Lease Options: Gold Mine or Fools Gold?
Have you heard what an ounce of gold is selling for these days? According to GoldPrice.org it’s around $1,552. That’s a 176-year high. Back in 2007, when the housing market first started its downward spiral, gold was worth approximately $600 an ounce.
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I’m no financial expert but it appears to me that this gold buying frenzy we’re seeing now is mirroring what happened in the real estate space just four years ago. I wonder how many people will lose their retirement funds this time around. Will all of these infomercial gold buyers and hedge funds get blamed in the media and sued by the feds if the bottom falls out?
When the real estate market in Phoenix went into the toilet in 2007 lease-option deals were my little gold mine. I owned 55 properties – all “subject to,” 1-3 year option contracts. Some cash flowed, others didn’t. But they all had one thing in common at the time – equity and lots of it.
Notice I said they HAD equity.
The bubble burst and I was locked into lease-option deals that were plummeting in value. A few of my tenants left voluntarily before their options expired. That allowed me to sell some of the houses before I lost money.
However, a majority of my tenants refused to leave. I had no way out. All I could do was sit there and watch the house prices drop far below what I paid for them. Of course, at the end of the option agreement I knew these tenants would never get a loan to purchase the properties. This made the process even more painful.
So I lost money when the real estate market crashed. A lot of investors did right?
But what may surprise you is that I lost money prior to the market collapse doing lease-options. Even worse, I got sued. Here’s a quick case study in how this happens (remember this is during the market boom):
The investor (me) buys a house for $200,000 and sells it to a lease/option tenant for $230,000. In three years the home’s value increases to $350,000. However, the tenant cannot qualify for a loan to purchase the property at $230,000. The investor evicts the tenant for failure to exercise. The tenant then sues the investor.
What did the tenant sue me for? You name it. His lawyer used terms like “equitable mortgage” and “unconscionable profit.” Finally, this tenant claimed I was robbing him of his “equity.”
My lease-option contract was rock solid and iron clad. I even videotaped the signing so there would be no confusion. The bottom line is anybody can sue anyone at anytime for any reason. And that’s exactly what this tenant did. Both the tenant and his lawyer knew they wouldn’t win in court. That wasn’t their objective. No, their plan was to legally extort thousands of dollars from me in the form of a settlement agreement.
This is why I’m not a big fan of lease-option deals in unstable real estate markets like Phoenix. From 2004-2006 prices here shot up by more than 40%. What followed was an unprecedented decline of 50%. Many experts claimed we bottomed out in April of 2009. There were some moderate increases and then another 12% decrease after the tax credit expired April 2010. That’s more than unstable, it’s downright VOLATILE.
There are contributors on BiggerPockets.com that have had tremendous success doing lease-options. Yes, they can be profitable – just not in every real estate market. If you want to strike it rich in a market like Phoenix, or other cities with uncertainty, you may find that lease-options are the real estate version of fools gold.