Lease options are big in America and they were introduced properly over here a few years ago and are now a normal way of investing for a few knowledgeable investors. Lease options take the concept of the option agreement to the next level.
Keep, in mind that the property market is at a stage now where it is very difficult for people to get a mortgage to get onto the property ladder, simply because, by the calculations that lenders normally use, they don’t make enough money to buy the average property.
And even though some lenders have recognised this and are trying to be more flexible with the amount they are prepare to lend, the potential house buyer is still left to find a 5% – 10% deposit. On a £225,000 property, that would mean they would have to find between £11,250 and £22,500 for a deposit.
How Do Lease Options Work
With the form of lease option I am writing about here, you as the investor own the property and you let it out to the tenant (potential buyer) with a view that, in an agreed set period of time, the tenant has the option of buying that property at a pre- agreed price.
You need to keep in mind that the tenant has the right to buy the property within the agreed period, but they are not obligated to buy it. Either way you, as the investor, are on to a winner because if they decide not to buy it or can’t for financial or some other reason, you can either arrange for them to stay on as tenants (still paying higher rent than market rate- but more about this later) or you can renegotiate a new lease option with them or another potential buyer.
This time you will take into consideration any positive moves in the property market, so you will be able to sell at a higher price than previously agreed. This is because the extension or new lease option is going to most likely take at least another couple of years to come to fruition. As the investor, you are on to a winner all the way. You may have heard of Rent to Own, these are a form of lease option.
You set the future purchase price of the property at the outset. This price is agreed between you and the buyer, and is normally the market value of the property today or the market value plus a small premium. How you work out the premium and what to set the rent at is negotiable.
If you set a higher premium because you think the house prices in the area are going to go up hugely in the next few years, you might have to set the rent at only slightly higher than market rate or at market rate itself.
But if you don’t add a premium you have more negotiating power and it seems more reasonable for you to set a higher rent, because the buyer will understand they will be buying a house in, say, four years time at today’s prices. (The length of time of the lease option is again negotiable and could be two years or it could be seven years: it depends on the potential purchaser’s and your circumstances.)
Buyers these days normally know that house prices generally go up, and the thought of buying their house in four years’ time at today’s prices will set the pound signs flashing in their eyes at the thought of all that potential equity. Hence, you can potentially up the standard rent by quite a bit.
Even in a property market that is going down slightly, (like the one we are in at the time of writing) must buyers will still understand that over time property goes up in price. If they don’t understand, then show them proof, so them statistics and open their eyes.
As you can imagine, because of the premium on rent, lease options tend to be a great positive cash flow machine. So when you consider that a lot of areas around the UK at the moment struggle to make yields attractive enough for the professional investor, then this is another way of being able to invest in those areas that otherwise would be off limits because the rents previously didn’t cover the mortgage by enough – well now they potentially do.
Benefits to You as the Investor
- You can charge the tenants above market rent
- The tenants look after the property incredibly well because they see it as their own.
- Much better cash flow than the standard buy to let.
- Almost a guaranteed sale at the end. And if they don’t buy, you could potentially do another lease option with them or someone else or just keep charging them the higher rent
- Less maintenance issues and a much better maintained property because the tenants treat it like their own home.
- If the tenants decide not to buy, you have benefited from all that increase in rent, plus if you have taken a non-refundable Option Sum from them you get to keep it.
Benefits for the Tenants (potential buyers)
- They can live in a property now and decorate it and treat it as their home because they know they will be buying it in the future. They don’t have to worry about moving to get onto the property ladder or to buy their dream home. They can live there now and buy it when they have more money to do so.
- They can get the property in the future at today’s prices or near to it, so in all likely hood they should have a decent amount of equity when they eventually do buy it.
- If the tenants are unsure of the area or the property for any reasons they are essentially getting a chance to try it out before deciding whether or not to buy it. Remember, they are not obligated to buy, so, contrary to the situation where they buy the property, decide they don’t like the area and have to go through the hassle of selling it, this way they have a while to figure out if they like everything before they eventually purchase it.
Lease options work well for all sorts of people in all sorts of situations, for example: first-time buyers who need a bit of time to raise a deposit, people on short term contracts or on their probation period in a job who are hoping to be made permanent, those who have just become self- employed and have to wait two to three years to get their accounts in order, those with a bad credit rating who are trying to rebuild it, but must wait a few years before they can get a mortgage and those who are new to this country but plan to live here a while but haven’t built up enough of a credit rating to buy their own home yet.
There is a slight variation on the lease option strategy above that is becoming popular at the moment, where you secure an option to purchase the property at some point in the future say 2-7 years and you take over the vendors (who doesn’t live in the property themselves) monthly mortgage commitment. You then source yourself a tenant who wants to buy and then do the standard lease option I outlined earlier. This is sometimes known as a “sandwich lease.”
Doing things this way, means that there is potentially no need for normal buying property costs upfront. Instead you just pocket the difference between what you pay the vendor and what the tenant pays you.**Nothing on this website should be confused with financial or legal advice. If you need this, or any other type of advice, please seek the help of a competent professional. In addition, because real estate laws change all the time and differ from state to state, and even city to city in the same state, everything in these pages should be considered general marketing advice and ideas. Please see link to full Disclaimer at the bottom of this page.