I am commonly asked the question, “Does it hurt the seller to do a lease option on a property investment?” My real estate investing strategies include this powerful selling tool so this video will detail why lease options are sometimes the best choice for sellers.
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Does It Hurt The Seller To Do A Lease Option On A Property Investment?
Joe: Hey, it’s Joe Crump. Does it hurt a seller to sell their property on a lease option? All right, so we want to look at the pros and the cons of buying and selling properties on lease option. Now, let’s put myself in a position of owning a property. I’m the seller, or I’m somebody who’s got a property and I need to do something with it. And let’s say it’s a property that I’ve been living in for a while and I decide I think I’m going to move. And instead of selling this property I’ve decided it makes sense to keep this property for the long term, let it pay for itself, let the tenant pay for it over time, and then I’ll have this asset that I can use at retirement. Which is what I’ve done with many, many properties. It really makes sense. Never sell your properties, unless you’re making a chunk of cash.
Joe: All right. So, I have a property and I want to turn around and I want to sell it on a lease option. What are the benefits to me doing that? First of all, I get a tenant who is going to be more like someone who owns the property. You know, you never wash a rental car. You take care of your own stuff, you don’t take care of stuff that you rent. It’s more likely that you’re going to find a good tenant who sees that property as their own because they’re buying it on a lease option. And that’s a good place to be. So I like the lease option tenants because of that reason.
Joe: I want somebody who’s going to take care of that property. I can also put in my lease option agreement that they have to take care of all the repairs. So we have to do a lot less maintenance. Now, if something major comes along we usually help out. Let’s say a furnace needs to be taken care of. It’s still the buyer’s responsibility to replace that furnace, but I also know that it’s not likely that they’re going to be able to come up with the money to be able to do that. So, often I’ll go in and we’ll replace the furnace and then have them make payments to us over time to cover the cost of that furnace, and still allow them to continue as a lease option buyer.
Joe: Also, a lot of people aren’t going to exercise that option. And they’re going to eventually move out. And then I’ll turn around and I’ll sell it to another person on another lease option, usually at a higher price, usually at higher rent. And so I’m able to do this continually forever. It’s fewer than 30% of lease option buyers will actually exercise their option. So, I have a pretty good chance of getting that property back which I like. If you really want to get rid of the property, then you can help those people, make it a little bit easier for them to buy the property, but even then, it’s unlikely that they’re going to exercise the option.
Joe: People move on average in America every two to five years. That means that if you do a three-year lease option it’s likely that your needs are going to change within that three-year lease option period. So, the likelihood that you’re going to exercise the option – even if you’re able to – is pretty low. You’re probably going to go out and find another property.
Joe: So, me, as a landlord, that’s not so bad. I get to keep holding onto that property, I can continue to depreciate that property over time and continue to get the cash flow on that property and continue to buy down my note if I have a mortgage on that property every month, and I get to continue to see the values go up on that property. So, I see appreciation, depreciation, cash flow, buy down on the note on every property that I have every month. And that’s just a beautiful thing because it means thousands and thousands of dollars a year for each property that I own.
Joe: And if I sell it, I make another chunk of money. And then I take that money and I’ll go out and buy another property. So, that’s a real advantage when you’re buying properties or when you’re selling properties like this.
Joe: Now, let’s look at the downside for the seller. A lot of sellers, when you talk to them say, “I just want to get my cash out of this deal. I don’t want to be a landlord,” or, “I’m absentee and I don’t want to think about this every again.” And so they’ve got that negative in their mind thinking that, oh, no, it’s not going to be worth it to me. Or, somebody’s going to come in and trash my property and I’m afraid of that happening. So, these are the fears that seller’s have and one of the reasons why they don’t want to lease option their property.
Joe: So, we have to help them understand about those fears and how big those fears are. Let’s take the one about trashing the property. That happens sometimes. It’s pretty rare, though. It’s rare that somebody actually just outright trashes a property. Now, there’s wear and tear on property and people can be pretty hard on property and I think that every one of my tenants drinks red Kool-Aid because they tend to stain my carpets all the time. So, that’s normal. And we have to go in and we have to clean that up or repair that stuff, and that can be expensive. But when I weigh that against the amount of money that I’m making through all the other forms of cash flow that I have on that property, I make more money by holding onto the property than it costs me to do those repairs. And if somebody actually does vandalism to the property, well, that’s against the law. And then you can call the police and you also have insurance to help you with those kinds of expenses.
Joe: So, that’s one of the big downsides. Also, I have a mortgage on this property and I want to get another house. So, can I do that? Well, the income that comes in on this property will offset that cost. And most lenders will look at 75% of the income and allow that to go toward the debt service on a property. So, let’s say I have $1,000 a month income on a property, and $750 a month of payment on that property. I can show that lender, look, I’ve got $1,000 coming in on it. They’ll take 75% of that, which is $750, and it’ll offset that debt. So it won’t count against my debt-to-income ratios when I try to qualify for another property. They’ll see it as income.
Joe: Now, they may want me to have experience. And a lot of lenders these days are asking for, if they’re going to apply that money, they want to see a year of experience as a landlord. If you don’t have that experience the way that you deal with that is you hire a property manager. And once you do that then the lenders will usually allow that, depending on the credit of the borrower. So, that’s usually not as big a problem as you might think it is.
Joe: Another negative is the cash. I want the cash. I need to sell this property and I want to get my cash out so I can make a down payment on the next property. Well, when you buy the next property usually you can put a much lower down payment on it than you think you can. If you look at FHA loans you can get in there at 3.5%, 4.0%, and buy those properties with very little down. You can have the seller pay the closing costs. You don’t need a lot of money to buy a property.
Joe: So, you don’t have to pull a chunk of cash out. And then they’ll say, well, I want to pull this money out so my payment will be lower on this new property. Well, you’re going to be having positive cash flow on the existing property that will come in and pay the money that you would have been buying down that note from on the new property. And, in fact, you’re not going to have to give away 10% or 15% of the value of your property. So, if owe $100K on a property, and the property is worth $150K and you sell it through a realtor, it’s going to cost you $15,000 or $20,000. That means that you’re going to have $30,000 left.
Joe: Whereas if you left the money in there, you’re going to have the value of having $50K in there. And you won’t have to lose that extra money. So it makes it actually cheaper to do it in the long run. When you sit down and pencil out all these numbers, it suddenly becomes very, very real that keeping your property makes a lot of sense. And that’s why this option that we’re giving our sellers when we go and make the For Rent Method offer to say, hey, you know, should you do this? They’re going to go for it because they’re going to make more money in the long run.
Joe: You also have to look at all the options that the seller has. And even if they don’t like the option that you’re giving them by doing a lease option, they may not like the other options either. Selling with a realtor – expensive. It takes a long time. You never seem to get the money you want. You may not have enough equity to do it. Or you have to give up a ton of the equity you created to a realtor who gets all that money. So, that’s not a great option. Dropping the value in a way that you can sell it for cash without using a realtor is going to cost you more than what a realtor could have gotten you.
Joe: Giving it back to the bank. There’s an option. You can do a short sale and give it back to the bank. But it’s going to trash your credit. But it might make sense to do that in certain circumstances. But, if you could protect your credit and you could keep the property and you could eventually come out of this on the other side and make a bunch of money, wouldn’t that be better? So, start looking at their options and help them understand what those options are, even if they don’t like the options that you’re giving them, if they understand what all their options are, then they can choose the best one for them.
Joe: All right. Lease options make a lot of sense. It helps both people who have the need and the people who have greed. People that have no other options and people that just want to make more money. Lease options are a great alternative and it’s what I do with a lot of my properties.
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Joe: All right – Thanks now.