to our target market. This means staying away from luxury or high end homes.

Why?

  1. We capture equity going into the investment which will allow us to be very flexible when negotiating with our potential tenants.
  2. It  provides a generous buffer or hedge against continued market or home value fluctuations.
  3. When the tenants exercise their option to purchase, I receive the difference between my purchase price and their purchase price. Usually a sizable a lump some!
  4. We can rent the home according to the CMA or Comparable Market Analysis which is usually much higher than what we paid for it. Thus increasing the positive monthly cash flow.

Once we have the house purchased we market the property.

Traditional marketing includes: Craigslist ads, local real estate websites, word of mouth, For Rent and For Sale signs from your local store etc…

Non-traditional marketing includes: brightly colored signs with phrases like: rent-to-own, no bank qualifying, bad credit OK, as well as your phone number

These signs are placed on both approaches to the property so traffic heading either way can see and read the signs. Another sign is placed in a highly visible window inside the home.

The purpose of the signs is obviously to get people interested, but more than that, by having all these signs it tells the passersby that we are normal people and are flexible because we are advertising many options.

Inquiries come rolling in!inquiries come rolling in

Once we have people calling in we set up home tours or open house events. We do not discuss money or pricing over the phone. We can give specs about the house itself like how many rooms, square footage etc..

We want to get as many interested parties to attend the same event as possible. This will create an atmosphere of excitement and healthy competition. It will help weed out those who are tire kickers and those who are genuine.

While at the open house we don’t have to “sell” the house  like a real estate agent. We invite them to walk around by themselves while we wait in another room. Upon their return you answer questions and present the flexibility and specifics of the program.

Let’s talk money!

This is where you would give them a flier or handout which details the specs of the property and at least three options of required money down and corresponding monthly lease payment.

For example:

Money Down Monthly Payment Monthly Equity Accumulation
$7,000 $1,000 $175
$5,000 $1,100 $100
$3,000 $1,250 $75

 

Much like a bank, the more money they put down the lower their monthly lease.

As an incentive for them to make their payments on time we typically offer $75-$175 dollars back per month in the form of a discount-at-purchase. On top of that we offer the money down as a discount-at-purchase too. We can do this because we purchased the house at 15% or more below market value.

By offering this as part of our program we can help them create equity in only a couple of years! If they were to get a bank loan they wouldn’t start realizing equity till 7 to 12 years down the road. This is a huge selling point for our program and people love it! Like I said, win-win!

Here is what this looks like on a real life example!

Share this article and let me know what you think! Leave a comment below!

Residential Lease Option Explained By Joe Nielsen

12 Comments

  1. Joe,

    Great advice man! Property investing is something I’ve always been interested in (currently have one rental) and would like to grow my property portfolio in the next year or two.

    I’ve never thought of leasing with the option to buy. I’m going to look into this further.

    Thanks again for the great advice.

    • Hi Jeremy,

      Thanks for stopping by!
      Congrats on having one property under your belt! Often times its the first one that is the hardest.
      There are so many creative ways you can invest in real estate and lease-options are just one way.
      I have made excellent returns and monthly cash flow from my lease-option properties so I know its possible.
      Also make sure to grab a copy of the free book I offer. It’s all about how to do a lease-option and do it the
      best way possible.

  2. Highly informative post! My husband and I are hoping to have a house by next year and we were actually considering this option. Very timely reading for me!

    • Hi Ariel,

      This is a great way to get into a place when one’s credit is not ideal.
      Just make sure to make sure the contract is fair in your eyes and have an attorney
      give it a once over to make sure there aren’t any surprises.
      Best of luck in finding that first home!

  3. Interesting stuff! Coming from the UK I have little idea of how things work over there. I have learned a lot! I will pass you site details onto a friend who is considering a big move across the pond next year.

    • Hi Michelle!

      I’m thrilled you found this article interesting.
      Luckily the basics behind real estate investing are pretty
      similar where ever you are. It is the local laws and regulations
      that one needs to brush up on.
      I’d be happy to help out your friend when the time is right!

  4. These are very helpful und guiding information about Residential Lease-Option, thanks for sharing your knowledge!

    • Hey Vera,

      Glad you stopped by and happy you found it useful!

  5. Interesting article and information on how all that stuff works! Thanks!

    • Glad you found it interesting and informative!

      • Yes you have reportable incmoe from your description of the situation.If in fact you are renting without a profit motive, then you would list all rent as other incmoe. You could not take a loss on the rental incmoe, and other expenses could be deducted on Schedule A only up to the value of the rent (miscellaneou deductions). This is an expensive way to receive the incmoe.The fact that there is no formal lease agreement, or that the rental incmoe you receive is less than your expenses, is not relevant to determine whether you have reportable incmoe. You may also not know the actual market rent for the units you are going to rent. If you rent your home at a fair market price, then you use Schedule E to record your profit and loss. It is common for Schedule E to show a loss, which can be used to offset your other incmoe.

        • Hi Victor,
          Sounds like you are knowledgeable about taxes. That’s great when investing in any asset. Taxes are most Americans single largest expense but not many really think of it that way. It’s amazing really how real estate offers so much by way of reducing or eliminating the tax burden for investors. Having a competent tax professional on your team to help plan for and implement taxing saving strategies is very important. Thanks for your comment!

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