Today’s topic will be the use and how to use a Sandwich Lease Option to your investment portfolio. To my knowledge this is the only technique where you are guaranteed a positive cash flow without actual ownership of a home. It doesn’t matter if you are buying in San Francisco or in a medium sized town in the Mid-West.
Over the past 6 years of helping owners find lease option tenant/buyers for their investment homes, I have strongly considered doing a “Sandwich Lease Option” on some of these homes. Let me begin by explaining the basics of a lease option and then the sandwich variety.
When a buyer wants to do a lease option with an owner the buyer is ideally saying he wants to buy the rights to buy a home at some later time frame (i.e., do a lease with the option to buy). This is not a transference of ownership; it is merely buying the rights to buy within a time frame, much like options in the stock market.
When this buyer does a lease option with an owner then the buyer has to provide some form of consideration (usually in the form of money) and a contract is drawn up between the two parties. Frequently there will be a monthly rent credit paid out of each of the monthly rental payments. This credit is considered an incentive for the buyer to buy.
The term of the contract is open to whatever terms the two parties will want but is often set on annual terms. In strong appreciating real estate markets the term can be one year or less and weaker non-appreciating markets the terms can be two to three years or longer.
Prices can be negotiated within an infinite number of ways. The most common is to set a specific price and that is the price. The second way is to set it at some appraised value (or appraised value minus some percentage discount) in the future. Either method or a combination of the two can be desired. A combination would be at an appraised value with a minimum or maximum value also placed into the pricing terms.
Thus, as you can quickly see there are a lot of variables when doing this rent-to-own process. Adding in a Sandwich Option takes everything stated above and then doubling the complication.
In a sandwich lease option there is an additional investor thrown into the mix as a forced middleman. This investor not only does a lease option with the owner of the home, but he also does a second concurrent lease option with a tenant/buyer. Of course the first option must allow for assignments or subleasing.
This is how it works. The investor goes into contract with an owner with very specific set of terms. These terms will include: 1.) A set purchase price; 2.) A set timeframe which is as long as possible; 3.) A set amount to be paid monthly; 4.) The best rental credit she can get; and 5.) The lowest option payment possible.
Then the investor enters into a similar agreement with the end user (tenant/buyer). Except in this case she is doing the exact opposite terms as she had with the owner. This means the tenant/buyer gets terms that are not as favorable as she made with the owner. The reason for this is that the difference is where the investor makes her profit.
Thus, in relation to the terms with the investor the end user’s terms are:
1.) A set purchase price – but higher than what the investor agreed upon with owner.
2.) A set time frame but shorter than with the owner. This way the investor can have time to find the end user or another client if the first tenant/buyer does not exercise their option.
3.) A monthly payment. This can be set $100+ higher than what the investor has with the owner.
4.) The rental credit needs to be equal to or less than what the investor has with the owner. This term will greatly depend upon the aforementioned monthly payment. Ideally, the rent credit should be less.
5.) The highest option payment the investor can get from the tenant/buyer. This is how the investor gets reimbursed for her option payment and where she can make some initial profit
Obviously, the terms will widely vary depending upon the part of the country the home resides. Monthly rents and purchases prices in Mississippi will not compare to Hawaii or California.
Let’s show a basic Las Vegas, NV deal.
Terms between Owner and Investor
- Set Purchase Price: $145,000
- Option Payment: $3,000
- Monthly Payment: $1,100
- Rental Credit: $200
- Length of Contract: 3 years
Terms between Investor and Tenant/Buyer
- Set Purchase Price: $155,000
- Option Payment: $4,000
- Monthly Payment: $1,200
- Rental Credit: $150
- Length of Contract: 18 months or 1.5 years.
Assuming the Investor is savvy and finds a tenant/buyer prior to actually initiating the contract with the owner then this is how the cash flows at the time the contracts are signed.
Tenant/Buyer pays $4,000 to Investor which pays $3,000 to Owner and pockets the $1,000 difference.
First month rental payment collected from Tenant/Buyer is $1200 and Investor pays $1100 to owner. This will continue for the next 18 months. I would suggest only giving the tenant/buyer a 3 day grace period while the Investor has a 5 day grace period with the owner.
If the tenant/buyer does not buy after the 18 months and decides to vacate then the investor can either find another tenant/buyer for the remaining 18 months or less. OR the investor can cancel the deal and walk away. Assuming the latter case then the investor made $1000 + 18 * $100 = $1000 + $1800 = $2800 on a property she never owned.
If the tenant/buyer were to buy in this case at the 18th month then the investor made:
$1000 credit on the option payment + 18 monthly payments cash flow of $100 per month + 18 months of $50 difference in the saved rental credit + $10,000 on the price difference. This becomes $1000 + 18 * $100 + 18 * $50 + $10,000 = $1000 + $1800 + $900 + $10,000 = $13,700. Not bad for never owning a property.
The dangers of a sandwich option comes mainly during the vacancy periods. If your first tenant/buyer vacates how quickly can you get the second one in there? Granted, you will be getting a second full option payment which you keep for yourself. What if it takes 3 months for you to do so. In the above scenario you paid three monthly payments of $1100 to the owner and thus paid out $3300 to get the second $4000 option payment. This means you only received $700 and you still have to credit the full $4000 if they were to buy. This can be dangerous if the new tenant/buyer exercises early.
If you are wanting to get into an unique method to invest in real estate with no money out of pocket and a guaranteed positive cash flow then the sandwich option may be your ticket. Make sure you know your numbers, though. Happy Investing!
Kevin A. Dunlap
Trident Investments Group
Office: (702) 516-5698
Cellular: (702) 591-1784
Kevin is a real estate investor for 8 years with specialties in lease options, creative investing, apartment complexes, and buying outside your region of residence. He has operated over 4 investment companies over this time and is currently residing in Las Vegas, NV.
Article Source: http://EzineArticles.com/3721390