We’ve talked a lot about positive cash flow. By now you should know that $100 is the minimum you need to get out of any property to make it worth your while.
But it would even better if you could get $125, $150 or even $200 in positive cash flow out of each unit each month, wouldn’t it? And what if you could get that guaranteed in a multi-year lease, too?
Sound too good to be true? It’s not. I’ve done it hundreds of times, and so have many of the real estate investors I’ve trained. And you can, too.
It’s called a ‘lease option.’ You may have heard it referred to as ‘rent to own.’ Whatever you call it, it’s a great way to increase your cash flow without increasing your investment of time or money.
In the simplest terms, a lease option is an agreement between you and the tenant that the tenant will buy the home in three to five years. The tenant agrees to a multi-year lease. You agree to set aside a certain amount of rent each month toward their eventual purchase of the home. (Even better if you can offer to provide owner financing.) The tenant thinks you’re doing him a favor – and you’re putting more money in your pocket every month.
Here’s 5 Reasons Why Lease Options are a Smart Idea:
Reason #1: You can charge 15 to 20 percent above market rent. Since you’re agreeing to set aside a certain amount each month toward the tenant’s eventual down payment, you need to bump the rent up. Say the market rent for your type of property is $800 a month. You can charge $950 and agree to set aside $150 each month toward the downpayment. Will people go for this? Absolutely. There are tons of people with plenty of ready cash flow and the desire to own, but no savings (or lousy credit). Most Americans are short-sighted and payment driven – they’ll look at whether or not they can afford the rent each month, not what the return will be long term.
Reason #2: You can get a three to five year lease. Dealing with vacancies can be a pain, and it impacts your monthly cash flow. With a regular rental, you can sometimes get a two year lease, but with a lease option you can get a three to five year commitment.
Reason #3: You can get more money up front. With a regular rental, you can ask for the first month’s rent and a security deposit. With a lease option, you can ask for several thousand dollars up front in earnest money – basically, money to show they’re serious.
Reason #4: You’ll get better tenants and fewer headaches. In the lease option agreement, stipulate that you’ll run comps and set the purchase price when they’re ready to buy. Tell them that if they pay their rent on time every month, you’ll discount the purchase price by 5% when the time comes. That’s pretty motivating for a lot of people. Also, lease option tenants will take better care of your property, since they’re planning to live there for awhile and think it’s going to be theirs soon. Many lease option agreements say that the tenant is responsible for all repairs under $500, which can save you from a lot of annoying maintenance calls. Again, that sense of ownership settles in even before the papers are signed – and that can make your job as property manager a lot easier.
Reason #5: You’re in great shape whether the deal ever happens or not. Here’s the little-known secret to lease options: four out of five lease option tenants walk away without ever buying the property. They take a new job, move to a new town, break up with their girlfriend, whatever – and when they do, you get to keep the earnest money, and the extra money you’ve been setting aside each month for their downpayment. Chances are the property is in great shape, and you can find another tenant – or another lease option tenant – quickly. You’ve lost absolutely nothing, and in fact, you’ve gained thousands of dollars – all for probably less effort than you would have put in to a regular lease deal. And if they do buy the property, you’ve still made a profit, on top of the cash flow the property generated for you over the term of the lease.
Lease options don’t work in every case, and you’ll want to make sure you’ve got an ironclad agreement that spells out all the details. But when done right, these deals can be a great addition to your real estate investment strategy.