Posted about 11 years ago

The Sandwich Lease Option

InvestorDirector.com

Who says you have to own property to lease it and sell it for profit?

A homeowner who wants to sell their home can move a tenant in, charge them rent for several months and then sell that home to the tenant. This sales technique is commonly called “rent to own” or lease with option to buy (lease option for short). What many people don’t know is that an individual does not have to own a home to profit from a lease option transaction. A “sandwich lease option” is a real estate investment technique that involves harvesting motivated sellers and selling their property to individuals that are either having trouble qualifying for a traditional mortgage or want to lease a home before “pulling the trigger” on a purchase. This potentially profitable technique involves patience, good communication skills and a backbone of support from mortgage professionals who can help qualify a lessee-buyer for a mortgage.

Invest time, not money

Sandwich lease option transactions are ideal for real estate investors that are low on capital because there is no monetary investment; other than perhaps some marketing expenses to locate a willing lease option seller and buyer. Most real estate investors buy a house using a mortgage, private financing or cash and either hold the house as a rental or rehab it and sell it for profit. Sandwich lease options don’t involve purchasing a home, but using someone else’s home as the investment vehicle.

 

Marketing to sellers

Sandwich lease options require an investor or real estate entrepreneur to identify and market their services to sellers; convincing them to use their skills versus a traditional sales method such as listing their home with a real estate agent. Generally, a sandwich lease option is reserved for sellers who are having trouble selling their home that is either vacant, or can be vacated to accommodate a lessee-buyer. Knowing this, a wise real estate investor looking to profit from a sandwich lease option will spend their time marketing to vacant for sale by owner homes (FSBO’s) or real estate agent listings that have been on the market a long time, or are about to expire.

Some investors insert flyers into mailboxes, while others mail materials or even knock on the seller’s door for a face to face proposal. Developing professional looking marketing materials that communicate something simple to sellers is all that’s required. “I can sell your home: no up front fee” with contact information would be an example. The important thing when marketing to sellers is that only a very small percentage of homes are ideal for a sandwich lease option.

Marketing to buyers

As with any real estate investment technique, it pays (literally) to build a database of home buyers before you locate sellable properties. This is especially true with sandwich lease options as there are so many buyers, especially in today’s tight credit market, who want to own a house but either cannot qualify or do not know the process of buying a home. A lease option is a healthy way for buyers to feel what home ownership is like before finalizing the transaction by exercising their purchase.

To build a pool of potential lessee-buyers for sandwich lease options you can run ads in newspapers, post ads on various websites like craigslist.com or you can place small signs along roads that say: “Rent to own houses”, “Homes for sale: Lease with option to buy”, “Homes for sale – good condition” or even “Can’t qualify to buy a house? We can help!” Make sure to put your contact information within the ad. Anything that suggests that you can help buyers who don’t think they can buy a house is good advertising and will help build a database of buyers relatively easily.

It’s important to gather the necessary information from potential buyers as they call you. Their name, current address, phone number, where they’d like to reside, desired property features (basement, number of bedrooms/bathrooms, build style, square footage, garage etc.) and price range. This information will help you match buyers to houses later on.In order to select the right type of buyer, which is the most important element to a sandwich lease option transaction, please read How to Screen Lease Option Tenants, also found within this month’s issue.

Marketing to find willing buyers is one thing – and is very easy; but qualifying a buyer who cannot afford the subject home, or has a marred credit report, is something that needs to be avoided at all costs. Lease option and rent to own transactions attract bad buyers who have no business leasing a home. In fact, many people posing to be home buyers are what experienced investors call “professional tenants”; people that bounce down payment checks and steal every valuable item in a home before leaving unannounced in the middle of the night.  If you place a lessee like this in someone else’s home, you will probably be sued by the seller for damages.

 

Sample Transaction

You notice a house with a FSBO sign on the lawn in your area that has been vacant for several months. You talk to the neighbors and get the owner’s contact information. The owner tells you he needs to walk away with $150,000. After researching area home values by talking to a local mortgage broker and an appraiser, you estimate the home to be worth $175,000. You explain to the seller that you will lease his home to a pre-screened lessee-buyer who will purchase the home for $175,000, with $150,000 going to the seller. You draw up a contract between the seller and yourself, giving you one year to sell his house. This contract also specifies that the lease payments will cover his outstanding mortgage payments, monthly taxes, insurance bills and provide a $150 premium to you. The $150 premium can be justified by your efforts in structuring this deal; working between a mortgage professional and the lessee-buyer in an attempt to qualify the buyer who will hopefully execute the purchase in the end. The contract also states that a nonrefundable $10,000 down payment will be put up by the lessee-buyer and go directly to the seller.

The seller agrees to the terms, and from your buyer database a lessee-buyer is selected (with the help of your chosen mortgage broker) that can afford the home. Before move in, the lessee-buyer agrees to a one year lease at $1,350 per month, a purchase price of $175,000 and puts up a nonrefundable $10,000 down payment. Each month you, the lessee-buyer and your mortgage broker meet to oversee the lessee-buyer’s ongoing actions to strengthen their credit scores. After 9 months, the lessee-buyer gets qualified for a mortgage and 45 days later, the home is sold. The seller gets his $150,000 (which he probably wouldn’t have gotten without your services), the buyer bought a nice home at fair market value, and after closing costs you walk away with $16,500.

You don’t need to get fancy with thick contracts between you and the seller as lease option gurus and “get rich quick” authors suggest. The key is to communicate with both buyer and seller and have your attorney draw up clear, simple documents that everyone understands. Let them know what you’re doing and what advantages you can offer both of them. Explain to sellers that you will get them what they want, but you have structure a profit in the deal for yourself. The whole deal hinges on selecting a lessee-buyer that may not be able to execute the purchase right away (as most can’t) but one that can be counseled by your selected mortgage professional and qualify for a mortgage later on. The ideal lessee-buyer is one who has had a job transfer and is already qualified for a mortgage. Many job transferees want to rent for a while before owning because they don’t yet know if their transfer is permanent. Other good lessee-buyers include individuals who can afford the proposed monthly house payment but have a few credit hiccups that can be improved over a period of months. Your mortgage broker should have all interested parties apply and be screened at his or her office. Simply put: mortgage brokers know what current mortgage guidelines are like and can determine who can obtain a mortgage and who can’t. Remember that mortgage professionals get paid a commission for closing a loan so they are happy to take your lessee-buyer to the finish line.

 

Drawbacks to Sandwich Lease Options

Real estate entrepreneurs who would like to profit from sandwich lease options must be aware of potential drawbacks with these types of transaction:

  • Sandwich lease option investors must spend the time to become an expert in real estate finance or build a team of several loan officers or a mortgage broker that can help qualify lessee-buyers. The whole transaction revolves around the ability of the lessee-buyer to perform, according to the terms of the contract, and purchase the home.
  • Most sellers will blow you off because your methods are unproven and they are wary of lessee-buyers that may trash their home or not perform.
  • It takes time to look for vacant homes. Sometimes the owners must be tracked down as they have already moved out.
  • Advertising to harvest buyers and sellers takes time and can be expensive, depending on how aggressively an investor markets and the advertising mediums selected.
  • Many homes are overpriced; that’s why the home is vacant or has been on the market so long. You may have a willing seller and a closable lessee-buyer, but a house that is worth less than what’s owed. Sandwich lease options work best in “hot” markets, or at least stable ones.
  • Buyers can be irresponsible, neglecting their responsibilities to cash the deal out. Many leave homes unannounced and vandalized. Some stop paying their monthly lease obligation. This is why it is imperative to collect a large nonrefundable down payment.
  • You must be able to screen lessee-buyers (with the help of a mortgage professional) so you don’t wind up in court. Be careful as placing a bad tenant can end in a lawsuit. This is an expensive lesson.
  • You must know home values and be aware of the areas that mortgage lenders “chop” home values in; and areas they simply won’t lend in.
  • You must work with an attorney and have him draw all the documents between you, the lessee-buyer and the seller. This costs money but saves you from potential lawsuits.
  • You should be aware of how the process of selling a home works. Closing costs, taxes etc can kill your profit in the end. Get a real estate sales license is wise and is cheap.
  • Sandwich lease options are a bad idea in depreciating markets where sliding values can cement a lessee-buyer into a non purchasable deal, killing your profit.

Comments (2)

  1. I have a question about the exit.  What happens if the deal falls through?  What if your lessee-buyer fall through at the end of the term and you're stuck with a huge payout that you cannot perform on?  What is the worst case scenario in this instance?  I have a potential deal that this would work well on.  I also have a few multifamily units that I would like to try it with, but I don't know if I could find an end buyer who wants to lease.


  2. This is a gold mine. Thanks for sharing!