In today’s market, the name of the game is to control as much real estate as possible. Prices are at ten year lows and sellers are having a difficult time finding buyers for their properties. Sellers are competing with REOs, short sales and foreclosures on price and losing. If you are investing in properties today, you are the answer to many sellers’ prayers. But don’t start thinking like a kid in a candy store just yet.
Even if you have very deep pockets, you will want to make your capital go as far as it possibly can. Paying all cash for a house or even coming up with down payments in the 10% – 20% range can quickly eat up your working capital. Lease option investing allows you to put less money into each deal and therefore control more properties than you could if you were to buy a property outright.
Your option consideration buys you more than the opportunity to pull the trigger on the deal: It buys you time. This works in your favor in a couple of ways.
Advantages of Lease Option Investing
1. When you buy using a lease option, you can negotiate that a certain amount of each monthly lease payment goes towards the down payment on the property. If your option runs for five or even ten years, you can build up a considerable sum towards your down payment. When it’s time to exercise the option and find financing for the property, a larger down payment increases your financing options. For example, many lenders lower your interest rate (and sometimes your points) with a larger down payment. Which brings us to…
2. Most conventional lenders treat financing of a lease option as a re-finance, not a brand new loan. A re-finance on a property generally has looser terms and is easier to qualify for. Most lenders want to see that payments have been made for a minimum of 12 months. The longer you pay on the lease, the more vested in the property and the better off you are in the bank’s eyes.
3. You can use the monthly payments to re-establish your credit. If you were hit in the real estate bubble or your credit is not as strong as you (or the banks) would like, you can ask the seller to report your payments to the credit bureaus. Make sure your payments are timely. Two years of on-time payments can do wonders for your credit scores. The higher your credit score, the more choice you have in loan products and the lower your interest rates. This will lower your payments and ultimately increase your cash flow.
4. Speaking of those monthly payments, lease option investing means that you are renting or sub-leasing the property to someone else. So those payments aren’t coming out of your pocket; you have a tenant taking care of that. While you always want to have a couple of months of payments banked in case the tenant doesn’t pay on time or doesn’t work out, you have effectively put yourself into a deal with minimal money down and, done right, a positive monthly cash flow to you.
5. One thing that most people don’t consider when negotiating a deal is the time value of money. Think back to the character “Wimpy” in the old Popeye cartoons. Wimpy would always say, “I’ll gladly pay you Tuesday for a hamburger today.” Was Wimpy really broke and hungry? Well, he looked pretty well-dressed and well-fed. Wimpy understood the time value of money. He really was negotiating a zero-interest loan!
Think about the effect of inflation on the dollar. If inflation is at 5%, one year from now, $100,000 will only buy $95,000 worth of something. Your dollars are worth less money. Now, let’s take a look at why lease option investing is so valuable. If you option a property for $100,000 and your option date is set five years from now, you will still pay $100,000. But that $100,000 will only have about $75,000 worth of buying power. Or, in Wimpy’s terms, I can buy 4 burgers for $10.00 today; in five years, at a 5% inflation rate, I would only get 3 burgers.
6. Appreciation. Maybe. Will prices start rising again? Probably, yes. Prices might not skyrocket again like they did last decade but even modest appreciation on a property will help you when it’s time to get new financing on the property. If a property goes up in value just 1% per year, in five years you’ve had a 5% gain in value. Not a big deal? Think again. That 5% counts as equity in the property which can get you better terms on your loan.
Control: The True Strength of Lease Option Investing
Most important of all, you control the timing of your deals. You can pull the trigger on any of your deals at a time that is right for you. By carefully planning out the length of time on your lease options, you can stagger your closings to correspond with your time table, not the seller’s or the bank’s. Lease option investing gives you control over every aspect of the deal which is exactly what the successful investor wants and needs.
Be sure to check out other posts by Cody Sperber - The Clever Investor at CleverInvestor.com