Real estate Lease options can be used by both buyers and sellers to maximize profits. In this post I’m going to talk about how a real estate investor can use a lease option to control a property for future appreciation and possibly cash low.

A lease option consists of 2 contracts, a lease and an option to buy. The lease gives the buyer the right to possess the property. The buyer also has rights to sublease the property, unless specifically noted in the lease contract that subleasing is not allowed. The option is a binding contract that states the seller must sell, but the buy has the option to buy. Unlike a bilateral purchase contract in which the seller must sell and the buyer must buy.

Normally lease options are used when a seller is having a hard time selling a property or the real estate market future is hard to forecast. The seller might try the lease option with the current tenant or with a new tenant. In the example I will use, You will see that you can perform a lease option as a buyer without being the tenant.

When entering a lease option, the buyer and seller will normally agree on a price for the property, The strike price. They will also agree on the lease option timeframe which can be any time, but normally 1-3 years. There will be a security deposit that is normally credited to the purchase price and rent credits. A tenant might pay a higher rent, but with rent credits (somewhere around 25%) will go towards the purchase price. There are many ways a lease option can be structured, and it is highly recommended to use a real estate agent or lawyer for a lease option contract.

Here is an example of a lease option in action.

the buyer is looking for a place to live, but has less then perfect credit and needs to build up their credit score before making a large purchase. The buyer finds a property seller that is having a hard time selling the property and finding renters because the property is also less then perfect. The buyer and seller agree on a lease option for 3 years in which the purchase price will be at current market value, minus  cost to perform some repairs on the house. in this example we will say $150,000 (market value = $160,000). The rent will be $900 a month ($100 rent credit), but the area rents are a little higher at $1,000. The buyer is required to pay a $500 security deposit, which also goes toward the property purchase price.

If the buyer does not execute the lease option, there are no refunds. the Buyer will lose the security deposit and rental credits.

The buyer, spends $5,000 fixing up the property and it is now worth $160,000. Since the property is now in good condition, the rent on the property can be increased to $1,100. The buyer decides to sublease the property for $1,100 and requires a $500 security deposit. The primary landlord is still responsible for property taxes, so the buyer is not responsible for anything, except if the sub-tenant damages the property. The buyer will therefore receive a monthly cash flow of $200 a month. As you can see for a very little amount ($500) the buyer has control of a property and making $200/month.

Over the next 3 years the property appreciates at 4%, therefore it is now worth $180,000. You excersize the lease option and sell the property at $180,000. You use a real estate agent with a 5% commission ($9,000) for a net of $171,000

Outcomes are as follows:

1. 3 years of rental income from sub tenant = $7,200
2. 3 years of rental credits of $100 towards purchase price = ($150,000 – $3,600 = $146,400)
3. $500 security deposit towards purchase price = ($146,400 – $500 = $145,900)
4. Net profit from sale ($171,000 – $145,900 = $25,100)
5. Total profits = ($7,200 + $25,100 – $5,000 (repairs) = $27,300) Not bad for paying $500 for control of the property

As you can see, many times real estate investing is not about buying outright, it is about controlling properties so you are in charge and can profit from leveraging you money.

My next post will be how the seller can benefit from a lease option. I think some will be surprised and some won't by the #1 reason why you should do a lease option on a property that's hard to sell or rent

[Post Update] This question is answered here: How a Property Owner Can Use Lease Options for Huge Profits

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