Creative Options in Real Estate Investing

Creative real estate investing is the usage of non-traditional ideas/methods of selling and buying properties. We like to call these “Options”. Typically, an investor will secure his finance taken from a lending organization and pay the full amount with borrowed funds (which will serve as his down payment). However, this is not always the case.

Paying in cash is, of course, one of the most effective ways of buying real estate property. However, most investors are not flushed with cash that they can drop over $100k or more to get into an agreement like this. Many investors will wait until they can afford a modest down payment and then work to secure what was left of the price of their purchase through a mortgage from a lending institution.

It isn’t advisable though for buyers to exhaust their entire savings just to pay a huge down payment amount. This will lead to a deprivation of reserves in the case any fall-back happens or if income goes down in the future.

What is an “Option”?

An option in real estate investment is defined as the right of an investor to purchase a property for a specified amount on a certain period. The owner may choose to sell his or her option to someone. The option buyer then hopes that the value of the investment property will either go up or down. The seller will receive a premium known as “Option Consideration.” Meaning, the buyer has the right to sell the purchased property to another person. This is usually done to gain control over the property without investing a lot of cash. Premiums in “Options” are generally non-refundable. Options represent the equitable interest and are recorded by the county recorder.

What is a “Lease Option”?

A lease option is comprised of two main parts – an option and a lease (rental agreement). This is written in either one or two contracts. A rental agreement occurs between the potential lessee or tenant and the owner is implied as a lessor. Leases hold the lessee responsible for paying the maintenance, upkeep, insurance, and taxes of the property. Lease payments are typically five to fifteen percent higher than the rent of the property. For the lessee to have tax benefits, this lease type is structured as if the tenant is the owner.

A lease option is different from a lease-purchase contract. A lease-purchase binds both parties to the sale, whereas in a lease-option the buyer has the option but the seller does not.

What is the “Sandwich Lease” option?

A sandwich lease is a lease in which the landlord of a property is also a lessee—leasing the property from the initial owner. This is a laborious and often risky endeavor of which an investor might undertake because it allows investors with minimal capital to start to invest in real estate markets, as an investor can initiate a sandwich lease with no money down, and without the involvement of a bank. To provide a mitigation option (a way of reducing costs and risks), a person can find a tenant to replace the unit. The tenant found for replacement becomes the tenant of the existing tenant and not the tenant of the landlord. The legal tenant will now have the right to create whatever rent, policy and deposit systems that he or she wishes to imply on the new tenant.

The moment the new tenant notices any need for maintenance or has encountered problems with the unit, he or she will contact the landlord who will then contact the real, legal landlord in for repairs and maintenances to happen. The new tenant is required to achieve payments to the temporary landlord who will then make the rent payment to the original landlord, thus, making things legal and paid.

Real-World Application

If a sandwich lease option sounds complicated, it is because it is. Here is an example of a sandwich lease option in the real world:

Let’s say that Jane Doe has an older vacation home that she can’t seem to sell and she doesn’t want the hassle of being a property manager. On top of that, she’s getting concerned that she won’t be able to continue to afford the mortgage on an empty vacation home and her condo in Florida.

Jane’s son, John, decides to help mom out. He’ll offer to lease her home for 6 years with the option to buy the house for $100,000.00 at any point during the six-year lease. Jane is delighted as John is a good son, and with her health, she feels this is a good option. As a part of the sandwich option, John agrees to pay his mother a $5,000 option fee to initiate the agreement and $800 a month in rent. The initial $5,000 option fee and the $800 a month of the rental payment, they agreed for it to be applied to the final purchase price if he decides to purchase.

John has no interest in living in the vacation home but it would be perfect for his son (Jane’s grandson), Junior, who just started a new tech job and needs little space. John establishes a lease with Junior who moves in with a very similar type of lease agreement as John has with his mother Jane. The difference in the agreement is that because Junior also wants to buy, instead of a straight forward lease, he will lease for $1000 a month with the option to buy for $120,000.00 before the six-year lease period ends. Similar to John’s agreement, part of Junior’s rent applies to the later purchase price. Because he’s John’s son, there is no option fee.

Now if John makes good and purchases the home, John can earn some money and Jane gets the price she wanted on the vacation home. Needless to say, it is easy to see how this scenario can end up with John scrambling to fill a hard-to-sell vacation home if Junior decides to move out and not purchase the house. This is why sandwich options need to be thoroughly vetted.

Securely Make Options Work

Options are a great way for investors to finagle investing to more easily fit in their budgets and business plans but with everything, it’s important to do your research and plan ahead of time before you sign on the dotted line. With investing, it could end up going in the opposite direction of what you were expecting. Make sure that you have a backup plan in case things do not go according to plan. Understand the people with the agreements you’re getting into and overall, protect yourself!