Have you ever come across a seller who is motivated to do a lease option with you, but not quite motivated enough to give up on all the future appreciation of the property? This is a perfect scenario to try using an Equity Split.
You may be familiar with the concept of “equity splitting.” This is where you and the seller essentially partner up and agree to split the profit from the resale of the property according to some specific ratio.
Here is how I teach my students to make up to an extra $25,000 or more on every equity split they do. It's call a Hybrid Equity Split and I think you'll like this simple yet highly profitable technique and want to add it to your toolbox of investing ideas.
The best way to understand the concept is to walk through a case study of a deal we did with the owners of a two bedroom, two bath property. The sellers were motivated because the husband had been transferred in his job. When I met with them we talked through doing a 8 year lease option on the property. Right at the very end they balked and I pulled out this Hybrid Equity Split idea to sweeten the deal just enough to get it closed.
The terms of the lease option were as follows: A term of 8 years with a monthly rent of $913 and a purchase price of $102,000. The up-front option consideration I paid was $1.
Now most investors would structure their equity split as follows: anything they as an investor sold the property for over $102,000 they would split with the seller on a 50-50 basis. For example, if they sold the property on a 2 year rent to own for $120,000 then they would give the seller the first $102,000 and split the remaining $18,000 profit 50-50. In other words, they would make $9,000 from the resale plus any cashflow the property generated over the two years.
The way we structured our Hybrid Equity Split was as follows: we did the 8 year lease option as described above and agreed that we would also do an equity split on anything we re-sold the property for above $127,000. In other words, the first $25,000 in profit would be ours alone and we would do the equity split on any amount above that.
By the way, why offer 50-50 to a seller when they will often times be thrilled with substantially less? We agreed they would get 12% of the amount we resold the property for over the $127,000!
How did we get the seller to agree to this? We simply asked the seller, “Mr. Seller, if there was a way where you would get your full $102,000 we talked about and on top of that you would get a chunk of the future appreciation from the resale of the property is that something we should talk about, or probably not?” (Those of you who have gone through any of our books or courses will recognize the “negative phrasing” I just used there.)
Once the seller says that yes he is in fact interested in talking about that you simply go on to explain, “Well, I don't know if we could do this, but what if we set a percentage that you would get from the resale of the property. Obviously we would need to build in a minimum base profit of $25,000 in to make this worth our time, but what if we said that anything we sold it for down the road over $127,000 you would get set percentage of that? What I mean is that you would get ALL of the first $102,000, that's completely yours, and you would also get lets say 10% or maybe a little more of any amount we sold it for over $127,000. Is that something we should talk through, or probably not?”
Our seller agreed to this, after negotiating strongly to move the percentage from 10% to 12% (notice he just accepted the $25,000 base profit!) We then sold the property on a 2 year rent to own with $3,000 non-refundable option money, for a rent of $1,000 per month, and a final price of $120,000.
While it looks like this tenant buyer will end up buying at the end of their term, if they don't then we pocket the $3,000 option payment plus the $2,088 of cashflow ($87/month x 24 months) and simply go find a new buyer. At that point the we'll sell the property for more money (probably $134,900) collect another option payment, and get more of a cashflow because the market rents have increased.
Key Point: You are only doing the equity split on the money from the resale of the property. You get to keep all of the cashflow and all of the option money that is left if a tenant buyer decides not to exercise their option.
Notice in this case, even if you offered the seller a “50-50” equity split on the amount over $127,000, you would still make 90% of the total profit! How? First you made $5,088 from your first tenant buyer, you'll make at least another $2,000 in cashflow from your second tenant buyer. Plus you will make $28,950 from the difference in your option price and your selling price (you get 100% of the first $25,000 plus 50% of the next $7,900.) All totaled you would make 36,038 from your equity split. Your seller would pocket an extra $3,950 (50% of the amount you sold it for over $127,000.) In this case you made 90% of the profit from your “fifty-fifty” equity split!
Just remember to build in a base profit for yourself on any equity split deal you do. Even if it's only $10,000 or $15,000 before you split the rest of the money that is PURE profit for no extra work.
The final point when you are negotiating an equity split is the manner in which you approach the seller. It's critical that the seller doesn't feel you are chasing after them like a hungry buyer desperate to make a deal. You need to maintain your “reluctant buyer” status.
The best way to be a reluctant buyer is to use the language patterns that reluctant buyers use. Qualify your statements with phrases like, “Well, I don't know if we could do this, but what if” Or, “My partner might not go for this idea, but what about”
I hope you put this advanced Purchase Option technique into practice in a profitable way. Good luck!