southstar


All About southstar

southstar's picture
Name: 
southstar
Location: 
Highlands Ranch, Colorado
Interests: 
Real Estate Investing

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Keith,
I appreciate you commenting on this thread, plus, thanks for offering to respond via pm..
I have been reading-up on pg. 200 in Dean's BARM...goood info.. But I still have a few questions about structuring a lease option "offer". 1. Exactly what form should I use?
2. Do you always give the seller their asking price?
3. Do you always request the "assignment clause" even if you want to hold the property for pos. cash flow?
4. How many years would be reasonable to ask for on the lease?
5. What about the rent credit? 50%???
6. What about earnest money...seems like I recently read where there is some option that only requires 10 dollars per offer???
7. This is a duplex zestimating at $276,090. Tax assessment @ $293,830, comps are between 250k and 310k.
8. The seller lives out-of-state and is a Real Estate agent in her home town.
8. What about the possibility of someone not paying, or they just choose to move...how do you plan for that expence early on? It would'nt be such a concern if I already had a positive c/f. How has it been working for you???
Thanks so much keith for any input...this is my first offer.

Rod

Lease Option

southstar's picture

Hey Rod,

Ok, so you want to lease option. Good for you, because I find that most people at DG.com avoid this great wealth building strategy which is so appropriate for today's market. I don't know what your overall plan is for REI, but if your goal is to aquire properties with little or no money down as well as generate cash-flow while preserving equity you can't find a better strategy. Most DG investors don't understand that equity is tax free, and most of these properties come with built in equity---at least thats what attracts me to them. If there's no opportunity for that equity payday I don't even bother. Focus on the 3 profit centers when dealing with your tenant/buyer, 1) The Option Fee/Downpayment, 2) The cash-flow on the monthly payments, 3) The equity when they purchase. Whatever you do, view all your investment plans Holistically.

In general let me just say this: When using lease options protect yourself. Although you can write one out on a napkin (I prefer a roll of paper towel) make sure to record the option properly, and make sure you retain important rights when you structure the option. However, you don't want the terms to be so binding that it is impossible to exercise. Involve an Attorney if you have to, though it's not necessary. Record the option---2 requirements, must be written, and must be signed. Must be a written contract to be effective. This informs the public of a pending sale.

Rights to retain in the contract:
Right to assign.
Right to extend.
Right to sub-lease.
If your contract dosen't include these, add them in an attached Addendum. A good contract will automatically include these. Again, involve an Attorney---keep in mind a lot of Attorneys don't like lease options.

Your questions:
1. You can use whatever form (contract) you want just make sure it includes the rights listed above. Dean includes one here at this site. It looks good although I have not gone through it with a fine tooth comb. Make sure the seller is comfortable with the contract, cause you both will have to negotiate it. Remember you want a win win situation. Now, if you're going to sub-lease, which I'm assuming you are since It's a duplex and you're talking cash-flow, you will need to also sign a contract with your tenant/buyer.

2. No! However, since you are technically purchasing the the property down the road it's only fair to purchase as close to FMV as possible. I typically will do a future value calculation---basically what the property will be valued at in the future. Use your option period (3yr, 5yr) along with what you think the annual appreciation will be to do this---you can get appreciation rates from your realtor, or go to www.neighborhoodscout.com and punch in beautiful Grants Pass. The first place you need to begin is to determine the current value. I'll explain more in question 7.

Future Value Formula: FV = PV(1+i)n.
FV=future value
PV=present value
i=rate of appreciation
n=length of time(your option period)

3. Yes! Unless it's a great deal, and you have other means to make money off the deal, like if you're going to acquire a lot of equity. The right to asasign is your exit strategy. If your tenant/buyer were to bail on you, and you could not find another, or a renter, you could, with the right to assign hand it off to another investor, saving whatever you could. Your only other option would be to wait and exercise your option, and that might be costly. Or, you choose not to exercise the option and walk away---that will be costly. When going into any deal, always have an exit strategy. Lease options offer many. Many buy & hold investors will use lease options as their exit strategy---I do.

4. That will depend on what you're trying to acheive with the lease option. Do you or don't you want to tie up any money long-term. Are you holding for cash-flow, then you would have a longer term. Here is a good rule of thumb---do a shorter term with one or two extension clauses. Like, a 2year option period with a 1year extension. It also depends on your seller and what they will allow. Just remember, a savy seller will make you pay for those extensions, by increasing the monthly payment on the extensions. Remember their goal is to SELL, and they will force your hand if they can---be fair. I personally like a 3 to 5yr period. It gives me plenty of time and options. However, on my end of the deal I will usually buy as soon as I can. If it's a sandwhich lease I wait until my tenant/buyer exercises their option. You could always re-negotiate the contract.

5. First, rent will typically be at the high end of the fair rent values in your area for that kind of property, unless it needs a lot of work, and you put in your contract that you will do the work in exchange for less rent. I typically don't like rent credit, but I would never do more than 30%. I prefer option fee or consideration also known as down payment. Sometimes you could do both. Here's what I like---on the sellers end I would do rent credit and no down, this way you are forking out a little bit of cash each month instead of all upfront. And that monthly extra will come from your tenant/buyer. And it will be applied to your down when you exercise your option. On your tenant/buyer side do the down payment and charge enough rent to cover your rent credit with the seller. The tenant buyer's down payment can be used for another lease option deal(I ask for a percentage typically 3.5% or $5K). If they can't make the entire down upfront, then have them do it in 3 installments. Again there's so many ways to structure this---Remember the option fee/consideration dosen't have to be cash it can be anything of value. If it's a good deal do it.

6. Again, put as little into the deal as posible. If it's a good deal, and it will cash-flow nicely, then do it. Here's what I do---on the sellers end if I have to put $3K down I will make sure on the tenant/buyer side I get $5K this way I net $2K, and I still don't have any money into the deal.

7. I would not put too much stock in zillow or any other of these tools they are notoriously inaccurate. However, it is a good starting point, especially their median sales price for your area and that neighborhood. You're going to have to do it the old fashioned way---boots on the ground. Does it need repairs, no zestimate will tell you that. Begin with nailing down the "estimated" FMV. Sqft cost is what you're after, that drives everything.

Ok, What's it worth!
1. Get 6-9 comps from your realtor, preferably sold comps within the last 6 months, and within 1 mile from your target property. You are going to have a tough time with this one since it's a duplex. You might have to treat it as just one SFR in that neighborhood.

2. Take each comp price and divide it by the total sqft for that home. That will give you cost per sqft. Repeat this for all the comps. Then select the best 6 comps.

3. Throw out the highest and the lowest of the remaining 6 comps (remember you are looking at sqft here). If you can only get 3 comps you'll have to keep all 3.

4. Add the cost per sqft of each of the remaining comps, and divided it by the number of comps you have used---if it's 4 then divide by 4. This will give you the ave. cost per sqft.

5. Finally, take this average cost per sqft(from step 4) and multiply it by the total sqft of the home you are evaluating(duplex). The result is the "estimated" fair market value for your prospective property.

Now, you could take this FMV and use it as a starting point for your negotiations---don't forget to take along your detailed comps from the realtor. Let her know this was a very well thought out number. Also, inspect the property and figure out what repair cost you may have and subtract it from the FMV. Then add in your future value(question 2) and you get a good idea of your purchase price/offer based on the length of your option period.

8. I'm not sure what you're after here, but if you're refering to the tenant/buyer, this goes back to what I was saying in question 5 & 6 on getting the down up front. If they bail on you, you keep the down/option fee/consideration, and of course any rent and rent credit. Protect yourself. Also, when you originate a lease option with your seller(the realtor)make sure you have the title clouded just in case the property starts to appreciates and she decides to sell it---although that would be a breach of contract on her part, it has known to happen. An Attorney can cloud the title for you, so can your title company, or ask your seller(realtor) to have it done as part of your agreement. Have as much protection built into the contract as possible.
Technically speaking she owns the property, but you control it and she cannot legally sell it without your notification since you have an option on it---just add that into the contract. Only deal with ethical people.

Every time I answer one of these emails it always reminds me how vague Dean's books are. They only serve as advertisement for his enterprises to bring in another wave of groupies. Well I hope this helps, and I apologize for it being so long. These are not simple strategies like Dean makes them out to be. Please keep me posted on how it goes and don't hesitate to ask any more questions. I'm interested in seeing what happens.

Best regards,
southstar

Just saw that you're

Just saw that you're online...
Keep up the good work!

southstar,

Joe Jurek's picture

Thanks for beng an active part of the DG website. I enjoy you taking the time to share your comments and insights. It is great when we can share information and learn from others. Continued success and good luck on all your current and future deals! Believe and Achieve! Smiling - Joe

Hi, Southstar!

Tracy Lynn's picture

Thanks for the 'hello' Smiling I noticed that you're in Colorado. My fiance and I have been talking about moving there in about two years. We'd still be close enough to both families (in cali and texas) and we both love winter and snow and you cant get that here in the desert! Sad

You said you would like to hear more about my RE market... I would too!!! Eye-wink

I havent had any luck with finding out much about my own area. I would greatly appreciate some pointers to set me off in the right direction. I post pretty much every move I make in my journal. They're lengthy but if you read them and gave me some insight I would be so grateful.

Again, thank you for the hello and I look forward to hearing more from you soon.