This is the final article in the seven part series on creative financing. I saved the best for last!!! The power of the lease purchase.
You know how you have that one friend who borrows stuff and never gives it back? If you don’t know, it is probably you. Give people their stuff back!!! Anyway, I have that person… it happens to be my sister. #ILoveYouApril #ImPuttingItOutThere
I am assuming that her belief that returning my items as an option and not a requirement stems from the fact that when we were kids she got all my old sh!# anyway. #handmedowns Well this went into adulthood and it has been pretty much everything…pants, shoes, lip-gloss, a crockpot…but there is one thing that gets “borrowed” so consistently that it is a joke among my friend group. My winter coat.
The way this tradition began was innocent enough. A tenant gave me a gift certificate to a popular, women’s clothing, catalogue. I found a beautiful, trench style, tan, white, and gold, tweed coat with brown, wooden, buttons. This was seriously amazing to me as I was still struggling to make ends meet. Legit, I was broke to the point where I couldn’t afford a winter coat.
My sister had a cute, black, peacoat. One day she came over for some sister time, #BornBFFs, and maybe a glass of wine or 5. All of a sudden I have a great idea!!! “Why don’t we trade coats for the week and that way it’s like we have two coats?”
My sis and I in 2011, one of the last years of the Great Coat Exchange. #bornBFFs
“Yea, great idea!!” and the coat swap is done.
Wha ha happen was… she came back the next week without a coat…but left with hers...hmmmmmmm. Now, somehow, she ended up with my coats each year for several years.
In the famous words of President Bush, “Fool me once, shame on — shame on you. Fool me — you can't get fooled again.” I think we both got hoodwinked more than once Mr. President.
I spent many a winter having this same conversation with pretty much everyone…“Where is your coat? It is freezing out.”“My sister borrowed it.”
“Don’t you have another?”
“She borrowed that one too.”
In the interest of full disclosure, the past 3-4 years, we have not coat swapped.
Now here is where I am going to tie this all together… well kinda…
We are talking about a lease purchase. This is basically where you lease a property but with the rights and responsibilities of ownership. Just like April used my coat but had all the rights of owning it, including my not being able to get it back from her. You will be contractually protected for the term of the agreement. And just like April ultimately owned the coats in the end, you too will have that option.
Now on the flip side, I will tell you another story with my lil sis…
One time when we were in our early 20’s, we decided to highlight each other’s hair. We buy one box of dye and are going to share it. Again, tough times call for drastic measures.
We started with her doing mine. She pulled my dirty blonde locks through the cap with holes that came in the box. We let it sit for the prescribed time and wash it out. Awesome, I have highlights…really more of a blonde but whateves.
Next it was her turn to go under the cap…. I pulled her light brown strands through the cap and we waited. When we washed it out, it was green. Flipping green hair!!! For a single chic in her 20’s, she handled that extremely well. No tears, just laughing!! And a lot of it!!! We laughed so hard our face hurt. You know what else we did? We fixed it. We dyed her hair an all over darker color. She was not stuck with it.
In a lease purchase, you are not stuck with a house that is not preforming. At the end of the term, you can jump ship if it is not the property for which you hoped.
Lease Purchase= A contractual agreement for possession of a property allowing the Lessee to have the rights and responsibilities of the owner as well as the option for ownership at the end of the term.
Let me just tell you that a lease purchase is my most used and go to acquisition method. I love the option. I have made more money with this style of investing than any other.
Is it glamorous like flipping? Hell no. It is your bread and butter!!! It keeps you fed when you don’t have a house to flip. With a lease purchase you have ZERO upfront cost, a residual income, and make thousands immediately. This really is the shiznit!!!
Let’s get into it.
How do you structure a lease purchase as the buyer?
When I acquire a property via lease purchase I try to extend the term as long as possible.
“Ms. Jones, wouldn’t it be nice to be guaranteed your monthly payment for the next 20 years? Never late, no vacancy, no repairs.”
20 years is not a likely option but 10 is. The average is 5 to 10 years.
We decide on the sales price based on today’s value less any adjustment for condition. This is the purchase price at the end of the term regardless of the value at that time. This is a great deal for you as in 5-10 years, it is a good chance that you will have some serious equity in the home. But if you do not, you do not have to buy the house. You just give it back.
I require that the seller offers an amount off of the principal purchase price each month of the agreement. This can be based on an amortization like a mortgage or a flat rate, say $250 per month. When the amount is amortized, I use a 30 year schedule regardless of the actual term with interest between 0% to 5.25%.
I assign myself all of the rights and responsibilities of the owner. This means I assume the responsibilities of maintenance and repairs but I can also upgrade the property should the market support that decision.
I do not make my first payment until my first tenant is in place after which I guarantee all payments for the term.
I do not make any down payment at all, ever.
How do you structure a lease purchase as the seller?
Whether I have purchased a home conventionally (but not with the intention of flipping), with owner financing, a contract for deed, sub to, or with a lease purchase; chances are, a lease purchase is on the top of my list as an exit strategy.
I will give the buyer a term between 2-5 years during which they will pay a monthly payment based on PITI (principal, interest, tax, insurance) at an interest rate between 6.9% and 8.9%. The payment in amortized over 30 years with a balloon option at the end of the term.
I charge between $5,000 and 10% down depending on the house. I have found that going below $5,000, even if the purchase price is $10,000, just ends in default. This is a non-refundable down-payment. This is not a deposit which is based on the concept of return.
The purchase price is set at an amount to include “projected equity.” This term means that you will calculate the current ARV (after repair value) but then increase it by the rate of growth for the term of the agreement. You can use Zillow as a big asset in this entire calculation. The site is pretty on point for area growth rate. If this evades you or is too much work, just add 3% per year.
The tenant/buyer has the rights and responsibilities of the owner but must get permission before doing anything more than painting or planting. I explain it to them as the same situation as an HOA.
What are my costs?
Zero. There are no fees associated with this type of acquisition or “sale.” I had an attorney who “closed” the contract when I was getting a large sum down for $250.00. Basically, he just explained the agreement to my client and certified the signatures. This made the whole “She never told me she was going to keep my money if I got evicted” argument before a judge a moot point. Once the attorney certified that (s)he explained it all to the client it was no longer a he said she said situation.
What is my exit strategy?
The exit is pretty much exactly what is described above but I will break down the numbers. I am going to use middle of the road numbers. Not the best but not the worst. Just average.
When I calculate profit, I am banking on the tenant/buyer NOT buying at the end of the term. I have only had them actually buy the house twice.
Ms. Jones has a house with an ARV of $200,000 and you are going to lease purchase it for 10 years. It needs some updating so you agree to an ultimate term purchase price in 10 years of $180,000 with an interest rate of 5%. Tax and insurance are $2312 per year which is an escrow of $192.00 for a total payment of $1159. In 10 years you owe $145,495. At a rate of 3% growth per annum the value should be $268,780.
You enter into a lease purchase with family 1 for $212,180 (ARV plus projected equity) at a rate of 7.75%. This gives you $1644 per month and 5% down up front ($10,609).
First 24 months: monthly income of $485 ($5820 annually) plus the down payment for a total profit of $22,249.
Family 2 does the exact same thing but now the projected equity puts the contract amount at $225,101, down payment at $11,255, monthly at $1727.
Months 25-48 net $24,887.
Families 3, 4, and 5 follow the same pattern. You have already made $140,117 even if you decide not to keep the property at the end of ten years. But since you owe $145,500 and the value is $268,780 you have room to put about $40,000 into rehabbing the property and cash out in the market with about another $40,000.
This, my friends, this is why lease purchases are the secret weapon of REI. You’re welcome. I just saved the best for last.
You know that I love to chat so feel free to ask questions. If you think you want more help than a few questions can handle, I got you there too. I do offer one on one coaching and mentoring.
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Happy Investing My Real Estate Junkies!!!!
I was born an entrepreneur. I am pretty certain that I was peddling passies in the hospital when the nurses left the room.All of the other kids in the neighborhood were riding bikes and playing with dolls I was selling jewelry out of a catalogue and creating a back yard consignment shop. At 21 I became a real estate investor and fell in love. This was/is/ and always will be my passion. I have been madly in love with flipping, holding, and writing offers on real estate that seem crazy for 18 years. Ladies and gents I am willing to share the love of my life with you. Maybe its polyamory maybe its jut because I can’t shut up about it. Either way I will be sharing every mistake I ever made and the lesson that came from it. I love questions. Please ask away!!!