More Lease Options questions

General Real Estate Investing
1

Hello to anyone viewing this post…

Is it feasible to structure a lease option that 40% of the Gross rental income for the duration of one year would apply to the down payment in conjuction with the “option money” or non-refundable consideration money (what I am trying to convey is that you refund a portion of their rent money if they opt to purchase) or is it preferable to just credit a portion of the monthly rent (5-10%) towards the down payment of the property?

  1. To clarify my statement, I mean collect two monthly checks, one check applying to the rent ($900) and one check ($100) applying to the down payment if they opt to purchase

  2. If they are late with the portion of the rent/lease option money for one month, example they pay the $900 dollars towards the rent, but neglect the $100 credit toward the down payment, should you
    a) levy a late charge (per day) and/or
    b) stipulate in your contract if party (potential buyer) refuses or neglects to pay $100 credit towards down payment within 3 days that rent is collected, this shall void the purchase option of the lease-option contract and any monies that was collected prior to the breach of the monthly obligaton is non refundable. (including option money and credit monies)

Am I on the right track, or does my question indicate I don’t know what I am talking about?

Fellow wealth pursuers, please give me some feedback
thanks a lot

2

Remember, with guns and real estate, follow the KISS principle, which is:

Keep
It
Simple
Stupid

The easier your setup is to follow, the easier it’ll be on you to do it and the easier it’ll be on your t/b to understand it.

The best way to ‘give’ rent credit is to just offer it for paying the rent on time. Example: The monthly payment is $750. a $100 rent credit will be applied to the purchase price of the home for every payment that is received on time, should you (the tenant) choose to excercise your option to purchase.

Don’t do 40% of rent income, or even 5-10% of rent payment. That forces people to think, and tenants usually don’t want to think that much. Much better to say $500 a month with a $50 rent credit than $500 a month with 10% going towards your purchase price.

NEVER collect two separate monthly payments, one for the rent, the other for the downpayment, unless you plan on escrowing that downpayment money. Doing so, does two things:
First, it gives the tenants equitable interest in the property. They have actually put money toward the purchase of the property, and have the check stubs to prove it.
Second, it is NOT your money, at least not until they actually do purchase the property. You have to escrow those funds (or whatever is required in your state), and if the tenant/buyer decides not to exercise their option to purchase, you’ll most likely have to return that money to them, in full.

Finally, you NEVER want to void one contract and not the other. If you void the option contract, then all you have left is renters. If you’re not wanting renters, that’s a bad thing. If you void the lease, but not the option, then you have a property that you can’t sell until the option term is passed. You definitely wouldn’t be able to do another L/O on it until the term expired, and it may be hard to even rent (not many renters will move into a place that may be sold soon. Landlord changes are scary).

Hope it helps,

Raj

3

You can actually collect two separate payments, but don’t call the 2nd one a “downpayment”, call it additional “option fees”. This keeps you from giving equitable interest and from having to escrow it.

A lot of investors regularly collect two payments, the second one to be deducted from the purchase price of the house. This allows the buyer to potentially apply it as a downpayment later, but also lets you keep it if they default on the agreement, or don’t buy.

The reason you have to collect two separate payments is because the “rent” portion is enforcable in court if they don’t pay, but the additional option fees aren’t… you just “hope” they pay them, lol.

Make sure it’s all in writing, and also keep copies of their checks for the option fee so they can use it later.

Z

4

Z,

I respect you, but I disagree with you on this one.

You can collect two separate monthly payments and call the 2nd one whatever you like, but an apple is still an apple whether you call it an orange or an apple. More important, anyone else, including a judge, will likely still view it as an apple, and not an orange, just because you called it that.

If you collect a 2nd payment to be applied to the purchase price, whatever you call it, you are in essense saying that you will hold these funds to build up a downpayment towards the purchase of the property. Funds collected for a downpayment or NOT the landlord’s/seller’s to keep OR to use. So they must be escrowed when paid, AND they must be returned in most cases, if the option is not excercised. If it would go to court, the majority of judges would rule in favor of the tenant/buyer.

By contrast, an upfront option fee is a fee paid for the RIGHT to purchase the property. This is usually nonrefundable, which is enforceable in court, because, as the seller, you have obligated yourself to sell the property which is why the fee is paid.
Also, collecting one monthly payment, the rent, and then applying a “rent credit” is a phantom credit. For example the rent is $800 month. IF paid on time (a requirement), a rent credit of $200/month will be applied toward the purchase price only IF the option is exercised (a requirement). It is NOT actual funds paid. Being the great landlord that you are, you’ll basically “deduct” $200 off the purchase price for every payment you get on time.

Raj

5

Roger,

I totally see your point of view, (and “technically”, I agree with it) but I don’t intend on being sued anywhere near as many times as I plan on not… so I can make the amount of $ ten times over by collecting extra $ each month than the 1 in 100 that might sue me can possibly force me to give back.

Haven’t you ever let someone who didn’t have the full option fee “up front” move in and pay you a little as they went? That’s what I’m referring to…

As far as the monthly option payments, they are simply the remainder of the option fee that the buyer couldn’t give me up-front. Out of the goodness of my heart I allowed him to move in and continue to pay me a little extra monthly. These are not collected and escrowed for a downpayment later, they are the remainder of the option fee they couldn’t pay me up front… the balance of of what they owe me to get the “right” to purchase. It states this in my contract as well, and are 100% non-refundable.

Obviously, if a judge orders me to give them back, I’ll give them back… but it’s never happened. (yet, lol)

In any case, this is what Ron Legrand taught me, and I’ve never had a problem with it. I’m sure that, like so many other things in our business, it can be interpreted 10 different ways, lol.

I love good discussions like this one, it opens up our minds a bit to different points of views and makes us “put our thinking caps on”.

Anyone else have an opinion? It would be great to hear some other takes on this and what others think/do!

Z

6

Set up the way you discribe it may actually work where it wouldn’t be viewed as collecting a down. And I think that it’s important HOW it’s done. Option fee is $3400. I’ll take $1000 upfront and monthly payments of $200 month for 12 months.

That’s a big difference from saying that ‘I’ll collect $200 month and apply it to the purchase price.’

Haven’t you ever let someone who didn’t have the full option fee “up front” move in and pay you a little as they went?

Well, not really. Mine are setup more like 'if you pay $X amount upfront, your payments are $X amount a month, $Y amount upfront, $Y amount per month.

Apples and oranges. Eat what you like :smiley:

Raj

7

thanks alot fellow wealth pursuers for the information, from what I gather from the responses, the sucess of a fullproof lease with option to buy contract is in the legal wording
My understanding is that if the potential buyer/tenant is late with the rent, this failure to pay rent on time does not automatically void the buyer’s option to purchase the property.In addition, the wording of the contract would imply that if a tenant/potential buyer does not pay their rent on time for that month, the individual portion of rent for that month would not be credited towards the purchase price.
As investors/landlords, have you encountered problems with tenants that were late with rent payments and optioned to purchase the property whent the lease with option to buy period expired?
Responses to this post would be very much welcomed. I hope this response illustrates that I am on the right track.

8

I have another question, if you choose to structure the lease option with the the tenant/potential buyer that he pays you a check for rent and a check for the option money and he neglects to pay the option money, what penalties would you enforce against the tenant?
a) charge some type of interest
b) his failure to pay the “option money” would automatically void his option to purchase???

9

Just to add some food for thought…As Roger said I would never seperate the two payments. You open yourself up to alot of needless confusion and possible litigation.

But to answer your questions from my point of view…

  1. In my contracts, if the tenant/buyer doesnt have enough upfront option consideration money then I will set-up a promissary note for say $300 for 12 months. This does 2 things; 1 it gives me my future equity right now, 2) I can charge an interest rate for them being late (as you are talking about). If they are late with the “second payment” then I charge a %15 late penalty and then $15/day for everyday late. Same thing for the monthly rent. Essentially is in the buyer/tenants best interest to pay on time, both the rent and the monthly option money, because it lowers the purchase price for them, I really dont care either way because I will get my money.

  2. As I said in the first paragraph, if you cancel or “void” every contract that doesnt pay you on time, then you wont make much money. What if your tenant/buyer had a medical emergency for the one month and couldnt make there rent, would you void the contract even though they have paid on-time every other month. You, as a landlord, can be compassionate sometimes, just know when enough is enough. Just state in your contract that if they fail to pay on time, they will loose their rent credit and that you will charge a late penalty of some sort, whether it be a percentage or a straight amount. Thats what I love about this business, the possibilities are virtually endless.

I hope I answered your question in full. And if you have anymore than ask away.

Jerry

10

I missed something here. Two payments monthly for what?

Here is how I see it.

  1. Option fee is paid up front via its own payment (IE its own check). This mainly is for bookkeeping. It will help your TB balance their finances too.

  2. Wording is: Lease is $1000 per month. For every on-time payment optionor will lower the final selling price of said property by $200. Said final sales price reduction is not associated in any way with the lease amount collected rather it is a performance incentive offered by optionor to reward timely payments by optionee. Said incentive has no real cash value and is void if said option is not executed by optionee.

One Payment monthly. You have your on-time payment incentive and it is clear that the lease is NOT $800 with a $200 payment on principle. With the way many structure their contracts, should the optionee not execute, they could easily come back and collect that $200 for each month it was paid as they did not buy the property. However, they can not collect on a performance incentive with no real cash value. The Lease is $1000 per month period.

The above was simplified of course to get the point across. Instead of saying “on-time” payment, you would spell out specific calendar dates, but the main message is there.

How you word your contracts is extremely important. I highly advise that you have a lawyer do it or review what you have. Most contracts I see have flaws in them. Also, if any part of your contract is not deemed legal and it is not written properly, the whole contract could be nullified.

11

Very often my tenant doesn’t have all of his option $ up front, so I let him pay me over time, that’s where the 2nd monthly payment comes in. I won’t accept less than $5k option on a property, no matter its price, so I have to do this from time to time on cheaper properties.

I never include monthly option payments as a part of the lease payment, nor would I ever accept combining the 2 payments in one check.

The future lender will not allow your buyer to use the monthly option $ he’s given you towards his down payment if it’s included in the same check as the lease.

12

Ah ok. See I would never do that. I believe in the sanctity of the Option. 100% option fee up front or move along. Of course, I don’t care for high option fees either. 1% to 2% on a good property is enough. On a 100k property, that is 1-2k. 5k in that situation would be too much. If the property was very nice and the market hot, then higher option fees are warranted.

You have to ask yourself, if the TB can’t come up with the option fee, what are the odds that they can exercise the option? Slim at best. I would want my TB to actually buy the property.

That is real nice of you to give them their rent credit in the form of a down payment verses a sales price reduction.

Another way to do that is putting in the contract that you will carry a note which equates to the amount of incentive bonus they have accumulated. This is the best of both worlds. Your TB needs less cash out of pocket to get the deal done, and you make a little more money. 24 months @ $200 monthly would be a note of $4800. On a 100k home, that is about 5% down. Carry the note for 5 years at 0% interest. You end up making $4800 that you were about to let get away and the TB will like the no interest carry. Even if the worst happens, that was money you were about to give away anyway.

Additionally, you could give the TB the option of either receiving the incentive as a note carried by you as above OR a sales price reduction. This gives the TB flexibility. If they have the money for the home, they will take the reduction. If not, they will take the note. Either way, you gave them good options and come out in good shape.

Just my thoughts for better or worse :smiley:

13

I would never sell any house, no matter how low the price, with only a $1k-$2k option fee. If they live there 5 months and ruin the carpet I’m negative. To settle for 1%-2% deposit to me is suicide. I guess my view is if they can’t afford $5k down, they’ll never have enough to come up with a 10% DP to cash me out eventually.

I also want them in it deep enough so they actually “loose” something if they walk out on me. The higher they give you up front, the better chance of them cashing me out. (although sometimes I’d rather they don’t!)

It’s $5k+ or nothing… although I’ll take $3k “down”, and an extra $500 a month for the 1st 4 months. Why should I accept $2k when I know I’ll get $5k+? On a $100k house $5k is a little low, I want $8k-$10k if I can get it.

I can’t see any benefit in me taking less money than more money, lol!

I think you’re letting the fear you won’t sell the property force your option fees down. Someone who only puts $1000 down isn’t buying, he’s renting, and paying less up-front than “1st and last, plus security”.

Z

14

You are not taking less money. It is all in the wording. You are actually taking more money and making more money. You could also loan the person the difference, via a private note, and structure it with a 4 month or whatever payoff @ x% interest to make even more money. You still get the money you want, when you want, but it is separate and clean. The note can be secured by the option itself so if they miss a payment, the option becomes yours, in essence voided.

If a TB walks out, they were just a renter who paid above market rent for their term.

Like I said, the market dictates. In my current market, you could ask for 8-10% all day long and you won’t get it. Not many, if any, will fork over $30,000+ for a LO here in our current market. However, you ask for 3% ($10,000 on a 300k home, which is our median home price), it might move depending on final price and terms.

You should collect first,last, security on all your LO’s. This would be one reason why you are scared of someone walking out on you.

An Option is one thing, a Lease is another.

If an optionee elects not to exercise his/her option for whatever reason, that is not a bad thing. You still own the property and can make even more money. I don’t think you should hope this happens because of negative reasons, but if it does, carry on.

By all means, I am NOT saying to ask for nothing. I am saying to get what you can and move forward. Look at wording and keep deals clean and to your ultimate benefit.

15

thanks alot fellow investors for answering my inquires, I beginning to realize from your responses that

  1. You can be very creative with lease option contracts
  2. You want to insert wording in the contract that gives the tenant/buyer an equitable interest in the property
  3. and the “non-refundable option money” should be in a range of1-2% of the property’s value in conjuction with a 2 month security deposit for the lease portion of the contract…
  4. Deal with a real estate lawyer that is versed in creating lease option contracts that are in your best interest.

If I am wrong about Items 2 and 3 please respond…

Good day

16

#3 depends on that market AND the home price.

For example, here in Vegas, a 10-15k option fee is common BUT the homes with these fees are 400k+. This equates to 3% basically. If you wanted say 5% ($15k on a 300k home), you would sit there. Especially now with lenders bending over backwards to loan in our market and the market being over supplied right now.

In another market you might only be able to get 1%, maybe 7% in another market. First thing to do is open the paper and look for LO deals. Check to see what the general consensus is % wise and price wise.

If time is not an issue, ask high and wait. Come down as you have to. In a hot market, I would load up, no deductions. In a cold market, you may have to take what you can unless you can afford to have it sit.

I have heard good advice over and over on making your first deal in an area. Don’t sit around and try to get the perfect deal and everything right. Do your due diligence, ensure the numbers work, and get it done. As deals are done, you learn more and make better deals.

17

Since the lease option subject is so discussed. My question is whether the Lease Option kit that is advertised on the forum list to my left has been used by any “investors” who are trying to get into this area.

Has anyone used it? Is it comprehensive. Does it answer the questions that have been asked on the forum?

18

A few comments:

The future lender will not allow your buyer to use the monthly option $ he’s given you towards his down payment if it’s included in the same check as the lease.

ZNICK, If by “option money” you’re referring to the monthly rent credit, then my suggestion for you is to find another lender, because I’ve credited up to 100% of each and every rent payment toward the purchase price, if necessary.

Also, as evergreen said, your area’s market will greatly determine what you can get for an option fee upfront. However, speaking to various investors in other parts of the country and my own experience, the usual option fees are between 1-3% of the option purchase price. At that rate, properties tend to move fairly quickly (thus not forcing the owner to make monthly payments on empty homes).

Also, if you are getting, or trying to get, 5-10% or more option fee, then you’re really not doing your tenant-buyers any favors. IF your true end goal is to actually sell the property, then most people with 5-10% will qualify to buy the property, IF you take the time to find a lender. I have lenders lined up that will loan up to 100% with credit scores as low as 550. You can get 500 scores financed at 90%. Most lenders want 5% of the buyer’s money in the home. After that, you, as the seller, can take a 2nd for the remainder. So, if they only qualified for 80% and had 5%, you could loan them the remaining 15%. Collect a monthly cashflow on property you don’t own is the best “lease” I can think of.

To me, evergreen has it listed out very well. That’s basically how my L/O’s are laid out.

To Wealthinvestigator:

  1. You don’t need to be “creative” in lease options. Remember the KISS principle.

  2. You DO NOT want your tenant/buyer’s to have an equitable interest in your property.

  3. The option fee should be whatever your market will bear and whatever holding period you can bear. The higher the option fee, the longer it will sit on the market. Lower option fee, higher monthly means more cashflow. Personally, I don’t charge a security deposit at all. If they have the money, then it goes toward the option fee, period. To each, his own.

  4. I would

Hope it helps,

Raj

19

I strongly agree with Roger J on not allowing a tenant buyer equitable interest in the property.If the tenant buyer decides to get an attorney who is slick and can file a judgemtn lien againest the property due to his client has an equitable interest you may have a civil litigation on your hands which is why your tenant should never be paying any property tax insurance etc or showing any record documetnation of paying that.
If a judge saw proof of that you would most likey lose your case ouch… and you would have to go by a costly judicial foreclosure to evict than say a unlawful detainer action…
What if your tenant is going through a bankruptcy or is the subject of a creditor charging order if the creditor can prove he does have an equitable interest he can put a lien on the property and so on I think you get the point.

Thanks,
Colvegas

20

thanks colvegas for the response, I understand that when I speak to my attorney or choose one, I must convey to this individual that I desire the option contract to be drafted in a mannerthat will not give my tenant/potential buyer an equitable interest in the property.