Using a Lease Purchase as a Backup Plan

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What do you do when you’ve got a buyer for your property and for whatever reason, when it comes down to it, they can’t get approved for financing? Interestingly, I’m in the middle of this exact scenario on one of my houses right now. Unfortunately, there are numerous buyers out there right now that have pre-approval letters that aren’t worth the paper they are written on.  Too many loan officers are willing to give marginal buyers false hope that they can get their loan approved without even talking to an underwriter first.

In fact, it’s been my experience that many loan officers will continue to project assurance that a loan will get approved while knowing good and well it’s got a minimal chance of getting final approval from an underwriter.  While this may seem harmless enough, it can wreak havoc on sellers who are banking on the property selling.  This was actually the topic of an article I wrote a few weeks back regarding the risks associated with repairs and upgrades performed for a buyer prior to closing.

As is the case with the property I am selling now, I’ve made a handful of repairs for this buyer prior to closing because the loan officer assured us that it was going to close.  As I am two months down the road with this buyer as well as invested in specific repairs, I am not very inclined to cancel the contract and start over.  Luckily, the buyer is highly motivated to get into the property and is willing to put a substantial amount of money down in order to accomplish this.

Having done a number of lease purchase transactions over the years, it isn’t a difficult decision make. While I would prefer to have the property sold now, it is actually possible to structure the lease purchase in such a way as to make more money on the deal in the long run. At the same time however, you’re helping the buyer get into the property they want now while working towards getting final approval on a loan. To me, real estate investing is always better when all parties involved feel like they’ve won.

Structuring the Lease Purchase

When structuring the lease purchase for a buyer, I like to create an incentive for the actual purchase to go through sooner rather than later.  As such, I’ll make the purchase price gradually ratchet up over certain increments of time (ie. 6 months, 9 months, 12 months, etc). This way, they buyer is motivated to work on the loan and finalize the purchase as soon as possible.

If the buyer had assumed they were approved for financing, the buyer also probably had the down payment saved or accounted for. As such, I like to collect this as non-refundable option money.  With this kind of skin in the game, the chances of the buyer walking away are greatly reduced.  When the buyer does eventually purchase the property, this money is credited as actual down payment funds towards the loan.

When it comes to figuring out a monthly payment, I’ll typically keep this in line with comparable properties in the area.  Ideally, this is an amount that creates decent cash flow in the meantime. Also, the rent amount is typically going to be more than the buyer’s eventual mortgage amount. As such, this also creates an incentive for the buyer to execute the purchase quicker.

Even if the lease purchase isn’t your first choice in exiting a property, it can be an effective strategy when the initial purchase transaction falls through. Having it as a backup plan is a great way to preserve profit and potentially create more!

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About Author

Ken Corsini G+ is the founder of Georgia Residential Partners, LLC - a real estate investing firm based in Atlanta, Ga focused on creating turn-key investments for investors all over the country. He's been investing in real estate since 2005 with hundreds of real estate transactions.

7 Comments

  1. Thank you for this informative article. We use lease purchasing exclusively and find this strategy helps the seller and buyer feel comfortable because of the transparency in the transactions.

  2. Ken – I like the idea of the purchase price inching up. But I think at least in my area, folks generally need 18-24 months (or longer) to straighten out credit issues.

    One suggestion that I would make, is to add a mortgage person to your team and send everyone to this same mortgage person. You need to have someone on your team that will always tell you the truth. You could also put it in the option that they would have to meet with this person every 6 monts or so for a “credit update”. That way if you are dealing with someone that will never get qualified, you find out and can move on more quickly.

  3. Melodee Lucido on

    Nicely done Ken. I like lease purchases in this present r.e. market because it can create a win for sellers and buyers.

    You explained each part of what you do very clearly. I hadn’t heard before about the ratcheting up of the price. Interesting.

    I have a wonderful woman on my team that works on credit restoration. She isn’t one of those scammer companies that just throw out a bunch of dispute letters. She knows her stuff and gives a projected time frame for when the tenant/buyer will be able to get a loan. Her specialty is the niche of getting people into mortgages.

    Thanks!

  4. Hi Ken,

    Great article. I have personally done a few lease/options deals on my own properties. In one case, the tenant/buyer stopped paying and I had to evict. The small claims court judge tossed the case out because the tenant confused him by saying that he was in a contract to purchase the home. This was in spite of the fact that I had two agreements… a lease and an option agreement. It seems once the tenant/buyer either gets too much into the property by way of option deposit and rent credits or the tenant/buyer does costly improvement work to the property the chances of having to foreclose versus having to evict go way up. Any experience or advice about this?

  5. When you collect such a large sum of money, the deposit the potential owner would have had, do you have to put that in a special account? is it actually money that you have access to?

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