Alright,
I have a challenge for everyone.
I'm not sure if anyone has read "The Real Book of Real Estate" by the Rich Dad Team but they reference using a lease option as being an investing method to purchase a property.
Also, I am curious how hard it would be to find a potential seller to what to do this.
I do not intend on using this as an investment property of my home, but rather for purposes of this being my home for a five year or so period like this investor did in the story below.
Either way I am trying to figure how this scenario would play out and can use your help if you are familiar with the process.
In the area that I am looking, Purchase price is around $400,000, HOA is $550/month, and taxes are about $4,000. Comparable rents are $2,400/ month.
Page 316-317 from the The Real Book of Real Estate by Robert Kiyosaki
"Real-Life Story: Student Success Story No. 3 This lease option was negotiated a number of years ago. The numbers may seem low, but the principles and the economics of the transaction are very much applicable in any market. The buyer (my student) owned a house worth roughly $100,000. There were a fair number of rental homes in the area; most of them rented in the $500 to $700 range. Seeking to find a substantially nicer home, the buyer sought out a nearby upscale town where the home values exceeded $200,000. Rentals in this upscale area were fairly scarce. The buyer found a home for sale for $220,000, and it appeared to be reasonably priced. The seller was very anxious to sell since he had already moved out of state, and the home had been on the market for several months. The buyer proposed a lease option, and they ended up agreeing to a four-year option at the asking price of $220,000. The monthly rent was $900 (low for this particular house, but high in comparison to almost all other rentals in the surrounding areas), and the buyer received a 50 percent rent credit ($450 per month) toward the eventual purchase. The seller was to pay taxes and insurance during the option period, and the buyer agreed to pay for all of the maintenance (an inspection revealed that the house was in very good shape). The buyer put down $3,600 as a nonrefundable deposit for the option consideration, which was equivalent to less than 2 percent of the option purchase price! The buyer was amazed when he figured out the “effective” interest rate that he was paying. He realized that, of the $900 a month he was paying, only $450 was the true “cost” of owning the house. From that, he subtracted the cost of taxes and 316 THE REAL BOOK OF REAL ESTATE 9781593155322_3-4:real estate_new 3/25/09 4:06 PM Page 316 insurance (which were $340 per month—an amount he would have had to pay had he owned the property) to yield a net “cost” of $110 a month. This worked out to an incredible effective interest rate of 0.6 percent ($110 times twelve months equals $1,320, divided by $220,000, which equals 0.6 percent). That’s less than 1 percent! After three years, the buyer was certain that he was going to exercise his option at the end of the four-year period (because, among other reasons, property values had been increasing very nicely in this area—at about 7 percent per year), but he figured it was worth the effort to see if the seller would be willing to extend the option in exchange for some additional consideration. The buyer and seller ended up agreeing to extend the option for one additional year in return for the buyer paying $10,000 of additional option consideration (which meant that it would be fully applied to the purchase price, but it would be forfeited if the buyer did not buy the house). Was this a good move? I sure think so. Even if it cost the buyer 10 percent interest to borrow the $10,000 for a year (which is $1,000), it was a small price to pay for another year of ownership at the effective interest rate of less than 1 percent. After the five-year period, the buyer exercised the option and obtained the necessary funds by simply securing an owner-occupied loan (loan programs specifically designed for owner-occupants) for $179,400, which was the total amount due to the seller ($220,000 less the deposit of $3,600, less the additional consideration of $10,000 paid in year four, and less the rent credit of $27,000, which is equal to $450 for sixty months or five years). The property appreciated, and it appraised for $290,000; thus, the new loan was for only 62 percent of the property’s fair market value. (By the way, the buyer eventually sold this house about a year later for $320,000 and, you guessed it, has since moved on to an even nicer home!) The buyer’s “profit” on his initial investment of $3,600 was $90,000—based on the property appreciation of $70,000, and the $20,400 savings of not paying taxes and insurance while living in the house. Under a lease option like this, the buyer (and seller, in this case) benefited in that the real estate taxes remained fairly steady throughout the five-year period because there had not been a reported sale of the property. The action that the buyer took at the end of year three (asking for and getting the seller to agree to an additional year’s extension) is an excellent example of the power of creative thinking. This would have been a great investment even if that had not occurred, but by thinking creatively and being willing to ask questions, the buyer turned what was already a great investment into one that was even better!"
"Benefits for the Buyer and the Seller Benefits to the Buyer Benefits to the Seller Flexibility of option to purchase any time within a four-year term (this option was additionally extended for one more year). The seller received full asking price. Out of the total monthly rental payment of $900, $450 is credited toward the purchase, which makes the cost of occupancy $450 a month. The seller is relieved of all maintenance responsibility and cost associated with the property. Initial down payment of $3,600 and subsequent option extension of $10,000 are credited directly against the purchase price. The seller receives sufficient income to cover the property taxes, insurance, and the principal and interest payment on the existing mortgage, plus a monthly profit. The buyer had the advantage of time to put himself in the position to buy a home that he may not otherwise have been able to afford. The seller receives a nonrefundable deposit up front. Based on appreciation of approximately 7% per year, the buyer will enjoy instant equity of $110,600 ($290,000 fair market value minus $179,400 option purchase price balance). The seller retains the $54,000 in rent payments ($900 per month) and the $13,600 total option deposit if the buyer fails to exercise the option. If he exercises the option, the seller credits back these amounts against the purchase price. The buyer will have a much easier time obtaining favorable loan terms with $110,600 in equity in the property and therefore needs a mere 62% LTV (loan-to-value) to pay off the balance of the option purchase price. The seller enjoys the reduction of the loan principal, which increases the amount the seller will cash out at closing or the equity the seller will have in the property if the buyer does not complete the transaction. The seller enjoys the deferment of taxes on the portion of money applied to the option purchase price (including the $3,600 and the $10,000 consideration) until the option is exercised or abandoned. The seller has the peace of mind of knowing that the property is under contract and is being maintained by someone motivated to take good care of it because, hopefully he will soon own it"
What are your thoughts?
