Master Leases With or Without an Option

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Topics: Landlording, Master Leasing

Master leasing has helped many CashFlowDepot members go from $0 cash flow to $10,000 or more in cash flow quickly.  With Master Leasing, you don’t need to save up for a down payment or buy houses and you don’t need to qualify for a loan.  Instead, you simply lease a house from an owner with the right to sublease it to your tenant.  Master Leasing is the quickest and easiest way to generate a lot of cash flow quickly.  You can also combine an Options with a lease but it is not necessary.

Learn more about Master Leasing (with and without an Option) in the article below which was written by Jack Miller.

When you combine a lease/sub-lease sandwich with an Option in which a credit is given against the Option price for each payment, then the sub-lessee is actually buying the Option for you. There is a negative cost in this investment. There is nothing quite like this anywhere else in the investment world. Each payment that is credited against the ultimate cost has the same effect as any principal loan payment made to amortize a mortgage, but with a major difference. Option payments “amortize” at a much faster pace. Here’s what I mean:

Options are the ultimate OPM strategy. If you were to buy a $150,000 house with a 10% down payment, it would cost $15,000 down, plus closing costs. Payments on the $135,000 balance over 30 years would be $990.58 plus taxes and insurance. At the end of 5 years, you would still owe $128,344 on your loan after having paid in a total of about $59,435.

On the other hand, suppose you had made exactly the same payment on a Lease/Option, but had negotiated a credit equal to 25% of each rental payment? First of all, other than your lease deposit, you would have made no down payment at all. Secondly, almost $15,000 would have been credited against the purchase price. Best of all, this would have been paid by your tenant, not by you.

The only problem with this arithmetic is that the rental market could weaken; leaving you with a $990.58 payment to make each month you experienced a vacancy. If you didn’t know how to manage rentals to keep them filled, over 5 years, you could wind up paying a lot of money for this lease out of your own pockets. One way to limit your risk is to write your lease in such a way that you shared the risk with the owner by giving him a fixed percentage of the rents that you collected, but this would limit your up-side profits. (This is called a performance lease)

Another way to capture maximum cash flow and profit while limiting the risk is to specify a term in your Lease/Option to only one year. You’d build in an Option to renew it each year for the next four successive years. This way, you would only be liable for vacancies that occurred in each year that you elected to renew the lease/Option. Of course, anytime you tired of leasing the property, you could either
sell the lease based upon the growing cash flow spread generated by rent raises; or sell the Option based upon the growing equity; or you might exercise the Option and simultaneously sell the house itself to capture your growing equity…

Lease terms can transfer negative cash flow and risk from the owner to the lessee, while using the tax code to help both of you. A person who is already experiencing negative cash flow because he can’t or won’t manage a rental would be desperate to have another person come along and alleviate the problem. His only cost would be a share of future sale proceeds, and that wouldn’t seem very important weighed against current cash flow needs.

He’d have no vacancy, no management, all the tax benefits, and cash from the rents to help him make his payments. On the other hand, the Lease/Option presents an outstanding opportunity for the entrepreneur who is able to garner equity through both the appreciation of the property and rental credits given against the Option price. It would be difficult to come up with a better arrangement.

Where do you find house owners who would be motivated to enter into this kind of arrangement? To locate motivated sellers, mine the newspaper ads for people willing to carry back installment payments and convert them to Lease/Options. Prowl the neighborhoods looking for vacant houses. Scour the courthouse for eviction notices. The owner of a rental who has to evict a tenant is about as disenchanted with the rental house business as he’ll ever be, and as willing as he’ll ever be to hear your proposition.

If you’ve already got a source of cash for payments, you can offer additional cash flow in return for a much greater Option credit to solve cash flow problems for an owner who needs money. In the above illustration on the $150,000 house with a $75,000 balance, instead of simply making the $990.58 loan payments for the owner, suppose you offered $1500 per month with an Option credit equal to 125% of the payment?

Let’s suppose that you were only able to rent this property for $1200 per month. Each month, you would be paying out $300 in negative cash flow, but getting a credit of $1875. This translates to  a return of $22,500 each year against the purchase price at a cost to you of $3600. That boils down to a yield of 625% on your invested cash, taxed as capital gain, that you would realize when you sold the Option after a couple of years.

Divorces present a rich source of Option opportunities. In a typical situation, when a household breaks up, the equity in the house is divided in such a way that the mother keeps possession while the father pays alimony and child support. Quite often, there simply isn’t enough money to provide much of a life style for either party, thus, alimony payments to the mother become very unreliable.

By getting both parties to agree to an Option in which tax-free payments will be received by the mother with which to make house payments, and credited against the purchase price in lieu of alimony or child support payments, it solves a real problem for both spouses, as well as their children. And, with an appropriate percentage credited by the Optionee against the purchase price, it can be extremely profitable for him or her.

Another kind of distress situation in which a lease/Option is welcomed with open arms occurs when a would-be investor is either burned out from management, or unable to cope with it. As you swoop in with a Lease/Option offer, you’ll look a lot more like an angel than a vulture to these people for the simple reason that you will be fulfilling a real need in a way that nobody else can. Options: Try ’em, you’ll like ’em.

USING SANDWICHING LEASES WITHOUT OPTIONS

When someone leases property from an owner, then sub-leases it to an occupant for a higher rent, this is called a “sandwich lease”. A lot of people get confused by the name, thinking that there is some sort of magic document that creates a sandwich lease. There is no special paperwork other than a lease the gives the tenant the right to sub-lease the property to another tenant. This arrangement is called a sandwich lease because the entrepreneur has placed himself between the person who pays rent and the person who ultimately receives rent.

A sandwich lease can provide low-risk cash flow with a negative investment for those who are willing to learn how to manage single family houses.

Negotiating Leases without Options require different approaches from Leasing with an Option. The seller keeps all appreciation in return for giving up a share of the cash flow. When Leasing without an Option to buy, the best lease targets are people who have been unable to sell, or who are reluctant to place vacated properties on the market because of all the hassle. A vacant house can be a real burr under the blanket when payments must be made on it. So, the potential lessee would present himself or herself as a desirable, responsible long term tenant who would take good care of the property. One might even agree to pay rent payments annually in advance for discounted rents.

Using a $150,000 house with a fair market rent of $1200 as an example, in a pure lease situation, the benefit to the lessee is in a cash flow spread between rent that is being received from a sub-tenant and cash that must be paid out on the lease. The benefit to the owner is a hassle free, vacancy free, maintenance free rental that he can write off while getting all the appreciation.

In a hypothetical situation, the potential tenant would try to get 10% discount for paying the rent one year in advance. It could be pointed out to the owner that he could recover this discount easily in today’s stock market. Next, perhaps 5% could be negotiated for signing a five-year lease. Just one month’s vacancy each year would be much more than that. Another 3% might be negotiated for taking care of all maintenance items under $100 per month, and as an override on any maintenance arranged on larger items. If you add all this up, the tenant winds up renting this house for not quite 18% under market, or $984.00 per month.

Let’s assume that market rents on the sub-lease could be increased by 5% per year- the first years net rental spread would be $2592. The second year the annual rents would rise by $1200 and the spread would increase to $3312. The third year the spread would be $4068; the fourth $4860, and the fifth year, the tenant would be receiving over $475 per month for doing little more than managing one rental house.

Of course, in the real world, none of these numbers would work out. There would be expenses, vacancies, etc. On the other hand, if, as is spelled out in the rental agreement previously covered, if many of these expenses were passed along to the tenant, it would be a very worthwhile endeavor for someone trying to find cash to feed a highly leveraged cash flow property.

Learn more about Master Leasing and Options with the Premium Training at CashFlowDepot.  We just added a new 2 hour training video about Master Leasing.  This information will help you get started with Master Leasing right away.

Tags lease options, master leasing, real estate options, sandwich leasing

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