Seasoned investors seeking their road to wealth will readily acknowledge that the easiest and surest path to long term wealth is through holding a portfolio of houses. And the best way to keep your houses is using lease options. To appreciate how important lease options are to your financial prosperity, it is important to first having an understanding of what a lease option is.
Lease options as an exit strategy may or may not result in the actual sale of your property. You are renting the house out to someone and giving them an option to later buy it. They have a rental agreement with you and then they pay you additional money in exchange for the right to purchase the property at some point during their lease. It is customary to charge 3-5% of the property’s market value for the right to purchase.
There are a Number of Lease Option Benefits:
- No realtor commissions to pay when the property is sold.
- You make up front profits from your buyer’s option consideration.
- Larger monthly cash flow than with a standard rental.
- Much higher quality of tenants than with a standard rental.
- You keep all the tax benefits.
- You profit from appreciation. Statistically, only a fraction of the buyers will actually exercise their right under the Option Agreement and purchase the property. So, the seller gets the property back with the property often appreciating in value when that happens, without any tenant headaches along the way.
- You get to keep and profit from the buyer’s forfeited option money
- Your vacancies will fill up faster.
- It is a way to delegate the management and maintenance of the property without giving up the ownership.
Deciding the Monthly Price and Payment Options
It is customary to set the listing price on the lease option property sales price for 5-10% more than its fair market value. You can do this because you are “selling” these properties to credit challenged buyers that cannot qualify to buy a house with a traditional bank loan. It is entirely appropriate to charge more for the property because you are offering something that they cannot get with a traditional home that is for sale. This is in keeping with the customary practice, previously noted, that you can charge 3-5% of the property’s value for the right to purchase under the Option Consideration. Always use a range when asking for this so that you can get a higher amount from people who have more to put down. Also, in a highly appreciating market, you may consider raising the purchase price even more.
As far as monthly payments go, there are two points that need to be addressed. First is the monthly rent amount, the second is the rent credit. The monthly rent amount should be set at 10-20% above the fair market rent. You can charge the higher price for the same reason that you can charge a higher selling price because you are selling to credit challenged buyers.
You should also offer rent credit on the property to further entice buyers to pay a higher monthly rental amount. Here is an illustration of this:
$1,000.00 month rent= $0 rent credit.
$1,200.00 month rent= $300 rent credit
Rent credit is money that is deducted from the purchase price if the buyer buys the property. The great thing about this is that the buyer only gets the rent credit if they purchase the property. If they pay the higher rent and then do not purchase the property, you keep that extra rent and they are not entitled to any rent credit. As previously noted, most folks do not exercise the option and purchase the property. Lease Options are a great strategy to have in your REI toolbox.