So you've gotten into the real estate market. You found a motivated seller who was really feeling a financial pinch brought on by the economic crisis. They reached the conclusion that their chances of saving their home was next to zero, so they chose to take the consolation prize: to walk away under their own terms with their pride intact and their credit report in better shape than they expected.
Because of your Real Estate investing education you were able to purchase their property with a subject to transaction. Knowing the smart money was on purchasing their property through a land trust, now you're ready for the next step - finding a buyer in today's market. The chances of quickly flipping the property for a profit are relatively low, so what can you do - short of renting it out and playing landlord?
Let me give you a better option.
What if I told you that instead of simply renting the property out for market rent you could find a tenant who might want to buy the property in the future for much more than it's worth now, is willing to give you a substantial "down payment", will pay a premium rental rate, and will agree to pick up most of the maintenance expenses? I don't need to pinch you; you're not dreaming.
Instead, I need to explain how you can step into a real estate investing goldmine. I'm referring to the lease option strategy to real estate riches.
The lease option is two agreements, although a lot of novice investors think it's just one. The first part is a standard rental agreement, while the second part is an option agreement.
The rental agreement lays out the terms of the rental - how much they'll pay each month for the privilege of living in your house. You'll also spell out all of your rules, explain their deposit, etc. It's a simple agreement. Even though you're a Real Estate investor who may just be starting down your personal pathway to prosperity, you've probably seen one of these agreements even if only as a tenant.
Where this Real Estate investing strategy becomes a work of art, though, is by incorporating a second agreement into the transaction: the option agreement. Don't be afraid of the lease option - it's not scary. You don't need to spend thousands of dollars on a worthless piece of paper that says "Bachelor's Degree" to understand lease options; in fact, you'll spend less time over-complicating the concept if you don't have one. Here's how it works:
- Your tenant-buyer pays you an option consideration fee (generically referred to by some people as a "down payment"). The amount is based on your comfort level - and your tenant-buyer's ability to pay, but is generally between $2,000-$10,000. This money will be credited back to the tenant-buyer when they finally decide to purchase the property. If for some reason they decide to walk away from the agreement or can't complete the purchase within the alloted time, they'll lose this fee.
- In exchange for the option fee, the tenant will have the right to buy the property for the amount that you negotiate before they move in. This price is always more than the property is worth today, which guarantees you a nice profit margin when they exercise their option. They'll have a fixed amount of time - usually 12-36 months to exercise that option.
- For every on-time rental payment for the term of the agreement, you'll grant them a rental credit that will also be deducted from their closing costs when they exercise their option.
- Because a lease option is further up the real estate food chain then a simple landlord-tenant relationship, the tenant/buyer will often agree to pay all maintenance expenses less than a certain dollar amount. Anything more than that you'll pay. What this does is help guarantee they'll be proactive in letting you know about problems quickly and it gets you out of midnight plunger patrol calls for clogged toilets.
When the tenant buyer decides to pull the trigger and exercise their option they'll receive credit for the option consideration fee and any rental credits they've earned along the way. If you agreed to a purchase price of $175,000 and the tenant gave you an option fee of $10,000 and they were to pay $1,500 per month with a rent credit $500 per month for three years, they would only need to bring $147,000 to the closing table.
The lease option is a tremendous tool for you to use in establishing yourself as a real estate investor, but it gives you another benefit you can't easily put a price tag on: It gives your tenant the pride of ownership. They have money tied up in their house, so they're going to be much more willing to pay their rent on time and prevent damage from taking place.
Recent market changes have shaken up the way the lease option works. Knowing this will keep you from making a mistake that could potentially strike a devastating blow to your transaction: lenders have added what are called "seasoning rules" to real estate transactions. All this means is that they're stating how long they want the house owned by a party before they'll approve a loan on that property. This is generally 12 months; since most tenant buyers won't exercise their option within the first 12 months anyway, it's a moot point. However, since you've purchased the property yourself with a subject to transaction and you placed the property in a land trust, you're covered regardless.
So get your real estate investing career off on the right foot by using the lease option in conjunction with a subject to transaction to quickly shove yourself down the pathway towards prosperity. You're gaining a valuable education in real estate; take your profits and invest them in your future by buying even more property creatively. The real estate world is your oyster; let your profit potential increase your drive to prosper in 2009!
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