Lease Option Pitfall # 1

July 9, 2024 lease option pitfall, Lease Options No Comments

Lease Option Pitfall Number 1

For people that are new to “lease with option”, you can either do it one of two ways,

the first way is to be in the middle or a sandwich lease option, where you are lease optioning from the seller, and then subleasing and sub option to a tenant.

Now the first mistake is giving the seller too much money.

It’s a huge mistake

Your profit is in the difference between what you give the seller and what the buyer gives you.

In our training you will learn:

The option fee, the option fee is where a lot of your profit is. An option to purchase agreement the minimum to be legal is $10. That’s what we give the seller. The option fee that we get from the buyer is generally 3% of the value of the property. If the property’s worth $100,000 we will ask for an option fee of $3,000.

Market rent, we generally charge 90% of Market rent to the seller. Why 90%, well it generally cost 10% for a property manager to take care of the property and that’s what we are doing. And we need a cash flow between the rent that we pay the seller and the rent we received from the buyer. The rent we received from the buyer is generally 105% 210% of Market rent. We earn the spread between the difference.

The back end, which is the exercise price that we give the seller. So in the option to purchase agreement, we will have an option to buy the property at a certain price. That price is generally 95% of market value today. But we pay the closing costs. That’s how we explain why it’s not 100% of appraised price.

Also on the back end, if the house is not appraised for the right price, meaning to low, the house will not be sold because the tenant buyer cannot get an FHA mortgage for that price.

So we like to have a formula for an exercise price of 95% of new appraisal with us paying the closing costs.

Now with the tenant buyers’ option to purchase agreement, we charge 100% of appraised price, whatever the appraisal is, the tenant buyer pays closing costs. The tenant buyer’s job is to earn 3% for a down payment for an FHA mortgage.

Can you now see why you can’t give the seller too much upfront money?

If the seller is stubborn about “The Upfront money”, we will entertain having him in a joint venture agreement with whatever we net for a profit.

Let’s say after expenses we netted $10,000 profit, we will offer the seller a portion, generally is no more than 10% of our net.

This is called an equity split.

The only other way we would give the seller more money is to prepay Market rent to him, if Market rent were $2,000, we’d like to be able to give a small security deposit and prepaid 3 months Market rent to him. Then then we have to hustle and get a tenant buyer that will pay first of last month’s rent plus a 3% option fee. We do not have to pay the seller for 3 months so the money that we get from the tenant buyer is profit, or just being repaid back The Upfront rent the seller received.