Creative Options and 0% Financing – Part 3

Options are an excellent way to obtain zero rate financing because they control an asset without any payment or interest other than the amount paid for the Option.  It's sometimes possible to get an Option without any payment at all as I discussed in Part 1 of Creative Options and 0% Financing. Investor's can even use Options to Negotiate Leases as was demonstrated in Part 2 of Creative Options and 0% Financing.  Let pick up right were I left off….

Options w/o Leases

Options without leases are an ideal tool for relieving an owner’s cash flow squeeze when he doesn't want to sell his property, or wants to move out and rent it.  Using the previous $150,000 house again, suppose the original loan dating back several years had been for $100,000 at 8% for 30 years and the current monthly payments were $733.36 plus taxes and insurance.  Suddenly, the breadwinner is laid off and there's no money in reserve to make the payments to protect the $75,000 equity.

Option Solution: A reasonable proposition would be to provide one third of the total payment each month for two years in return for one third of the equity.  Thus, for about $300 per month for 24 months, or $7200, the Optionee would, using an Option strategy, be able to leverage into a $25,000 net equity without any management chores at all.  Not a bad spot for the Roth IRA at all to park your profits.

Option Solution: When you combine a lease/sub-lease sandwich with an Option in which a credit is given against the Option price for each payment, then the sub-lessee is actually buying the Option for you.  There is a negative cost in this investment.  There is nothing quite like this anywhere else in the investment world.  Each payment that is credited against the ultimate cost has the same effect as any principal loan payment made to amortize a mortgage, but with a major difference.  Option payments “amortize” at a much faster pace.  Here's what I mean:

Options – Ultimate OPM Strategy

Options are the ultimate OPM strategy.  If you were to buy a $150,000 house with a 10% down payment, it would cost $15,000 down, plus closing costs.  Payments on the $135,000 balance over 30 years would be $990.58 plus taxes and insurance.  At the end of 5 years, you would still owe $128,344 on your loan after having paid in a total of about $59,435.

On the other hand, suppose you had made exactly the same payment on a lease/Option, but had negotiated a credit equal to 25% of each rental payment?  First of all, other than your lease deposit, you would have made no down payment at all.  Secondly, over the same 5-year period, almost $15,000 would have been credited against the purchase price.  Best of all, this would have been paid by your tenant, not by you.

Beware: The only problem with this arithmetic is that the rental market could weaken, leaving you with a $990.58 payment to make each month you experienced a vacancy.  Over 5 years, you could wind up paying a lot of money for this lease out of your own pockets.  One way to limit your risk is to write your lease/Option for one year, with an Option to renew it each year for the next four successive years.

This way, you would only be liable for, vacancies that occurred in each year that you elected to renew the lease/Option.  Of course, anytime you tired of leasing the property. you could either sell the lease to another entrepreneur who wanted the growing cash flow spread generated by rent raises; or sell the Option  to a passive investor based upon the growing equity.  You might sell half of the Option to the investor for cash flow, and keep half as your own investment.  Or, you could simply exercise the Option and simultaneously sell the house itself to capture your growing equity.

Lease Terms Are Key

Lease terms can transfer negative cash flow and risk from the owner to the lessee, while using the tax code to help both of you.  A person who is already experiencing negative cash flow because he can't or won't manage a rental would be desperate to have another person come along and alleviate the problem.  His only cost would be a share of future sale proceeds, and that wouldn't seem very important weighed against current cash flow needs.

He'd have no vacancy, no management, all the tax benefits, and cash from the rents to help him make his payments.  On the other hand, the lease/Option presents an outstanding opportunity for the entrepreneur who is able to garner equity through both the appreciation of the property and rental credits given against the Option price.  It would be difficult to come up with a better arrangement.

Dealing with Motivated Sellers/Owners

Where do you find house owners who would be motivated to enter into this kind of arrangement?  To locate motivated sellers, mine the newspaper ads for people willing to carry back installment payments and convert them to lease/Options. Prowl the neighborhoods looking for vacant houses.  Scour the courthouse for eviction notices.  The owner of a rental who has to evict a tenant is about as disenchanted with the rental house business as he'll ever be, and as willing as he'll ever be to hear your proposition.

If you've already got a source of cash for payments, you can offer additional cash flow in return for a much greater Option credit to solve cash flow problems for an owner who needs more money.  In the above illustration on the $150,000 house with a $75,000 balance, instead of simply making the loan $990.58 payments for the owner, suppose you offered $1500 per month with an Option credit equal to 125% of the payment?

Let's suppose that you were only able to rent this property for $1200 per month.  Each month, you would be paying out $300 in negative cash flow, but getting a credit of $1875.  This translates to a return of $22,500 each year against the purchase price at a cost to you of $3600.  That boils down to a yield of 625% on you're invested cash, taxed as capital gain, that you would realize when you sold the Option after a couple of years.

Hold on, this book is about creating positive cash flow, not negative cash flow.  The solution would be to sell half of your Option to a private investor (Dare I mention Roth IRA?) who would be delighted to pay the negative for only a mere 100% return, leaving you with the remaining $17,300 in Option credit each year.   The key is to find the person who needs this kind of deal.

Divorces present a rich source of Option opportunities.  In a typical situation, when a household breaks up, the equity in the house is divided in such a way that the mother keeps possession while the father pays alimony and child supports.  Quite often, there simply isn't enough money to provide much of a life style for either party, thus, alimony payments to the mother become very unreliable.

Your solution is to get both parties to agree to an Option in which tax-free payments will be received by the mother with which to make house payments, and credited against the purchase price in lieu of alimony or child support payments paid by the husband.  This technique solves a real financial problem for both spouses, as well as their children.  And, with an appropriate percentage credited by the Optionee against the purchase price, it can be extremely profitable for him or her.

Creative Options and 0% Financing Conclusion

Options are an excellent way to obtain zero rate financing because they control an asset without any payment or interest other than the amount paid for the Option.  An Option is a marvelous tool that reduces risk while passing on to the holder most of the benefits that can be obtained from leveraged real estate.  It can be the ultimate use of OPM to finance your future real estate investments or cash flow deals. Best of Luck!