ok, lease option plan -- layout. This right?

General Real Estate Investing
1

ok, think I got the Lease-Option thing worked out. Please tell me if this looks ok. Seems like a good way to make money so maybe something is wrong :smiley:

Buy home for 93k
Appraised: 102k
After my good down, PITI is say $650 monthly

I offer it on LO for:

  1. $1500 option fee (1.5% of home value)
  2. Security deposit = to 1 months rent (or more if tenant warrants)
  3. $1050 monthly rent w/ $50 credit (market rent in area is about 1100-1200)
  4. LO is for 3 years with rent going up 3% per year and sale price 4% per year. So I have built in equity and rent increases. No surprises. The area will most likely appreciate about the same rate. Not sure how to structure this any better. Doing a appraisal at time of option being exercised to come up with purchase price is not fair at all to the TB. What if they put in new flooring in that 3 years or a new kitchen. Certainly don’t want to discourage them from upgrading the home :smiley:
  5. TB is responsible for all repairs since they are buying and for keeping it in same or better condition.
  6. Clause in agreement against subletting and transferring.

Ok.

Monthly income = $1050. PITI of 650+50 rent credit = 700. Net Profit $350.

Let us assume the TB rented for 12 months then exercised the option.

12 months x $350 = $4,200 profit
Home bought at 102k - 93k = 9k

Total profit for the year $13, 200.

If my down was say 20,000, my ROI for the year would be 66%.

Is this basically right? It seems to me that it would be best if your TB could close within about a year for best ROI.

If this is correct, then you could go buy 2 props and so forth.

JUST WANTED TO ADD: I know some people say to put the sales price as the max sales price so no matter when they exercise the option, you get full price for 3 years. However, if the property is overvalued, they will have problems getting financing and that is not good.

2

First, I don’t know what state you’re in, so be sure to check your state’s landlord/tenant laws BEFORE doing anything.

Now,

As far as determining monthly cashflow, you need to figure that you financed the property 100% (you should be doing that anyway). I don’t know your credit history, etc. but doing some basic assumptions, I’m guessing a PITI on this would be about $800/month 100% financed.

$1500 option is good, especially if you’re asking for a security deposit as well (plus first month’s rent, right?). I usually don’t collect a security deposit. Is the option fee going toward the balance of the purchase price?

Check your landlord/tenant laws on Security deposits. Usually there is a limit to how much you can charge and how you have to handle the funds.

If market rents are $1100-1200 month, then why are you offering yours for LESS? With a L/O, you generally collect MORE than the normal market rents. Personally, I’d be looking at 1200-1400 a month.

IF you are trying to get the t/b to buy within one year, then don’t do a 3 year L/O. Simple. Your t/b’s credit will really determine how long they will need to lease before they can buy.

The purchase option price needs to be a FIXED amount, not some “to be determined by appraisal at a later date.” IF you do a one year L/O, price it at TODAY’s value. Tenant get’s the benefit of any appreciation. IF you do a three year L/O, price it at todays value plus 1/2 of the expected appreciation. For this property, that would be about $110K or slightly less. IF the property doesn’t appraise when the go to buy it, then you LOWER your price to the appraised value. Again, simple.

By your figuring, your “profits” will be a little off. Rent credits are DISCOUNTS that you give the tenant for paying you. They are NOT profit. The rent credits will be applied to the end purchase price IF the t/b buys, so they will impact your profit.

Example: Your option purchase price is $102K. Option fee = $1500, with a monthly rent credit of $50.

$102,000

  •   1,500

  •      600 ( $50 x 12 months)

=$ 99,900 Final Purchase Price

$99,900

  • 93,000
  •  3,000 (closing costs buying/selling)

= $ 3,900 Final profit for one year

Cashflow:
$1200 month rent
-$ 800 month PITI

=$ 400 Positive cashflow
X 12 months

=$4800

Total profit: 4800 + 3900 = $8700 year.

Hope it helps,

Roger

3

I would be putting 20% down because I am doing stated income, am self-employed, and am not giving any IRS docs. Therefore, my PITI is lower than the 800 quoted. After reading last night, I decided that 2 year LOs are the way to go and having it be a fixed price no matter when they exercised the option.

4

evergreen,

I understand that you put 20% down. However, you NEED to figure like you did 100% financing (including the closing costs). My rough estimate of 100% financed monthly PITI was about $800/month. You do plan on paying yourself back the 20% right?

Also, 20% is STILL too much to be putting down. My suggestion is to start looking for a better lender program. There are a ton of ways to get 95-100% financing if you think outside the box a bit.

Hope it helps,

Roger

5

If my PITI (because of my down) is $650 then I am getting back $150 more per month than your figure, which is 1800 profit per year.

I will recapture my 20% down, or any down, when the house is sold. If I am indeed stuck at 20%, what do you think about 10% down and trying to get the seller to carry 10% for 3+ years at a low interest? What is the idea note terms for you? Most residential owners (mom and pops) won’t carry a note for ages and I don’t want to get so creative that it becomes very hard to get a house that I want.

And yes, there might be a all-star broker out there who can get me in with 10%, but I need to find him/her. My broker here in Vegas does not do Texas.

I was mainly concerned with having the general idea right verses actual numbers. Seems like I got that down. Now I just need to fine tune. Someone told me to ask for 3-5% of purchase price as the option fee if doing more than a 1 year and that 2 years is optimal.

6

If my PITI (because of my down) is $650 then I am getting back $150 more per month than your figure, which is 1800 profit per year.
No, it’s not profit. It’s merely a cash on cash return of your initial dollar amount, and it’ll take you 124 months of collected rent in order to fully return your initial investment. So it only becomes “profit” after slightly over 10 years of owning the place.

I will recapture my 20% down, or any down, when the house is sold.
Will you? What happens if the market value drops? If you don’t get a tenant? If the place burns down and the insurance only pays off the loan balance? If your tenant is caught making drugs in the house and it’s seized by the feds? If something else unforeseen happens and you can’t make the payment? How will you recover your 20% then?

Sure, some of these may seem unlikely, but I’ve seen them and more, happen.

What is the idea note terms for you?
A good note is one where you have little to none of your own money involved to get into the deal. Idea terms are when you get a check at closing for buying the place.

And yes, there might be a all-star broker out there
Doesn’t have to be an all-star. Just one who can think outside the box a bit, that’s all.

I was mainly concerned with having the general idea right verses actual numbers. Seems like I got that down. Now I just need to fine tune.
No offense meant, but I’d say alot of fine tuning before you really have it “down.” Personally, I’d NEVER even look at buying a $100K FMV property for $93K. Discount, discount, discount. The better the discount, the easier the financing.

Someone told me to ask for 3-5% of purchase price as the option fee if doing more than a 1 year and that 2 years is optimal.

I personally like 2 year terms, but it really depends on the option fee supplied and the potential of the tenant/buyer. A low fee and/or a questionable t/b will get 1 year.
3-5% is something to shoot for, but be prepared to hold the property for 3-6 months, or longer in some markets, if you’re really planning on holding out for it. In my experience, l/o’s normally collect from 1-3% of the purchase price for an option fee. At that rate, they generally tend to move fast. However, it’s important to actually know the market that you’re investing in and setup your business based on THAT market, not someone else’s idea of what to do in THEIR market.

Raj