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A Walk through a Lease-Option Deal

How do you find good lease-option deals? What’s the best source?
Look under Properties for Rent in the local newspaper. Every landlord
or landlady who is renting properties has major complaints. They say,
“Tenants bug me; repairs, repairs, repairs; it’s a lot of work; there are
lots of headaches.” They rent properties for $1,000 a month but never
make $1,000 a month because they’ve got to spend a lot of time and
money fixing them up. They might be empty right now because the last
tenants ran out on them. It’s frustrating. Anyone in the landlord business
has plenty of problems, headaches, and repair expenses.
If you could get them out of the repair business—and could ensure that
they receive their checks on time every month so they can go on vacation—
would they be interested in talking with you? Definitely.
Start by talking with them and finding their pain. Ask questions. How
long have they had the property? How’s the rental going? What do they
rent it for? What have the repairs cost over the years? If you found the
landlord through a For Rent ad, then the property is empty. If so, you’d
ask these questions: How long has it been empty? One month? Two months? Three months? Last year, how often was it empty? What were
the repairs? Have they enjoyed being a landlord or landlady or manager?
Have they had any problems? What don’t they like about it? What
would they change about it?
Then work the numbers for the landlords you talk with and show them
a solution in writing. For example, it they rent a property for $1,000 a
month but it’s been empty for two months, that means they’re not collecting
the full $1,000—they’re really collecting about $700 prorated
over the year. How much did they spend on maintenance and repairs?
Say they spent $1,000 cleaning it and painting it. That means they’re
not making even $700 a month; they’re making only $600 a month.
Work the numbers backward, both annually and monthly, for the past
two or three years. Then ask them how much time they spend working
on or worrying about the property. They might say about four hours a

month—they had to drive over there and fix the commode. Is their time
worth $10 an hour, $30 an hour, $50 an hour? Now the income isn’t
even $600 a month; it’s $500 a month. Show them that, with all the
work, all the headaches, all the problems, all the bills, they’re really making
only $500 a month as landlords.
Work the numbers. Say that landlord is making only $500 a month, and
the market rent is about $1,000 (which you verified by calling some
other property managers and landlords). Ask this question: “Mr.
Landlord, if I could get you out of the repair business and get your
money to you every time, what’s the least amount you’d take per
month?”
“Well, I rent it for $1,000, but it’s clear I’m making a lot less than that.”
Okay, you negotiate, negotiate, negotiate. Let Mr. Landlord speak first,
but mentally know your ceiling price—the top price you’re willing to
offer. Maybe it’s $650, maybe even $700, because you know you can
rent it for at least $1,000.
Let’s say your negotiations are weak and he insists on $700, that’s it.
You lease it from him for five years for $700 a month. That effectively
locks in the rent amount for five years, too. Maybe you can lock it in for
10 years, even 20 years.
Now ask the least amount he’d take to sell this property, because you’d
like to make an offer to buy it. Let’s say you think the house is worth
$100,000 and he responds to that question by saying, “I just had an
appraisal. It’s worth about $100,000.” Because you’re both investors,
he might say, “I know you’re going to make a lot of money, I’ll sell it to you for $88,500.” Well, that’s not a good deal; it’s is a bad deal because
it’s only 12 percent below what it’s worth.
This could be a dangerous deal, but let me show you why it may not be
such a bad deal. You could continue the negotiations by saying, “Mr.
Landlord, if I pay you $700 a month, give me $150 a month credit
toward the purchase price. That way, every month you make a payment,
you get a bit of equity buildup or debt payoff, just as you would if you
had bought it and borrowed the money.” Also remind him how much
the little repairs drove him crazy—the broken sinks and commodes and
all that (which tend to be 70 or 80 percent of the repairs). You’ll take
responsibility for those repairs off his shoulders; the landlord will still be
responsible for the big repairs, anything over $500 or maybe $1,000 or
maybe $300—whatever you can negotiate.
In cases like this, landlords will ask for money down. Every property
needs repairs, so let’s say there are $3,000 worth of repairs. We’ll get
that taken care of, so instead of giving them $3,000 option money,
you’ll do the repairs. Who’s really going to do the repairs? Your end
buyer, not you; you are out of the repair business. You’ve gotten a landlord
out of the small-repairs business. You have a five-year option to buy
the property for $88,000, and it’s worth $100,000. Horrible deal, $150
a month credit. Protect yourself: The question in your mind is, what if I
can’t rent this or sell it quickly? You’re stuck. The property is currently
empty, so negotiate delaying the first payment for 90 days or 100 days.
What if they don’t go for that? Try 60 days. What if they don’t go for
that? Try 30 days. Make a business decision.
Disclose everything you do in writing. Tell them you’re a real estate
investor—that you don’t represent them or their interests, that this offer is based on your being able to remarket the property in the next 60 or
90 days. If you can’t rent it in 60 days because the market is terrible and
the house is horrible and you made a big mistake, you walk away.
They’re not any worse off, it’s empty anyway—they’re not making any
money. Not everyone will agree to that disclaimer or contingency, but
you’ll get it most of the time if you ask properly.
Let’s say you have 60 days. They signed a lease for five years at $700 a
month, giving $150 a month credit, and you also have an option to buy
it for $88,000 within the next five years, with some of the rent going to
knock down that purchase price. How much money do you put down?
Zero. How much money have you borrowed? Zero. How many contractors
have you hired? Zero.
Clean up the yard and give the house a coat of paint to make it marketable.
Then run an ad in the paper: “Easy qualifying, become a homeowner,
stop throwing your rent dollars away, no banks involved, won’t
last.” Create a sense of urgency. Have a voice mail people can call that
describes all the attributes of the house. You think the house is worth
$100,000. You think the market rent is $1,000 because you’ve done
research—gotten comps and verified figures with property managers.
Your phone might ring off the hook because now you can sell a house
with easy qualifying.
The first responders call and say they’d like to buy this house; they’re
familiar with the neighborhood. The number one qualifying question to
ask a potential lease-option candidate is this: “How much money do
you have to put down?” Ask additional questions like these: “Do you
have anything to sell? Any tax refunds coming? Any other sources of funds?” People often don’t think about some of these things. Tell them
you might get back to them and put their information in a file.
The second responders call and say they’re looking to buy a house, but
they don’t think they can qualify. They don’t have a big down payment,
they have only $6,000. You can screen them over the phone.
Do a credit and criminal background check on everybody. Also screen
them by sending them to your mortgage company and getting them prequalified.
Explain how your home-ownership program works: They
don’t have to have perfect credit. They don’t have to have a big down
payment. But you need to check them out. Sometimes the mortgage
company calls back and says your candidates are prequalified. Say the
mortgage company has a 95 percent loan program for them, and they
have enough of a down payment to proceed.
How much are you selling the house for? You thought it was worth
$100,000. What’s the actual difference if they pay $105,000 or
$109,000 for 30 years at 7 percent? About $8 or $10 a month. So you
write a contract for $107,000, in which they pay all the closing costs
and fork over $6,000 as a down payment. They’re happy. They didn’t
think they could buy a home, and you showed them how. Now you’re
ready to close.

Call the original seller. He wanted $88,000 but you can renegotiate
that amount. As of now, $107,000 minus $88,000 means $19,000
profit in your pocket. And you already have $6,000 in option money.
So you’ve received $6,000 plus $19,000 and you’ll make another
$13,000 at closing.

How would you like some extra money? Call up the original sellers and
say, “Hey, I have five years.” Always count it out, 2003, 2004, 2005,
2006, 2007. You’ll give them $88,000 in five years; however, you’re
paying off some of the loan as you go, so it won’t even be that much.
Ask this question: “Would you like the money sooner?” They might say
yes. If they receive the cash in the next 30 days, they tell you, they’d take
a vacation, pay off bills, and so on. Great. Next ask them, “If you get
that cold hard cash in your hands in the next 30 days, what’s the least
amount you’d take?” If they say $87,000, what do you say then? “Can
you do any better?” If they won’t, you agree to $87,000. You go to closing
and sell it for $107,000. You just made $20,000 on a bad deal that
you put no money into because you learned how to lease-option and do
credit financing. You learned how to hustle, market, and take action.