Using Lease Options to Grow Your Profits

Dan Austin: [0:02] Welcome to the Collecting Keys Friday Focus. Hey there. Welcome back to another episode of the Collecting Keys Friday Focus. These are the episodes where Mike or I like to spend a few minutes doing a deep dive on a specific topic or just talk about something that's top of mind for us in our business throughout the week. I will be your host today, investor man Dan, also known by some as Dan Austin. And today, I wanna talk about creative financing, but don't shut it off yet. I know you've probably heard a ton about creative financing so far. I know Mike and I have talked a lot about it. I'm not talking about it on how you acquire a property. I'm talking about on how you sell a property. Because today, in today's market, everyone's talking about like, if you wanna keep buying properties, you gotta go creative, just because interest rates and prices are are both too high at the same time. Well, if you wanna sell a property, you have the exact same problem. You don't wanna have to drop your price just to sell it. So what about selling it creatively? Mike just sold a small portion of his portfolio, going subject to the existing mortgage, and that helped him capture most of the equity he had in those properties, without having to drop his price super loaded to high interest rates.

Dan Austin: [1:06] Well, today I wanna talk about another deal that him and I own together, it's a small little bungalow we're selling, and we're going to sell it on a lease option, also known as a land contract, also known as a rent to own agreement. And the reason why we're doing that, is because we have this on a seller note, and the seller that we bought this from does not want his money back. He wants to keep collecting his monthly payments, even though it's 0% interest, which is actually a sweet deal for us. However, he doesn't want his money back, and it's a break even property for us, we're not cash flowing anything on it, and we want to increase rents, but to do that, we need to renovate the interior unit. And again, we can't refinance, so we would have to park say $20,000 in here, not get our money back. In the long term vision for this, the five year vision, because we actually bought two lots next door to each other, we've since sold the one off. The long term vision here though was, let's build a three bed, two bath rancher on the other half of this lot, because it's a corner lot, so there's two sides of access. Build a three two, and then this one one, this little bungalow becomes the ADU, and we can rent it as a duplex, so it'd be just a cash flow king for us. However, we've kind of pivoted, and we don't wanna wait that long to do this, and so what we'd like to do is get some more money out of this, and increase our cash flow, and offload some of our responsibility of the property to the tenant, so that we can focus on other things. So to do that, that's how we got to the idea of a lease option for a prospective tenant.

Dan Austin: [2:30] So why would an owner wanna do this? Let's talk about that first. An owner wants to do this because one, you retain title to the property, which means you retain your tax benefits, so you can continue to capture depreciation from this property. We're still getting principal paid on our mortgage, that's also a benefit, so we're still leveraging debt. And then, we get to pass off all or most of the expenses to the tenant, right, so all the maintenance expenses, utility expenses. We're gonna keep paying taxes on this, we don't want to put that responsibility on the tenant just because they're gonna pay us more rent anyways, and we're just gonna pay taxes. So we're okay with that. Anyhow, those are just a few reasons of why you would want to do this as an owner. The typical structure, let's dive into that. What is a typical structure now? It's called creative financing for a reason, because there's not a standard way to do this, there's just creative ways, and you can adapt and change however fits your situation or your tenant situation. But fundamentally, what you tend to do is you collect a down payment upfront, which is called a lease option fee, generally speaking. I like to collect as large of a down payment upfront, as large of a option fee upfront as possible, but 10% tends to be pretty standard. If you go 20%, you know, depending on the situation, you could, but you're gonna reduce the amount of folks that you're going to actually be able to advertise this property to. However, I will say if a live buyer is less qualified, you may choose to collect a larger fee upfront.

Dan Austin: [3:53] Then you need to determine what the market rent is for your property, and what a good option fee on top of that is. So if market rent's 1,200, you could rent it for 1,500, and that spread, that $300 that they're paying above market rent, can also be considered an option fee. You can do a few things with that fee. One, you can just collect and say, hey, to retain the option to buy this property, you gotta pay me $300 additional in rent a month. You can also say, hey, I'm going to use this $300 a month towards the principle of the ultimate sale price. So that's a pretty fair way to do it. Or you can come up with some other split, however you wanna do that. I like to use it as an option, as a fee to retain, even though I've collected a fee up front. Sometimes I can collect a good fee upfront, and then also say, hey, instead of collecting this larger fee, I'm going to collect some of it throughout the throughout the year. But I definitely think you gotta collect a fee upfront too. So the next thing you need to do is determine a purchase price. Now you can use today's values, or you can use, you know, the at the end of the option values. It'll just play into what you collect during this option period. But like, I like to choose something kind of in between, where I can kinda where I get like, a really good solid market value for it, or maybe slightly above it, but not like, way out of the ordinary, because I wanna be fair to these people, right? They're good people, and they just are looking for a place to live, and wanna do it creatively for for several reasons.

Dan Austin: [5:14] So once you've once you've done that, once you've determined the down payment fee, once you've determined your monthly fee, and once you've set that sale price, then you just have to figure out what that payoff date is. I like thirty six months, it's not too short, but it's not too long. The last thing you wanna do is have a long contract out there, especially if the relationship with this tenant deteriorates, but not enough for you to evict them, you don't wanna have to be beholden to this option, right? Which is a good point, you could still evict these tenants if they don't obviously follow the rules of the lease and the option, so you're still protected by all tenants, all landlord tenant laws there, as they are as well. So now the next question a lot of people ask us, why would someone do a lease contract? Like, you're talking about collecting a down payment, you're talking about collecting more than rent, and then then they have to do it within a certain period of time. It's not, you know, the most ideal always for them. A lot of times going get an FHA or a 5% down conventional loan is a great deal for them, but they can't sometimes. Right? Sometimes they have bad credit. They went through a divorce, a bankruptcy, or just a bad situation from COVID, like they lost their job, and who knows what could happen. Bad situations, bad luck happens to people all the time, and that's unfortunate, but a bank won't lend to them. Or maybe they're awesome, they have great credit, but they own a business, and they have a really hard time getting a loan, which is the case for a lot of business owners and entrepreneurs. Or maybe they don't like to, or they don't want to, or they don't even know how to use traditional banking. In a lot of different cultures, you know, is a melding pot, there's a lot of cultures out there that don't use traditional financing or traditional bank money, for whatever reason, they just choose not to, or they don't understand it, so they don't see it as an option, so when a lease agreement, a lease option pops up, these are the type of homes that they wanna buy, or the type of lending that they wanna deal with one to one, people to people.

Dan Austin: [7:02] So, and one side note here with all this stuff, I would say, when we're talking about qualifying people, and who is is going to be this person that you're going to ultimately do this lease option with, I think you gotta be able to collect a down payment, and if they can't even raise the three to 5% that they would need for an FHA or conventional loan, regardless of their other qualifications, you probably don't want them, because that means they don't even have enough money to actually own a property. Right? Because when you own a property, there's a lot of different expenses that come with it, like when the furnace goes out, or when you gotta paint the exterior, or you know, caulk around the bathtub. If they don't have money, even just 3% for a down payment, they probably don't have enough money, or enough income to actually maintain your property for you. So I would I would just caution you there. But anyhow, a lot let's be honest here. I wanna talk let's go back to like who you're talking to. Renting, like, I feel like it's gotten a bad rap, especially in the real estate investing world, because we're always like, why would you pay someone else's mortgage? And totally true. That's not great, but like, you hear things like, you know, if you're renting, you know, you're low income, and all these other things, which is definitely not the case for people.

Dan Austin: [8:06] And you know, I own quite a few properties that I love for the wealth creation, but like, I'm down to rent too, like, I don't always love having to worry about my lawn, or worry about how I'm gonna replace the roof on my house, and this and that, you know. So renting is actually a a pretty good gig. And for these folks that you're trying to qualify, don't get kinda turned off by the fact that they want a lease to own, because like I said, they might be a business owner making great money. Mike and I sold a a duplex to a business owner on lease option. He makes 6 figures a year, but because of the way his business works and how he expenses things, he doesn't show enough income to buy a $450,000 asset, which is what we sold him the duplex for, but he had plenty of money for a down payment, he makes plenty of money to pay our monthly lease option, so he's a he's a great person. So just don't, I guess, don't automatically get turned off by the fact that people may not choose or can get qualified for a traditional mortgage. Anyhow, I've blabbered on about lease options, I've probably talked more about it than you really cared to hear, but if you do wanna know more, I do think this is a great option, so hit me up on Instagram, that's investormandan, I'm happy to share with you any of our documents and things that we use. If you wanna learn more about how to acquire properties like Mike and I do, so you can sell them creatively, go ahead and go to the instantinvestorprogram.com, or sorry, instant investor program. If wanna learn more about the instant investor program, go to collectingkeyspodcast.com and select instant investor, the little blue button at the top. And also, we have our store live.

Dan Austin: [9:31] So if you wanna go out there and get that BDE shirt, that Big Dan Energy shirt, go out there. We don't make any money on these. These are just fun for us. We wanna see people wearing our merch, and we think it's pretty cool. You can also get, you know, just regular collecting t shirts out there. But yeah. Anyhow, go there, check them out. Hit me up on Instagram if you have more questions on this. Again, investor man Dan. Other than that, have a great weekend. Thanks for listening to this collecting keys Friday focus. Be sure to subscribe wherever you listen to your podcasts.