There’s little difference in finding Lease and/or Option opportunities and in finding properties to buy. I prefer to ‘cold canvass’ neighborhoods on foot and through flyers delivered door to door. Most other people mine the newspaper advertisements for hidden gold, court house records and ‘bird dogs’ that turn up motivated Sellers. All these sources work with Leases and Options if the Buyer/Lessee/Optionee takes the time to delve into the motivation of the other party. But there are clues all along in the process.
Remember that you do not need a lease to buy an option and you do not need to get an option every time you get a lease. A Lease and Option can work together or they can work separately.
A newspaper advertisement to rent or to sell is a cry for help. Anytime that an owner is willing to accept installment payments, that’s a sign that a Lease/Option approach might work. In many ways, there’s little practical difference between a Note and Mortgage with a Balloon Note, an Installment Purchase with a Balloon Note and a Lease/Option with a cash buy out at a future date. Each of these can be structured to generate the same tax, use, amortization, cash flow and leverage benefits.
About the only difference between them lies in the SECURITY offered to the parties. When a Note and Mortgage or Deed of Trust is used, fee simple title passes to the Buyer from the Seller in most cases, creating more risk for the Seller who must foreclose and quiet title to regain ownership. When an installment sale contract is used, fee title remains with the Seller while equitable title is transferred to the Buyer. In some state foreclosure is required to return the property to the Seller. In others, the property is more or less repossessed by the Seller without resort to the courts. Lease/Option transactions are treated like installment sale contracts in many States.
The party who winds up holding the fee title to property is usually in the most secure position, so Sellers are easily persuaded that a Lease/Option purchase is safer than a Note and Mortgage once all the factors have been explained to them. Since the paperwork and formalities can be made much simpler than in a conventional sale, both Buyers and Sellers accept them.
When a party advertises a property for rent, it’s always a good idea to ask for a ‘rent to own’ deal, or a Lease/Option. It’s amazing how easily an Option can be obtained from Landlords who are advertising rentals. As always, the key is to obtain some sort of credit toward the purchase price and to have the right to sub-let the property. Owners of vacant properties are easier to deal with, because they’re usually more motivated. When the owner is also out of the area, it’s much easier.
Don’t overlook straight Lease opportunities even when there’s no possibility of an Option. One enterprising lad located a 20 unit apartment which had a chronic 50% vacancy factor because the out of area owner was never around when someone wanted to rent a unit. He negotiated a lease under the terms of which he agreed to Master Lease the entire apartment building at exactly the same net rents the owner had averaged over the preceding 3 years as verified by tax returns. Now came the fun part.
First of all, he moved into a vacant apartment and solved his housing problems at no cost. Next, he spruced up the appearance of the property and cleaned up the common areas and vacant units, then placed signs all over town at bus stops, 7/11 stores, Laundromats and in shoppers guides. In short order he’d rented up the vacancies, which dropped on the average to 2 units counting the one he was using for his own residence.
With rents averaging $500 per unit, the 8 extra units he rented up were producing $4000 per month net cash flow to him. That added up to almost $50,000 per year with only moderate exertion. I never cease to wonder at people who are always looking to exotic real estate financing formulas to produce cash flow when it is available for those who understand the rudiments of leasing. Couldn’t you do this too?
The beautiful thing about the above approach is that almost any owner of rental property would be willing to let someone take over all the management and maintenance effort so long as his or her cash flow wasn’t affected. I’ll tell you about another innovative approach.
In this situation, a 50 unit apartment was suffering a 25% vacancy rate and the owner was at his wits end. Enter the professional manager who agreed to lease the property to provide the owner with the same cash flow he’d been realizing. All increases to remain with him. So much for the lease. In return for an Option to buy based upon current cash flow net rent multipliers as were explained in the early portions of this book, the entrepreneur offered to give the owner the rents equal to 20% of the total current rents for the next 5 years with full credit against the purchase price.
Let’s say these amounted to $500 per apartment times 50 units times 75% (occupancy) times 20% times 12. That would come to $45,000 per year or $3750 per month. The purchase price would calculate out to 50 units times $500 per month times 12 months per year times 75% occupancy less 50% for operating expenses times 10 times net operating income. This comes out to $1,125,000. or $22,500 per apartment unit. At the end of 5 years, a total of $225,000 would have accrued against the purchase price. The owner agreed to carry the remaining 80% of the price himself.
Let’s take a closer look at the numbers. Presumably the manager was able to keep the complex reasonably filled up. Let’s say there was a 5% vacancy factor year around. Remember, it was only 75% filled when he took over. By increasing the occupancy rate to 95%, the 20% increase in rents funded the amount being given to the owner for the Option each month. In a perfect world, the manager wasn’t being paid for management, but was using the owners own property to pay for his down payment. But there’s more to this than meets the eye.
All of the above figures presume that the manager was unable to increase rents. Let’s assume that rents could be increased by 5% per year. Initially 50 units times $500 per month times 95% occupancy times 12 months per year would equal $285,000 in gross rental income. $45,000 of that would be paid to the owner in return for the Options as mentioned before. But see what happens as rents go up.
When a manager raises rents, most of the increase goes directly to his bottom line profits because so much of apartment expenses are fixed when tenants pay their own utilities. If average rents were to increase by 5% per year, the second year $299,250 would be collected, the third year these would be increased to $314,212. The fourth year $329,923 would come in and the fifth year the manager would pocket $346,419 in rents.
Over the entire period the manager’s operating profits would add up to $149,804 over and above the $225,000 he would salt away toward his Option. When you calculate that he will earn $374,804 over 60 months that comes to over $6000 per month. Not bad with nothing down.
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