Ep. #29 - Making Deals With Lease Options - How I've Done It

Most people rule out Real Estate Investing as something they can do, because they don't have the 20% down-payment that's often required to purchase an investment property.

But did you know...? Alternate methods exist that can get you into a rental property with little to nothing down! On this episode, I tell my story of how I've used Lease-Options to control and later buy 3 rental properties - which will hopefully give you some insight into how you may be able to do the same.

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Intro...

Welcome to Episode #29 - Making Deals With Lease Options - How I've Done It

So how do you get into a rental property with little to nothing down? One method is called Seller Financing - but in full disclosure, I've not yet done a Seller Financed deal directly, so I'll talk about that later - once I've actually done one myself.

But what I HAVE done is a Lease Option deal... In fact, I've done 3! And then I later completed each purchase a year to two after the lease term started.

If you're not aware, a Lease-Option is a two part contract - the LEASE and the OPTION to BUY. And its an OPTION to buy, not a REQUIREMENT - but more on that later.

In a Lease-Option deal, you are leasing the property for a period of time (essentially no different than would be the case for a Tenant of any Rental Property) - but with a few additional provisions and considerations. And you then also have an Option to Buy the property at some later date, for an already established price.

Its a two-part contract, because the Lease portion establishes your right to control the property as if you were the Tenant, but with the additional right to sub-lease to the actual live-in Tenant of your choosing. And the Option portion establishes your right to the property as the future Buyer, and sets your purchase price and other terms of the purchase, such as the date by which it must take place and several other factors. The Option portion of the contract must be notarized and gets recorded against the title or deed of the property at your local Register of Deeds office. This prevents the owner from selling the property to anyone else but you, during the Option period.

So with a valid Lease-Option contract in place against a property, you effectively fully control that property (depending on the specific terms of the arrangement), but you don't actually own it - yet.

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So I've successfully done 3 Lease-Option deals to date. In order, they were my 4th, 5th and 6th properties acquired - and I count the establishment of the Lease-Option as the acquisition date, even though I didn't actually complete the purchases until a year or two later for each.

I got each of these properties under Lease-Option contracts within months of each other in 2016, and completed the purchase of 2 of the 3 in 2017; and the third in late 2018. All 3 of these properties were in the same Townhouse community where my very first rental property is located, that I acquired in July of 2015.

Of course, I liked this community, so I started sending monthly direct mail pieces to every Townhouse owner. But most didn't respond. Some who did respond were completely unreasonable - especially those who were investors, owning the properties as rentals. One investor offered to sell me his rental units in the community for $150,000 each; whereas, I had bought mine for just under $61,000 - and these units aren't even worth that much TODAY, let alone back in 2016. They're worth about $135,000 now.

But over time, some owners started to responded who were not completely unreasonable in what they wanted for their properties. That's when it got interesting.

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One owner called who owed just under $70,000 on their 2BR / 1.5BA Townhouse in the community - but I didn't know what they owed at the time. They wanted to sell it to me for that amount. While today I would jump all over that with a full cash offer and have it closed in a week or two. Back then, cash was tight and I knew that most of these units needed something like $10,000 of rehab and upgrades to be rental ready.

Also, this would have been my 4th investment property purchase. I had done the first 3 in my personal name, along with my wife - but qualifying for each was getting progressively more difficult. I had to put down 25% on the 3rd just to make it work, whereas, I was able to put down 20% on the first two. So I didn't think I could qualify and have sufficient down-payment funds, plus reserves as required to close on this purchase conventionally.

Further, I just didn't want to pay $70,000, when I had bought the first for just under $61,000 - that just happened to be identical and literally right next door. And it was not in as good of condition either. So I offered them $61,000 and I was going to do whatever I needed to complete the purchase at that amount using conventional financing. But they refused the offer. And like I said, I didn't know why at the time, but I later learned that it was because they owed $70,000 (or almost that amount), so accepting my offer at $61,000 would mean that they'd have to come up with about $9,000 at closing - money that they did not have.

So they decided to look into listing it with a Realtor or maybe doing a short-sale. I also tried to speak with them about doing a Lease-Option as a potential solution, but they weren't interested - and then things went silent with them.

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So months went by during which I continued sending direct mail pieces to every house - except that investor who had multiple units and gave me a ridiculous price of $150,000 each. Then I got a call from another prospective seller in the community. This time it was an end-unit, 3 bedroom with 1 full bath and 2 half baths. They were upside-down, owing about $80,000 - but the most I could pay is about $70,000 considering it again needed over $10,000 of rehab and updates to be rental ready.

So I suggested a Lease-Option as a solution right from the start and I scheduled an in-person meeting to go over how everything would work to our mutual benefit.

It was my first in-person seller meeting... I was so nervous, that I had to focus a portion of my attention on making sure my hands weren't shaking, which then resulted in my legs bouncing. Somehow I got through it and gave a creditable enough presentation that they agreed to do a Lease-Option deal with me where I'd buy the Townhouses for $69,900 at some point within the next 2 years - with an optional 3rd year upon payment of an additional $1,000. And between now and then, I'd directly pay only 1/2 of the monthly mortgage payment, which included escrow for taxes and insurances, and I'd pay all of the monthly HOA fee. I couldn't pay the full mortgage + escrow payment and still have the needed monthly positive cash-flow, so it had to be 1/2 + HOA.

I'd also be responsible for paying any other expenses associated with the property - including any needed rehab / updates, repairs / maintenance, everything. So if the HVAC went out, I'd have to pay for it or a replacement. And since the Option portion of the contract must be accompanied by some exchange of value, I paid a $100 Option Fee, which is non-refundable, but does get credited back to me as a pre-payment at purchase closing when that occurs.

I didn't get any credit for my HOA or 1/2 mortgage payments over the Lease term, but my payments towards the mortgage along with the other 1/2 from the seller over that 2 year period resulted in his no longer being upside-down once I completed the purchase years later. In fact, he got some money back at the purchase closing.

So the benefit to the seller was that they started something like $10,000 upside-down with a Townhouse that needed maybe another $10,000 of rehab work. They had just gotten married and his spouse already had a house they were moving into, so they didn't need this second house, but couldn't sell it being upside-down and couldn't rent it out being in need of lots of work - that is if he even wanted to try his hand at being a Landlord (and he didn't).

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Then weeks after I had this first Lease-Option established, that first potential seller who had decided to look into selling with a Realtor or maybe doing a short-sell - and had gone silent on me. They called again and wanted to speak with me further about a Lease-Option. I'm not sure what happened... Maybe they had spoken to the other seller that I had done a deal with a short time earlier. Whatever it was, they were now interested in at least hearing more.

So I scheduled an in-person meeting to discuss it. And an amazing thing happened... I wasn't nervous. I was now experienced at this. I knew that I could do it; I had done it before; and now I knew better what to say and how to say it. We had a great meeting, but they wanted to think about it. They were getting married also, and so just like the first seller, they didn't need two houses, couldn't sell this house due to being upside-down, and didn't have the money needed to rehab it into a rental - nor did they have any desire to become a Landlord. And even more so than the first seller, they really needed to get out from under the mortgage and HOA payments for this unwanted Townhouse.

A few days later they called and said they wanted to proceed. But whereas the first deal had an Option Fee of only $100; this seller wanted $1,000 - but not paid to them. They were way behind on HOA payments, so my $1,000 Option Fee was to be paid directly to the HOA to bring them current - and I would still get credit for this amount at purchase closing.

The mortgage payment here was a lot lower than on the first deal, so I agreed to pay their entire monthly mortgage payment directly, including escrow for taxes and insurances - along with the HOA fee as well - like I said, they needed to be free from all payments towards this house. But this seller didn't want to go out 2 or 3 years on the Option period, so we agreed to 18 months with an optional additional 6 months for another $1,000 - paid to them this time if that occurred.

And that was just a protection for me. I don't know what the economic conditions are going to be 18 months from now; or what my personal financial circumstance would be - so I just like to have an additional cushion, even if it costs me a little extra.

I got everything drawn up by my attorney and ready for notarizing - and then they called and said they had changed their mind (again); and now no longer wanted to proceed. So I said, hey the choice to proceed (or not) is 100% up to you, but I'm happy to have another call or stop by to discuss any concerns. So we had another call and I learned that they had gone to a party or something that prior weekend and mentioned to a family friend (who I think may have also been an attorney) - and they were scared out of proceeding by whatever that person told them. I think their main concern had to do with potentially being sued by my future tenant (their still being the property owner); or me failing to pay the bills as agreed - and just tying up their house with no real intention of buying it. Remember that a confused or scared mind just says no.

So I followed up the call with what must have been a highly persuasive email, because a few days later they called again and wanted to meet with me once more. I scheduled that meeting at one of my other rental properties (the 3rd one that was still vacant at the time) - and they again agreed to proceed. I said great! And I quickly arranged to have the Lease signed and Option contract notarized and recorded.

And note that I purposely had that meeting at one of my other properties, so they could see that I was already doing this and owned properties nicer than what I was potentially buying from them. I don't know if that had any impact, but it's also worth noting that I have nice business cards, a great website, a great company / brand name - and that name is Blue Chariot, and I drive around in a very nice BLUE Ford F-150 with Blue Chariot signs all over it. It may mean nothing, but I think presentation and credibility matters when you're asking someone to trust you. Trust that you will improve their property, that you will pay all the bills on time as agreed, and that you will eventually buy the house - but until then, please give me full access and control over your house for essentially nothing. I don't think that you can pull that off if you don't look and sound like you are legitimate / real, honest / trustworthy and knowledgeable / experienced.

So, long story short... I got the property rehabbed and rented, and around 15 months later, I completed the purchase and the seller got a nice check at closing. They had gone from being upside-down to having a profitable sale. They also gave me a great testimonial, and they are now one of the people I'll have potential Private Lenders and sellers speak with to learn if I'm a person of my word and able to do what I say. They're the perfect reference, because they went in scared and came out whole and happy - with everything happening EXACTLY as I said it would.

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So now at this point I've got 5 rental properties and the last 2 were via Lease-Option - and then I get another call from a relative of an owner in this same community. She knew the sellers of the first Lease-Option deal that I had done, and wanted me to speak with her relative about potentially buying his slightly upside-down Townhouse as well.

So were these people responding to my mailings? Did they see my truck driving through the community with Blue Chariot signs? Or was it all just the result of comments or referrals from that first seller that opened the door to consideration of a Lease-Option deal by the others? Who knows? Who cares!?

I was now sitting in the living room of the third potential seller within this community, and my days of being nervous about speaking with them was long gone. I presented the values and benefits of doing a Lease-Option deal with me, and this seller agreed as well. And unlike the others, he was not significantly upside down (just a little) - and the property was not in all that much need of rehab compared to the others. He had done a nice job at keeping it well maintained an clean. Also, unlike the others, he wasn't getting married to a spouse who already had a house that they were moving into - but I think he was changing jobs and needed to relocate.

So here, I agreed to pay $72,500 for the 3BR / 2BA Townhouse within 18 months, with again an optional 6 months pushing it out to 2 years for another $1,000. And I agreed to pay the full monthly mortgage payment, including escrow for taxes and insurance - plus the monthly HOA fee. But the Options Fees kept getting higher... This time I paid a $3,000 as an Option Fee directly to the seller, which again, I got credited back to me at closing of the purchase about 2 years later as a pre-payment towards the purchase price.

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So there you have it... That is the condensed version of how I took down my 4th, 5th and 6th properties as Lease-Option deals. The first cost me only $100 up-front to the seller as an Option Fee; the second was $1,000 paid to the HOA; and the third Option Fee was $3,000 paid to the seller. Additionally, I had to pay for all needed rehab of the properties as needed to make each rental ready.

This all may sound like a lot, but $1,000 or even $3,000 is nothing compared to 20% down on a $70,000 property - that's $3,000 versus $14,000 or so. And then you'd still have the same additional expenses for rehab either way.

But let's speak on that for a moment... Let's say that my rehab expense for one of the properties was $9,000. And as each Lease-Option went for at least 18 months, that comes out to $500 per month. And without accounting for reserves, each of these properties generated positive cash-flow of at least that amount. This means that by the time I completed each purchase up to 2 years later, I had little to no money remaining in the property. The property (that I did not even own yet) - had produced enough positive cash-flow to pay for itself and pay me back. That essentially makes these FREE houses!

But it got even better... Over the term of the Option period, these properties had increased in value - so I wanted to get a bank loan based upon the current appraised value, and maybe take some cash out myself at purchase. But the problem with that is that most conventional lenders (or at least those that I reached out to) - would not do a cash-out loan based upon 75% of the current appraised value, because I didn't already own the properties for the required 1 year of "seasoning". A Lease-Option is not ownership. And you can't do a cash-out purchase from a Lease-Option - or at least not with a conventional lender.

So what I did instead... I got a Private Lender to fund my purchase of each property at 80% of current appraised value - but it was at 9% interest, which is likely twice what I would have paid to a conventional lender under my personal name. This put some cash in my hand for each property, but it also increased my monthly payments. So monthly cash-flow decreased, but I had gotten all my money back out of each property. So they truly were now FREE properties, and my ROI on the remaining positive monthly cash-flow was essentially infinite, as I no longer had any of my own money invested.

And then a year later I was able to refi the Private Lender out on 2 of the 3, and in those cases, I was able to pull out still more cash - as the properties had continued to increase in value - and since I now had actually owned them for a year, I could do a cash-out refi. I expect to be able to do the same on the 3rd when I refi the Private Lender out on that one within the next few months, And despite the mortgage on the property getting larger, my monthly payments decreased because the interest rates went from 9% to something like 5.5% under my LLC.

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So it was a multi-step process, but I had successfully taken 3 properties from being upside-down for the sellers to being positive cash-flow rentals for me - and now with a ton of equity present in each.

But how or why did this work? And can it still be done today, in the current market condition? Was this something that worked in 2016 or 2017 - but has no chance of working here in 2019 or the coming year of 2020?

In all honestly, I can't answer that question with 100% certainty, as I had shifted my focus (possibly mistakenly) from single-family homes, trying to get multi-family properties and even apartment complexes - so I've not been pursuing opportunities for additional Lease-Options deals this year. But my gut instinct is that now that I'm looking for single-family homes again, I will continue to do Lease-Option deals wherever it makes sense. But it has to make sense! So what are the elements that need to be present for a Lease-Option to be attractive to the seller?

There does need to be a reason for it. If the property owner has a pristine house that's in move-in ready condition, ready to sell at top market price; and less is owed than the value... Then WHY would such an owner not just sell the conventional way? Of course, that's what they'll do! Their certainly not going to be doing any Lease-Option deals - they don't have to!

In 2 of my 3 Lease-Option deals, the sellers had just gotten (or was in the process of getting) married, and their spouses already had a house into which they were planning to move. They didn't need the house I was seeking to buy, but they couldn't sell it conventionally due to being upside-down and not having the money to cover the difference. And then the Plan-B of renting it out was also blocked, because the house needed lots of rehab and updates to make rental ready. And they had no desire to become Landlords anyway. So in other words, there were multiple pain points - all of which were solved by the Lease-Option.

So while it is less common for someone to be upside-down in the current market with home values at or near all-time highs, I recommend targeting pre-foreclosures, tax liens and tax delinquencies. Also not a bad idea to target Landlords of existing rentals, where the property is physically distressed or they just had an eviction or code violation. And there are a high number of vacant properties. You can also target any house that needs significant rehab work to be rental ready or to sell at market price - and you can find them just driving for dollars. Or do what I did - find a neighborhood that you like and send direct mail to everyone in it.

So don't say it can't be done. Don't say it worked then but can't work now. A Lease-Option is a viable solution for the right circumstance of problems. Use it as just as you would any other tool in your belt as a "Transaction Engineer". It can work great when you don't have a lot of money. It can also work great when the rehab actions needed at a property can be paid by credit card - especially if you have access to zero-interest promotions.

And an additional selling point is that the owner continues to get the full tax benefits, mortgage interest deduction and any escrow refunds during the Option period.

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Now if you have additional questions about Lease-Options, or you want access to my contract, terms, provisions, and all... including my phone and email scripts, talking points, checklists and more - I'll be working on some premium content that I'll be making available early next year. I've been reluctant to share these items. For example, I've gotten multiple requests for my lease. But I have a problem sharing someone else's work product - which in that case would be the work of my attorney.

So I'm working towards being able to share everything to that level in a membership section of the site in the near future. But until then, I hope that you found details such that I've shared here and in prior episodes of the Podcast to be helpful. That's my goal... To make this as informative a resource as I can that chronicles my journey and gives access to what I (and others I occasionally bring on the show) have learned along the way - to thereby shorten your journey to the same point and way beyond. Go out and do great things - and hey, let me know how I can help. Right now I'm still conducting FREE 30 minute consultation calls with anyone having questions about Real Estate Investing and being a Landlord that I might be able to answer or provide some direction or insight. Reach out and let's see if I can be of aid... Its Free!

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Outro...

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