Why using a lease option is a good idea

 

I am starting to feel old ya’ll, and it’s not because I’m about to be 41 years old. Granted, I am in a strange age spot. I often make song, show, and movie references from my childhood that the people a little older than I am may or may not get, but the people younger than I am often have no idea to what I am referring. As a matter of fact, it’s a running joke around the office to see if the 23-year-old can guess what movie or show I’m quoting.

But where I’m feeling a little aged or mature is in the real estate investing world. I had a call come in from a young man recently where he had been investing for a little over a year. He started asking questions that sounded more like text messaging abbreviations to me. Now investors do abbreviate things like ARV for after repair value and things of that nature. But this young man told me in one sentence that he was very interested in “STR’s” even though he had some “LTR’s” and he was wanting to “JV” with some people in order to move forward.

 

I had to laugh. You see, LTR stands for long term rental, STR stands for short term rental like vacation homes, and JV stands for joint venture which is where two or more investors pool resources together in order to do a deal. And the reason I was laughing is because when we started STR and LTR weren’t a thing. Everyone just called them rentals or long term holds to differentiate between them and flip projects. And JV was just called partnering.

 

As you can see, terminology evolves over time and so do markets. As such, different strategies come in and out of play as market conditions change. And this week I have seen where the strategy of using leases with an option has been very beneficial to the investor.

 

Now before we get too far into this, I want to dispel something. Lease-option is not one word. It’s not even one strategy. Instead, it is taking two very different strategies and using them in conjunction with one another to control, rent and either buy or sell a property. So, let’s break that down.

We have two words here — lease and option. A lease in real estate is an agreement that establishes a tenant landlord relationship where the right of use to the property is given to the tenant in exchange for certain conditions of which one is payment of rent to the landlord.

An option, on the other hand, is an agreement where one party, often the landlord, grants another party, often the tenant, the right to purchase the property at some point in the future for an agreed upon price. And in consideration for granting the tenant the right to buy the house in the future, the landlord gets paid something called option consideration for giving up that right.

 

So just to solidify things: leases have to do with renting a property, whereas options have to do with the buying and selling of property.

 

Combining those two into the lease option strategy is great for both the landlord and the tenant. The landlord gets paid a lump sum of money up front for the option consideration, a future sales price that is acceptable and a great tenant who is motivated to perform because they want to be an owner one day. The tenant gets to rent and live in their forever home while they get qualified for the mortgage they need to purchase it. (And just as a side note, since the tenant gets to rent the home until they buy it, this strategy is also often called “rent-to-own.”)

 

I have heard people say that they are selling their house with a lease option. I think the term rent-to-own probably explains it better because you are not selling it with a lease option. Think about it like it is in stages: First, you have a tenant-landlord relationship. Then it moves to a seller buyer relationship once the tenant is ready to exercise their option to buy.

This is an important distinction to realize because in the first phase, you are governed by the laws associated with being in a tenant-landlord relationship. At the point the tenant exercises their option, things change. But you should not confuse those two situations.

 

Now the reason this strategy is coming back into play is because the interest rates on mortgages have gone up making it more difficult for rental properties to cashflow at today’s rates. But by using the lease option strategy, the tenant will agree to pay premium rents, give you that lump sum I told you about called option consideration and be more consistent with their monthly rent payments because they don’t want to lose their opportunity to buy the house. And all those together can help turn a break-even property into a positive cash flowing deal. And that makes using a lease option a good idea.

 

Joe and Ashley English buy houses and mobile homes in Northwest Georgia. For more information or to ask a question, go to www.cashflowwithjoe.com or call Joe at 678-986-6813.