Lease Option Program - Buy & Hold Investors - Opinion

10 Replies

We are putting together a program that will allow Buy & Hold Investors to find properties they want to make rental income with and controlling interest in them without having to having to get a bank loan to purchase them. 

What do you think of this program?

Let's say we purchase a property and Lease Option it back to you for 3 years. The option price is set today, so you gain the appreciation for the next 3 years. There are NO rent credits.

Requirements:

Location = Any, it doesn't matter to us.

Annual Cap Rate = 10% or higher

Annual Cash-on-Cash Return = 15% or higher

LTV = 65% or Less

Proof of Funds = 10% Option Fee, Repair Cost & 6 months of Lease Payments

**ONLY NON-Owner Occupied Properties**

Fees:

$2k - Loan origination Fee (included in Loan)

$2k - Processing Fee (included in Loan)

10% - Option fee (Paid at signing of Lease Option)

5% - Increase in Option Sales Price from the Original Purchase Price

2 Months Rent - Security Deposit (Paid at signing of Lease Option)

What we need to evaluate a deal:

  • Property Address
  • Minimum of 5 exterior photos & 5 interior photos
  • Purchase Price
  • Market Rental Rate
  • CMA from the MLS and from a Licensed Realtor. CMA is to include the Retail Comps and Rental Comps
  • Proof of the repairs which needs to be in writing from a licensed and insured contractor. Must include cost of materials and labor, plus the about of time to do the work.
  • As with any product, if you can get folks who are interested, why not (not legal advice).  

    If I understand it correctly, in this structure you are basically financing the purchase, but not the rehab.  In our market, the fix up costs are often higher than the purchase price for the home, so this product would not be super exciting.  I realize that in most markets, that is not the case!

    I may be missing a few details, but looks like your client would need over 50% of purchase price up front? Or, since the proof of funds list doesn't include down payment, are you getting that on the back end? Perhaps the 65% LTV is based on ARV, not purchase price?

    My math: 35% down, (65% LTV), 5% for 6 mos rent (at 10% cap rate), 10% option fee, 1-2/3% for 2 mos' security (again, 10% cap rate-although not listed in proof of funds, so maybe not required over and above the 6 mos' rent required there?), so almost 52% cash upfront plus any fix up monies and 35% of $4k closing costs (yes, included in loan but still have the 65% LTV ceiling).

    As a potential buyer, I would want to compare this to a hard money lender - this seems like a similar structure, but the (effective) lender holds the deed and isn't financing fix-up costs, which would make it less interesting to me.

    I agree with @Harriet Baldwin as far as the concerns. The numbers, based on only 65% LTV, with rehab not included, won't work in most markets...even mine, which is saying a lot.

    This is however a program that with different numbers, I would be very interested in...on a very large scale.

    @Harriet Baldwin & @Joe Villeneuve - Thank you for the feedback. 

    We have reviewed the numbers of the program and this is what we have come up with.

    Example of a Transaction... 

    You have a contract with a seller. You contact us to buy the property. You provide contractor quote for repairs and CMA. We agree to move forward. You assign that contract to us for $1. If title work clears, we go to settlement on that property. At settlement we create a note against the property with the purchase price, loan origination fee, processing fee and closing cost included.

    Now we sign a Lease Option agreement with you for 10% more than the note amount on a 3 yr term. The option fee is 5% of the Option price. You are required to give 2 month's rent upfront for the lease. 

    $50,000 - Contract Price w/ Seller

    $55,800 - Note amount created from Purchase

    $62,000 - Option Price 

    $3,100 - Option Fee

    $725 - Lease Monthly Payment

    $4,550 - Down Payment

    Uhhhhh...NO.  Thanks, but no thanks.  What you are proposing is:

    1 - for the REI (let's say us), will go out and negotiate a deal that is at 50% of the LTV

    2 - The REI then hands the property to you for free

    3 - You get what amounts to a refi loan from your source that the REI pays for (at 12% interest)

    4 - The REI also pays for the REHAB out of pocket

    5 - The REI also pays you 10% increase on the
         a - Total Cost
         b - Rent/Lease Payment

    6 - At closing, the REI pays for the -
         a - Closing costs
         b - Origination fee
         c - Processing fee

    7 - At closing the REI also is paying you 10% Option Consideration
    8 - At closing the REI is also paying you 2 months rent for SD

    ...which means you get a free property, already analyzed that's a great deal, accept income streams in both lump sum and monthly (at HML interest rates), and all the out of pocket costs are from the REI...to you.

    So basically, this is just a HML package, but much more expensive to the REI.

    Am I missing something here? What benefit is this to the REI?

    @Joe Villeneuve - No I don't think you are pretty much right. What are the benefits to the REI you ask..

    1. Well what all do you have to go through to obtain a loan with HML?
    2. What do you have to come up with for a HML?
    3. Plus you secure the property today and gain the appreciation difference in 3 years. 

    I believe if the HML process and HML cost are in comparison to this program much harder and more expensive.

    This program is for those that want the properties they find and want to be purchased and added to their portfolio with the least amount of upfront cost in order to obtain positive monthly cash flow now and make their profit on the back-end. 

      @Joe Villeneuve - No I don't think you are pretty much right. What are the benefits to the REI you ask..

      1. Well what all do you have to go through to obtain a loan with HML?
      2. What do you have to come up with for a HML?
      3. Plus you secure the property today and gain the appreciation difference in 3 years. 

      I believe if the HML process and HML cost are in comparison to this program much harder and more expensive.

      This program is for those that want the properties they find and want to be purchased and added to their portfolio with the least amount of upfront cost in order to obtain positive monthly cash flow now and make their profit on the back-end. 

      Originally posted by @Brian Sinclair :

      @Joe Villeneuve - No I don't think you are pretty much right. What are the benefits to the REI you ask..

      1. Well what all do you have to go through to obtain a loan with HML?
      2. What do you have to come up with for a HML?
      3. Plus you secure the property today and gain the appreciation difference in 3 years. 

      I believe if the HML process and HML cost are in comparison to this program much harder and more expensive.

      This program is for those that want the properties they find and want to be purchased and added to their portfolio with the least amount of upfront cost in order to obtain positive monthly cash flow now and make their profit on the back-end. 

      1. Q: Well what all do you have to go through to obtain a loan with HML?
        A:  No different than what your program has
      2. Q: What do you have to come up with for a HML?
        A: 5 points (5%) only...which I can roll in. The loan covers rehab too...within that same 65% LTV
      1. Q:  Plus you secure the property today ...
        A: I secure the property how? You hold the note. Same as the HML.
      2. Q:  ....and gain the appreciation difference in 3 years. 
        A:  Property appreciates over the next three years regardless.

      Generally agree with @Joe Villeneuve .  

      I think this is a niche product - for those with enough capital to flinch at HML rates, but not enough capital to completely self fund. If you are targeting buy-and-hold folks, I assume that a conventional refinance is the most likely mechanism to fund their exercise of the option - if their credit is that good, they may be less likely to use you in the first place. If they're going to sell the property, then your target client is more a slow flipper than a buy-and-holder. However, even if the market is just 1% of REI, that may a big enough niche to operate in...

      @Brian Sinclair , this may be a nit-picking question (but details are where the devil is, right?):  Your first post has a 10% option fee and a 5% increase in option price from original purchase price.  Your spreadsheet has a 5% option fee and a 10% increase in option price from original note principal amount.

      Also, not sure how others on BP would opine, but a $50k property where $10k will make it a $100k property, that would be especially sweet (and unusual!).  You might want to use more typical figures.

      One last thought, are prepayments allowed and if so is there a penalty (I assume yes prepayments allowed, and no, no penalty - but never hurts to double check).

      Originally posted by @Harriet Baldwin :

      @Brian Sinclair , this may be a nit-picking question (but details are where the devil is, right?):  Your first post has a 10% option fee and a 5% increase in option price from original purchase price.  Your spreadsheet has a 5% option fee and a 10% increase in option price from original note principal amount.

      Also, not sure how others on BP would opine, but a $50k property where $10k will make it a $100k property, that would be especially sweet (and unusual!).  You might want to use more typical figures.

      My typical deal is a buy at around $43k, plus rehab around $12-15k, that gets me an ARV of between $75-85k.  With my funding in place, that gets me all of my cash back (in this example around $55-60k), with all expenses in place, (& a PM), I would cash flow between $450-550/month.

      My HML terms are at 3.5 pts  & 12% interest, at 75% of buy/rehab ARV.