Hi All,
I’ve read a lot of the great articles on this website, and got a lot of information on investing. But I have a question … When is it appropriate to lease option homes, and when is it better to hold them for rentals? :help
You want to lease option every house that you can get lease optioned. I say that because of the cash curve. With a lease option you get a hunk of money up front, you get more lease per month and you get the house sold in the end. So instead of making $100/month for 12 months and selling it for a $20,000 profit after one year to get a total of $21,200. With a lease option you get $5,000 up front and $200/month for 12 months and $20,000 when the person buys it at the end of the option period for a total of $27,400. Plus you don’t do any of the maintenance on the lease option house because you have them do the maintenance.
The down side is that every house can’t attract a person that wants to lease option it. The house has to be a little larger and nicer. It also takes a little longer to find a person to put in to the house. I can get a renter in 2 weeks on average but it takes almost a month to find a lease option person.
Thanks for the reply! What about Lease Option vs Renting it out long term?
I want to pay my debt down, and provide income. I just don’t know if I should start by focusing on the cash flow (rehabbing and renting them out), or build cash and use a chunk to pay down debt (sale / lease option).
What’s best? :rolleyes
It depends on what you want to do. I have the equivalent to lease options (they don’t work in Texas) and most people don’t convert at the end and you still keep the house. So all things being equal, I would get the chunck of money up front and still get the cash flow. The only difference between a lease and a lease option is you get more money with a lease option and you give up a little time in the screening process.
How long before someone typically buys that house from you? Then you have a short term gain, and lost a long term asset, right?
Would it be logical to rehab single family homes, and lease them to cover my monthly liabilities - and then lease option additional properties?
or
Does it make more sense to lease option , rehabbed homes, and save up for a multi-unit rental property?
siloxtreme,
I am in the rental business and I generally do not do lease-options. What Bluemoon said is correct in theory, but often works quite differently in practice. For example, how many people do you think have terrible credit, but yet still have a big pile of cash so that they can pay you a big option premium? In my experience, not many. So, while you’re waiting for that rare tenant with a big pile of cash to show up, you could have rented the property to a regular tenant and been collecting rent.
In addition, while many people try to make the tenant responsible for the maintenance, that is ILLEGAL in most states. Most states require the landlord to maintain the house in a habitable condition. Having a lease-option does not change that. When things go wrong, you can count on being sued and losing if YOU did not do (pay for) the maintenance. That happened to a friend of mine.
As Bluemoon said, most lease-option buyers don’t buy the property. They were never really anything more than tenants. When they realize that they are not buying the property and that you are keeping their big pile of cash, things can get nasty. Angry tenants often damage property.
Finally, if you do indeed sell the property, your equity in the property is gone and you will pay tax on any profit you make. I never sell the goose that lays the golden egg. By keeping your rentals, you build net worth and have a cash flow that will last a lifetime.
Good Luck,
Mike
siloxtreme,
I don’t know any serious buy and hold investor who routinely lease options every property they purchase. The buy and hold guy usually does not intend to sell, the lease option guy usually hopes to sell.
In fact, if there is someone who routinely lease options every property acquired, then I will argue that that person is not an investor, but instead is a dealer to real estate.
If you have a primary residence or an investment property for sale and you are having a hard time getting a buyer, a lease option may actually facilitate the sale. The non-refundable option consideration and any cash flow you may collect during the option term simply mitigates your damages if the tenant buyer fails to exercise their option.
Maybe a more meaningful question would be: Selling vs Lease Option - When is it the right time
Thanks for the information, as it helps me figure out where to start. :smile
I was asking this question because I also want to be in the rental business (long term) and wanted to have the cash to grow investments. I guess it would be better just to Refinance the property for the investment capital, and make sure there is still positive cash flow?
Follow-up question: What takes priority - growing investments or paying debt?
I’ve got a speciific type of property that I want to hold. If I buy one, I hold it.
I am not looking for any other type of property, but if I get a really super deal on a property that doesn’t meet my criteria for a hold, I would rather fix and flip.
Tenants are difficult enough to deal with without them thinking they own the place and can do anything they want.
Maybe, in the next few years to come, if the banks get really unreasonable, there might be buyers who are qualified, have down payment, and still can’t get a loan. But at this point in time, if their credit is good enough for me to loan them money, it is good enough for the bank.
silo, I think the answer to your questions is what do you want to do with a particular property. If you bought it with an eye on long term appreciation, obviously leasing with an option would be counterproductive.
On the other hand, if you are trying to facilitate the sale of the property, leasing with an option to buy is a good way of doing this.
Both are viable strategies and each has its place and time. The question is what your plan and goal is for the particular property.
Good luck!
What Mike said is really true, I just gave you the readers digest version. When you do a lease option you don’t want a person with terrible credit you don’t want the person running down a bumpy financial road hitting every credit bump that exists. You want the person that has hit a speed bump. He lost his job made a mess of it but is working again but now he can’t get a house. Most of mine actually can get a house but they just don’t know it.
All these concepts Contract for Deed, lease option, owner finance, Land trusts, lease to own. These are all the same concept. They are called executory contracts. That means that for some consideration now (Cash) we will give you something in the future (the deed). You pick which executory contract works best for you where you are with help from your lawyer. What I do is not actually lease option. Where I am I use a land trust owner finance. What I do is put the deed in a trust. Now the trust owns the house. The ”tenant” owns part of the trust I own part of the trust. The trustee is my LLC (since I am the president of the LLC, I am in effect the trustee and make all the decisions). Thus since the tenant is part owner of the trust and thus the property he can be made to do his own maintenance. Also my rentals in the lease I make the tenant responsible for the first $250 in maintenance (which in effect makes him responsible for all the repairs).
In business everything is always for sell, just at the right price. I am actually a buy and hold guy. I am also a no maintenance landlord. The way I do that is a buy houses, make it perfect when I purchase it and then rent it out. Since new things don’t break, if it does break it is under warranty I do no maintenance. If the tenant breaks it, the tenant fixes it (up to $250 which is basically all the maintenance). After 2 to 4 years things start to break and maintenance rears its ugly head. I then 1031 it into another property that I can rehab and I have another no maintenance property. If in the mean time I have a “lease option” tenant that wants to pay me retail price (say $100k) for a house I bought for investment price (say $60k) then I will 1031 that into a new house at that time and keep going.
Wow that is some good info blue moon thats enough for me to think about…I will take notes on that one… thanks for sharing the knowledge :biggrin
Hell Yea, I am learning a lot too!! :bobble
Are you saying that all your tenants are lease option tenants? Is that how you get the tenant to pay for the things that break? If so, then your business model is buy-rehab-lease option-1031-and repeat? Do I have that right?
In the state of Texas the state laws make lease options not feasible. I use a land trust owner finance vehicle. About half of my properties are straight lease and half are done this way. But my model does have me turning my properties after no more than 5 years. The 1031 allows me to move to more properties with better cash flow. The typical property goes like this. I buy a house worth $100 for $60k with $10k fix up. I get the whole thing finance and have no money in the deal. The cash flow is $100/month. I sell it after 3 years for $100k and 1031 the $40k into another house worth $110k I buy it for $65k. Because of the 1031 amount the cash flow is now $200/month repeat.
The portfolio remains the same or grows, but the portfolio is not made up of the same houses.
Has this trust strategy survived an IRS audit? If so, how did you get around the dealer disposition tax treatment on all your sales ?
I have not been audited but in general dealer status occurs if you don’t hold the properties 12 months, I still own the properties as part owner of the trust. The deeds are transferred into the trust but that is like a lot of investors that transfer their properties into LLCs and partnerships. I of course am not a CPA and I advise you to get advice from a CPA before you do anything.
The holding period is irrelevant in a dealer disposition. There is no 12 month threshhold that applies to dealer realty.
The more you tell us about your business model, the more concerned I am that the IRS will deem it to be a dealer activity. If so, then no depreciation is allowed, no 1031 exchanges are allowed, all profits are taxed as ordinary income and self-employment income taxes will probably apply.
Suggest you also get your business model reviewed by a competent tax advisor or perhaps an EA. I hope I am wrong, but let us know what you find out.
What makes you suspicious about dealer activity? It is no different than contract for deeds other places.
A contract for deed is an installment sale that takes place on the date you and your buyer enter the contract. If you purchase a property today just to sell it tomorrow on contract for deed, or sell it on a lease option, you are flipping your property. Property flipping is a dealer activity.
If you are engaged in a dealer activity, the holding period does not matter. Even if you delay the sale (as in a lease option) for a couple of years, the sale is still a dealer disposition and still subject to dealer disposition tax treatment.
I see your equity sharing strategy as a property flipping technique, so that is why I strongly suggest you get competent tax advice as to whether your tax treatment would survive an IRS audit.
I know you said you are in TX, but you need to be aware that OH has attacked the equity holding trust (a la Bill Gatten) as an illegal trust scheme. Here is a link with more details.