How to go about doing a sandwich lease option for a newbie

[Maria Mendoza]

Hello all! I am currently living in Miami, but I'm from Kansas City. I found a decent lease option in KC that would be $600 monthly. This house would rent for about $800-900 monthly (based on Redfin, Trulia, & Realtor info). Not the greatest neighborhood, but I grew up in a similar neighborhood and know what that entails. I would like to lease option this home to someone else or just rent it out. How would I structure this deal? Would I be responsible for repairs, cosmetic and/or more at the beginning?? 

Thanks for all you guys' help! 

[Erik W.]

@Maria Mendoza, hello to a former Missourian from a current Missourian (Springfield)!

What you're describing is a somewhat specialized area of REI know as rent arbitrage. In short: you rent a place for $X and then turn around and rent it out to someone else for $X + $Y, pocketing the difference. Seems simple and easy to get started when one has little or no money, but as I am about to demonstrate, there's a reason why not many people use this strategy.

To be sure we're setting you up for success I have a few questions.

1) Why would you prefer to L/O vs. traditional buy, hold and rent?

2) What experience/knowledge do you have with the RSMO for land lord/tenant law?

3) How do you plan on managing this property: self or via a PM?

4) How knowledgeable are you with CURRENT rents in KC?

The reason I ask is there are a lot of reasons why one might think that a spread of $200-$300 per month is too tempting to pass up, but with that better than normal spread on a sub-$1000/month unit may come a host of issues.

I have a sis-in-law who lives in KC and until recently was renting a 2-bed SFH in an "okay" hood. She paid around $1,400 / month. Based on that, I'm really struggling to get my mind around what a $600/month lease option home would look like in that market.

Also, if it's renting for $600, how do you plan on renting it for $800-$900? Do you think the owner/Seller is simply ignorant of the "true" value or will you be assuming duties and responsibilities that normally would be the LL's in exchange for discounted rent? Most L/O deals put some or all of the repair/maintenance burdens on the tenant/optionee. That will quickly devour and $200-$300 "profit", especially if a major system like a central furnace goes out.

Long-distance LLing is tough, and most who do so successfully hire a PM, who will take a minimum of 1/2 month rent to find a tenant AND will require 10% of the monthly rent. Many PMs won't mess with low quality houses. They want Class A or at minimum Class B. Think about it: if you were a successful PM, would you want to waste your time on a beginning LL who doesn't even own the house...all for a meager $80-$90 a month? They would have to go thru you to your L/O seller each time a repair over the maximum authorized threshold. Also, would they be willing to go and inspect your property 2-3 times per year to see if the tenants are cooking meth or have 10 friends living with them, all for such a small fee? Many good PMs want an investor with a portfolio of many units: it takes as much time and effort to communicate and send out monthly statements for an investor with 1 house as one with 20 houses. A single house often won't tempt them, unless the rents are very high and they will make some good money for doing it. So you'll be self-managing is my guess. How will you keep eyes on the property that is 20 hours away?

I'm not saying you can't successfully L/O low-end, long distance houses using arbitrage but it is HARD. Even if your rent spread is accurate, I'm not sure it's worth the risk especially going in for the first time. I'd consider investing locally in something you can keep your eyes on and learn the ropes before diving into a very specialized niche of REI.

Best wishes!