if she liked it.
Roberta had poor credit and seven dogs. Most landlords won’t rent to someone with seven dogs, and most mortgage lenders won’t do a mortgage for someone who has poor credit. With an inability to get a mortgage she is also unable to work conventionally with a Realtor®, so what is she going to do? No one will rent to her, and no one will give her a mortgage. This puts many people in a situation where they desperately need a solution. I am trying to help people with this type of situation. They want the American dream, yet they are unable to obtain it any other way. Lease options give people a second chance to improve their credit while working towards the purchase of the home they desire to own.
If you’re a landlord, all you get up front on any of your rentals is the security deposit, and that is just not enough cash to take on the risk of someone with poor credit and seven dogs. You can change this scenario by converting these people from tenants to tenant-buyers. Then, the risk that once was on you is shifted to the tenant-buyer - where you truly want it. With Roberta putting a lot of money down (option fees are not refundable), she was taking on the risk.
Let’s look at how the deal transpired:
My Out of Pocket costs:
I didn’t even own this home and yet I had $5,000 in my pocket. Roberta is the one risking $10,000 with her option fee, as it is non-refundable. If she doesn’t buy, she’s walking away from a lot of money. She now has a lot of risk on her also with her $10,000 option fee.
Janet asked for $1,100 per month, and I in turn asked Roberta for $1,450 per month. That way I was able to pay Janet and still have a cash flow of $350 per month which would add to my profitability in the deal. In this case Janet had a lot of equity in the home, and I was able to leverage that equity to get her to accept the lower monthly payment of $1,100.
The option sale price I set for Roberta was $225,000. How did I get that figure? I put a 10 percent option premium on top of the retail price (to be discussed in a later chapter – Determining Profitability of Deals) plus I added an additional 6 to 7 percent appreciation rate at 18 months which was approximately another $20,000, I rounded it up a little to get to $225,000.
Now I understand that you may or may not have appreciation in your market at the time you’re reading this book. It doesn’t matter if you do or don’t; you account for that in the beginning before you make your offer to purchase.
What was the property actually worth? Value is always determined on what a buyer is willing to pay. Roberta later had the house appraised at $267,000. Did I lose $42,000? I don’t think so. After all, I did make about that much. Was Roberta happy with the appraisal? OF COURSE! Janet is happy because she got the price she wanted, and Roberta is happy because she’s suddenly has an appraisal that gives her an additional $42,000 in equity that she can utilize if she wants. Janet won, Roberta won, and I won. I believe this demonstrates what a classic win/win/win deal is all about.
Here’s my profit at closing: Not bad for not actually owning anything (except for 2 hours) – just controlling it!
* It is not exactly $43,700. There are transfer fees in a few states, title insurance fees, and I give my buyers option credits each month when they pay their rent on time. The extra $2,800 on tax pro-rations was given as extra profit to me also (not available in most states - a bonus when both the buyer and the seller paid for property taxes at closing. Only one person needed to pay for property taxes. Therefore, the extra $2,800 is given to the investor in the middle of the sandwich lease option deal.
Financial Freedom – You can get there!
This examples show you how lease options can be very profitable. The previous example is a fairly simple version of the lease option technique, as there are many other creative ideas you can do to make them more profitable and more complex as you choose (covered in chapter 9). Remember, you may need several deals just to lay the groundwork for your future financial freedom. It doesn’t happen with one deal, and it doesn’t happen overnight. However, with persistency it truly can happen!
There are several “paydays” using these techniques:
While the option fee is non-refundable, don’t get excited on your first deal by immediately going out and buying that big screen TV you’ve always wanted. What if something happens down the road in six months? In owning or controlling real estate there are things that come up that are completely unexpected: broken furnaces, leaking roofs, unpaid rents, etc. Plan ahead for those things and you will be safe. If you have held the option funds in reserve, you will be able to cover your expenses. That’s just good business sense. Yes, the money is yours to keep, but be wise with it because you may need it. You might actually want to put it aside entirely for a “rainy investor’s day” so that you will be prepared. Then after the deal closes, you can take another look at the money because not only will you have that initial option fee, now you’ll have the backend from the closing. As you are getting started in this business or any other business, it is important to be conservative with your cash flow and money. I recommend you keep your spending very tight and conservative. Also, you may want to be prepared to buy the next property should a good deal be offered up to you. Unfortunately most of our country does not have good spending habits, and therefore these habits allow people to get into financial trouble. It is very important to be on a strict budget for this type of business. If this will be hard for you, then you may want to find some outside help to get you on a system, which can enable you to get this set up. I cannot stress enough; it can be a make or break for people!
Let’s say you made $30,000 overall on the deal. Here’s one positive way to use that money:
Reinvest. Reinvestment will continue to bring income, but you will also want to pyramid your income. For example: if your first property made $30,000 overall and you received $5,000 in an up front option fee, now you’re going to want to look for 2-3 new properties, probably with the same profit ranges. You’ll need money up front to pay your option fee to the seller, even though you will reimburse yourself later with the option fees from the buyer. Also, the properties may need repairs that will also need to come out of your pocket up front, so you need to have the funds available from the previous sale. During this time you will probably still be keeping your day job just to keep enough cash flowing in while you are building your new business. Reinvesting also doesn’t just mean pouring money into new properties. It can also mean purchasing new office equipment, software or anything else you need to continue to build your business. Maybe it’s time you trashed that clunker computer and got one that was made in the 21st century, install a 2nd phone line or get bookkeeping software. I cannot stress enough: be prepared for your future!
At this time my average deal is $40,000 in profit for a sandwich lease option. Lease options typically turn over every 18-24 months. Depending on what part of the country you reside in the profit range will vary from $20,000 – $120,000 (Midwest to Northern California). You decide how much you need to make, and then you will know how many homes you need to lease option. Not only can lease options set you up to live today, but they can set you up for Future Financial Freedom and retirement. Just sit back and imagine…how would it feel to be completely debt free? Real estate is the vehicle that can allow you to achieve just that.
