Reading recent articles on Real Estate success stories about lease/options reminded me of not only the lease/option buying that I have done over the years, but of the tremendous advantages to “selling” on a lease/option (L/O). My income increased dramatically when I discovered the benefits to selling on a L/O.
The two biggest benefits are 1. Selling without paying a sales commission, and 2. Receiving a higher than market purchase price (than you would if you sold conventionally).
First, by eliminating the need for a Realtor, you save 6-7% right off the top! On some properties this amount could be your entire profit! By L/O to your tenant you “cut out the middleman” (Realtor) and save substantially. Furthermore, when your tenant holds the option to buy, he doesn't have to move after the closing. What this means to you (the owner/optionor) is NO VACANCY during the marketing period. Obviously, the smartest way to use a L/O is to offer them to all of your tenants first.
As a side benefit to L/O to your tenants, I find that the “caliber” of tenant is much better too. They tend to take better care of the property (because they feel like “homeowners”), pay their rent more timely, and pay for improvements out of THEIR pocket.
Secondly, the purchase price that I quote to prospective L/O's tenants is about 10% – 15% higher than today's Market Value. I do this because at the end of a one year L/O the property will probably be worth more than it is today. I also do this as a “premium” charge for not paying me cash today.
I know that many people who L/O say to not lock in a price today and make the option price based upon the appraised value when the option expires. After being married to an appraiser for 25 years, I disagree with this philosophy. My wife/partner/appraiser tells me that, “if an appraiser has a value to ‘shoot for' it is much easier to appraise the property for what you want, than if you just ask the appraiser to ‘tell us what it is worth'. I think we can all read between the lines here and figure out the advantage. Right?
My experience tells me that only about 25-35-% of the people who hold L/O's actually exercise those rights. So, if this is reality, set up your L/O's to benefit from this fact. I have a one year extension right built into my options that allows the tenant/buyer to extend our one year deal for another year. What does it cost him? First, the option price is increased by 5%. Secondly, the rent is increased by 7%. Why? Because I want to cover myself if property values continue to increase in the second year of the option and rents always go up every year, don't they? I want the tenant/buyer to know that if he absolutely has to extend our deal, he can. But there is a disincentive built in the option contract to make sure that he doesn't extend “just for the fun of it.”
Another side benefit to having 65-75% of the tenant/buyers NOT exercising their option is that they forfeit their option consideration. If you get heavy into the “option” business, this can add up to some big bucks. Last year I received $17,000 of forfeited option consideration ( and I only do about 5-6 options per year). The bottom line to this business is that you really don't care if they exercise their option or not—you will make money one way or the other!