Lease Option my own home?

Question

Hi all,
I'm fairly new to real estate investing and am looking to venture into lease options.  I purchase a short sale home as my primary residence for 189k just over 4 months ago.  A house with the same floorplan down the street is on the market for 215k.  I was thinking of trying to sell the home as rent-to-own (lease option).  This is how I see the numbers.  Based on my calculation on a two year term I could make around 40-50k assuming a 5% annual appreciation with the current market value at 215k.

I was also thinking of buying a fixer upper and flipping it buy selling with a lease option.  I have never flipped before and find it a bit more risky than selling my current home as mentioned above.

Can anyone give some advice/recommendation on either situation?

Thanks,
Mike

Jeremy Hardy · Answer

Depending on your credit score then yes you do have enought saved up..

Mike Cartmell · Answer

Well do I have enough funds (25k) in reserves to purchase an investment property to rehab.  Every lender I have been referred to thru other investors have required 10% down and closing costs.  I would like to have at least 10k left in reserves after I buy the house.

Mike Cartmell · Answer

I have thought of refinancing to a IO to reduce my payments and create cash flow but then I take on the risk of the market dropping further and no principal paydown.  In your rehab/lease opton sales, do you finance with IO's?

To finance a house at 103k would require a ton of money down.  I want to save my 25k in the bank for vacancies and  emergencies when I can not find a tenant buyer.  The whole purpose of the tenant buyer is to fix there credit and to eventually purchase the house.  I do not plan on renting it.  Please keep the input coming.  It is nice to hear constructive criticism that I can learn from.  Thanks

Jon Holdman · Answer

In the other thread you post that your PITI payment is $1250, and you think you could rent it for that amount.   Even with a lease option, you will be losing money each month, over the long term.  Despite what gurus, and sometimes wholesaler, say, cash flow does not equal rent - PITI payment.  There are other expenses, like damage, and vacancies.  The fact the house is new will avoid major capital items like furnaces and roofs, but won't avoid minor items or tenant damage.

I recommend you do some more reading and learning before venturing into the deep end of the pool.  You really have to apply rental economics to lease options, since it likely you will be leasing it for some time.  For a property that rents for $1250/month, you want to pay (pay plus rehab, if you go that route), no more than about $103,000.  I get that by deducting 40% for expenses (including taxes and insurance), then deducting $100 for my desired cash flow, then computing the maximum loan the remaining $650/month can support.  The 40% for expenses assumes I will be managing it myself, and working for free.

Jon Holdman · Answer

I don't mean put a huge down payment on a $189K house to make the loan to $103K.  I mean find a house you can pay $103K for that will rent for $1250/month.  Then you're got a deal.  Even if you put in a down payment, you have to consider the opportunity cost of your investment.  A house that costs $189K and rents for $1250/month is a very bad deal.

This may be fine as a primary residence.  Its a terrible house for an investment.

I agree with JHardy.  IO for short term rehab loans, 30 year (or shorter) loans for permanent financing.

Jeremy Hardy · Answer

Interest only I assume means IO?
 That wouldn't be a good idea at all. There is a time and a place for a IO loan. When necessary they should only be used in short term meaning 1 yr max and or rehab loan or construction loan. Both of which require you to pay off early and cost you lots of money in the long run. 
I honestly would suggest here that you actually sell this house and use a different house/project for your investment. I am unfamiliar with your market but venture to guess that you are really close to markey value on what you already owe. based on your previous post. This isn't the cash cow you were looking for. move on to another one..

Jeremy Hardy · Answer

I see what you are asking now. It would be more risky to do as a invest property. For the simple fact that you have to pay for both houses if you can afford to do so then no big deal.

Jeremy Hardy · Answer

I agree with the above statement, in addition to what he said. The only differenc that is worth calculating in your thoughts between a rental and a lease purchase are usually the lease purchase tenenats are going to take better care of the property because they ahve interest in purchasing the property. From my Experience I have made more money on the lease purchase in the short term but made much more over the long term with rentals. 
I would imagine that you would need alot of rent to cover your payment and taxes and insurance. May be difficult to find that person that can cover that. Chances are if they can cover that for you then they should be able to aquire financing on their own to purchase property now, while it is a buyers market..

Jon Holdman · Answer

I seriously do not think we will see 5% annual appreciation over the next two (or five) years.  Many places will decline.  You need to have some local factor driving demand if you expect to see appreciation.

How much can you get in rent for this place?  Even with a lease option, you will still have expenses you have to pay - taxes, insurance, some maintenance, vacancy until you get your tenant buyer, advertising, etc.  Maybe less than with a pure rental, but some here will argue the expenses are the same for a lease option as for a pure rental.  Can you get enough rent to cover your monthly note and the expenses?

What's the market like there?  Is it declining, flat or rising?  Can you really get $215K?  Just because a house is on the market at $215K doesn't mean it will sell for that.  Unless CO Springs is different than Denver, I'd predict it will actually sell for no more than $200K, and the seller will give $5K or more in concessions.  The seller will pay commissions and closing costs, and will likely net only about $180K.  You may do better offering lease option terms.

For an investment property, you paid way too much.  If its realistically worth $200K, you would need to pay no more than $140K, less the cost of repairs.  Keep that in mind before you start trying to do a flip.

Mike Cartmell · Answer

Thanks for your input, it is much appreciated.

I did not buy the home with intentions of flipping.  I am just trying to get some experience with lease options and have no intentions of making it a rental.  The home is new (built in 2005) and needs no repairs.  The house is actually in Fountain, next to Fort Carson.  Its a military community.  I think there will be some decent appreciation in years to come because of the troops that will be coming home.

As far as flipping a property, I would be doing so with another property that I have not purchased yet and then sell it on a lease option.  I was just asking if it would be less risky to invest in another property to get some experience or just do it with my own home?

Thanks again!