Legal Risks with the "Sandwich Lease Option"

Someone may have told you that the “sandwich lease option” is a way for you to make money in real estate without investing any of your own money. What they probably didn’t tell you is high level of risk involved. The high level of risk comes in many ways that are not obvious to even the most experienced real estate investor. Before you are lured into the promise of making money in real estate with no money invested, take the time to explore the risks.

How the industry describes the parties to a sandwich lease option:

• New Tenant Buyer / Lease Option Tenant

• The Middleman / Investor

• Home Owner

Legal designations for the parties to a sandwich lease option:

• Sublessee / Optionee

• Lessee / Optionor

• Owner / Landlord

You will need to become familiar with the legal designations for the parties if you are going to do a sandwich lease option, so I will use the legal designations from here on out.

I will highlight some of the risks and problems you should be aware of before pursuing a sandwich lease option.

• 1)Even though you may ask for a ‘non-refundable’ option payment, you should be aware of the many circumstances that may require you to refund the ‘non-refundable’ option payment. Some of these include:

The Owner/Landlord may fail to perform their obligations under their Option Contract or their Lease Agreement, which will result in your inability to deliver the property or the sublease to the Sublessee/Optionee.

The property may be sold under a foreclosure proceeding, which will result in your inability to deliver the property to the Sublessee/Optionee.

The owners may file or be involuntary pushed into bankruptcy which will result in your inability to deliver the property to the Sublessee/Optionee.

The property could be subject to a condemnation or taking which will result in your inability to deliver the property to the Sublessee/Optionee.

You may fail to perform your obligations under your Option Contract or the Lease Agreement, which will result in your inability to deliver the property to the Sublessee/Optionee.

If the Owner/Landlord fails to perform the obligations under the mortgage loan or any loan modification agreement, you may be unable to deliver the property to the Sublessee/Optionee.

If you fail to obtain a title opinion prior to executing the Option Contract or Lease Agreement, at closing you may find that there are title defects that delay or prevent closing from occurring or that cause you to have to pay out of pocket to cure the title defects.

• 2)If you are unable to deliver the property to the Sublessee/Optionee, for whatever reason, and the Sublessee/Optionee has performed all of its obligations under the contracts, then you may be liable beyond returning the ‘non-refundable’ option payment. You may also be responsible for any money the Sublessee/Optionee spent improving the property at its own cost in reliance on representations you made that he had the option to purchase the property. You may also be subject to claims of fraud or constructive fraud since you received the benefit of the monthly rent and the option payment without having the ability to deliver the property.

3)If the Sublessee/Optionee fails to timely make its monthly rent payments or fails to perform its obligations under its Option Contract or the Sublease Agreement, you will be liable for your ongoing monthly payments to the Owner/Landlord under the Lease Agreement.

4)If the property is damaged in a tornado, fire, or other casualty or becomes uninhabitable and the owner is unable to pay for repairs, you may be responsible for costs to make the property habitable. Further, any insurance proceeds from such an event will likely go to the mortgage lender.

5)The Owner/Landlord’s mortgage documents will likely have a provision that requires the Owner/Landlord to get the banks approval before he sells or transfers the property. Failure to obtain the prior approval can result in the immediate payment of the entire mortgage debt. If the entire debt cannot be immediately paid, the property could be sold at foreclosure. Don’t be fooled, the transaction contemplated by the documents needed to make a sandwich lease option possible would qualify as a sale or transfer of an interest sufficient to trigger that provision in the mortgage documents.

6)If you market the property for sale prior to having signed contracts with the Owner/Landlord, you may be liable for a breach of real estate laws that prohibit individuals form performing the duties of a real estate broker without a license.

7)If you plan on obtaining a Power of Attorney from the Owner/Landlord so you can make direct payments to the bank, insurance company, and the tax commission, you are assuming additional responsibilities called ‘fiduciary duties’. Failure to perform your fiduciary duties could result in substantial personal liability to you. This is very serious. If you don’t know what your fiduciary duties are then you have no business obtaining a power of attorney. You will absolutely need to talk to an attorney if you want to know how to manage this aspect of the transaction.

There are too many pitfalls to attempt the sandwich lease option from documents you downloaded online or that your friend used on her last deal. You will absolutely need an attorney to point out the pitfalls and help you navigate the risks that are particular to your specific transaction. No matter how skilled your attorney may be, there is really no way to fully insulate the investor from all of the risks associated with the sandwich lease option. If you are the type of person who can handle these risks and has the desire to engage in creative investment strategies, then the so-called sandwich lease option may be worth considering. Just remember, each transaction will have its own issues that your attorney will need to account for in your contracts.

If you chose to pursue the sandwich lease option, here is a list of documents you will likely need your attorney to prepare:

• Limited Durable Power of Attorney from the Owner/Landlord

• Lease Agreement with the Owner/Landlord

• Option Contract with the Owner/Landlord

• Memorandum of Option Contract signed by the Owner/Landlord

• Sublease Agreement with the Sublessee/Optionee

• Option Contract with the Sublessee/Optionee