Episode 51: Lease Option – Case Study

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Show Notes

Welcome to the Discount Property Investor Podcast. In this episode is going to be an awesome episode, it is going to be a case study on a property we recently just purchased.

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David: Alright guys, welcome back to the Discount Property Investor podcast; this is your host David Dodge joined by co-host Mike Slane. Hey Mike!

Mike: Hey Dave, hey everybody welcome to the show, glad you guys are joining us. We always like to invite people if it is your first time listening to check out our free wholesale course. There we put together a complete course on how to wholesale real estate. So if you have never done it or even if you have, we have got a whole bunch of great information out there. We have got a contract, joint venture agreement. Again, anything you are going to need to wholesale; we put together a great starting point for anyone to get started. So freewholesalecourse.com, please feel free to check that out and give us some feedback. We always like to hear people’s feedback on that course. So far we have had nothing but thumbs up so… let us know. So Dave, what are you going to talk about today, man? What’s going on?

David: We are going to talk about a case study today. So today is going to be an awesome episode, it is going to be a case study on a property we recently just purchased… we had a really awesome exit on this particular property, we leased optioned it to a tenant buyer. We are going to talk about how we found the property, what we paid for the property, then how we designed our exit on this particular property. So exit may be the wrong word because we are holding the property; it is a buy and hold investment. However, we lease optioned it so we have a tenant buyer in place.

Mike: I like to call it the exit still.

David: You have a tenant buyer in place and the main thing is it limits us from having to manage it.

Mike: Here is why I call it an exit… flipping or renting or wholesaling; you are always exiting it, it’s just the speed with which you get paid.

David: That’s a great point.

Mike: So the way I look at it is, the wholesales are the quickest way to get cash. The flip… actually doing some rehab work on it, it’s a little bit slower, but again a bigger profit. The rental is a much slower pay… but you can make a lot of good money on that as well has a lot of tax advantages. So… yeah you are just getting paid slower. Let’s dive in, Dave. I didn’t mean to digress again.

David: You’re fine.

Mike: So what is the property we’re talking about?

David: That is a great question, Mike.

Mike: Do you remember the address? You know more about the purchase than I do. Do you want to talk about where we found the lead and how we ended up getting the property under contract?

David: That’s a great question; let me pull it up real quick. We do so many deals I get confused…

Mike: Do you want me to refresh your memory? It was [00:03:28.01 – inaudible].

David: This particular property was purchased through one of our good buddies here in St Louis; he purchases properties at the auction. He bought this… it was a foreclosure so he bought this at the foreclosure auction… people say at the Court house steps… but in this particular auction it was inside a building. It is a live auction he is with a couple of other investors in there… auctions are great; the only downside to the auction is you have to have cash available that day or within 24 hours. Brad called us and said, hey I got a pretty good deal on a property… North County property. This is what… we think we can get the property for.

Mike: So the auctions are… here in St Louis anyways it is kind of an insider’s game. So Brad is pretty good friends with Dave… and when Brad finds a good property… he will let us know and ask if we are interested. He will basically buy it and we will pay him a fee. It is basically just a relationship we have with people. This lead is basically referral to Dave, because Dave is good buddies with Brad and… we are able to pick up some of his good deals, or his great deals at pretty good prices so… it is not really a slam dunk wholesale… it really would have been even if we bought it from Brad… or if he closed it we would wholesale it and send it out to our buyers list. We would have still made money on it. So referral, it’s another… a lot of your networking, it’s a great way to get leads. So this one came to us through one of the auctions, a good buddy of Dave’s… anyway Dave go ahead.

David: Yeah sure. This particular property is up in North County St Louis, in a good area. Four bed, two and a half bath property. Approximately 1500 square foot. So the property has an assessment of about 100,000, it was 97,000 from looking at it online, built in 1964 so it’s a good property. Four bed two and a half bath… is a really great property when it comes to renting. The rent estimate on this property was $1200 a month. We bought this property off of Brad… we essentially JV’ed with him. He bought it, he used our funds and then we were going to wholesale, that was our initial exit; it was a House Sold Easy purchase with a joint venture with Brad. We were going to wholesale it and just split this property 50:50. So if we were to make 10,000 on the property, we paid brad five and we would have kept five and… paid ourselves back and so on and so forth.
So after we actually purchased the property and secured the property and were able to get in the property… because that is one of the things about the auctions is that you are not always able to get into the properties, they don’t have lockboxes. Once we actually got the property paid for, we owned it, we secure it; we realised this was a pretty good property. We could wholesale it and make a good chunk of change, or we could just buy Brad out and keep it as a company holding. Our company is starting to buy a few properties each and every month to add to our portfolio so we can make some passive income, so we are not always wholesaling. But that is the nature of our business is wholesaling. Long story short we decided it was going to be a good property for us to buy and hold, let’s keep it, we contact Brad and we told him we think we might be able to wholesale this for… roughly 10,000. Would you be okay if we gave your $5000, no expanses to… cancel or end our joint venture agreement? So essentially we are buying Brad out of the deal. He said, yeah that’s great, no problem. So Brad did… he did most of the due diligence but he had none of his own money invested. We gave him five grand and he was off the deal. He was happy, we were happy, we got a deal and he got paid. We decided we were going to keep this property. So what we did was we fixed the property up a little bit. Not sure exactly how much we spent, Mike. Any idea? Maybe five or six grand? Something like that.

Mike: On the rehab on this one?

David: Yeah.

Mike: I couldn’t tell you the exact budget; I think it was closer to eight. Because we did a lot in the basement so… Dave and I walked out the property, talk about that. This is a great property. David mentioned it is in North County, so good little rental area. We walked it… it needed very little work
to get really rent ready. The upstairs was in great condition, it has got a two car garage with… I don’t even know what you call it; it has a garage door on the back of the garage as well. I just think it is really neat because you can pull your lawn tracker through or whatever. Great big back yard, basement that was semi finished. But the reason I am talking about this is because the basement needed a little bit of work to make it really feel like a new finished basement that you would want to throw a bedroom down in. So we put in flooring, cleaned it up, got it painted, it just looks really clean now, really good basement for a bonus bedroom essentially. There is a bathroom down there but I don’t think there is an egress so… I think it was about 8000 all in on our rehab on that one.

David: Perfect, so… with this particular property we actually… we were going to re-finance it; so we paid in cash. Again when you buy at the auction you have to pay cash right then and there. Our business has a line of credit that we use to purchase most of our properties. We get leverage on some of them, some of them we don’t. On this particular property we were 100% into it for cash, we didn’t have any debt, we didn’t have any leverage. It was cash that we had purchased the property with and it was cash we used to pay Brad his wholesale fee, finder’s fee, whatever you would like to call it. We spent another $8000 getting it rent ready, call it a rehab, call it a make ready, call it whatever you want. But essentially we spent about $8,000 to get an occupancy inspection pass. The inspector came out two or three times, couple of things here and there each time. We got all that stuff done and we got the occupancy inspection. So we actually marketing this property as a rental. I am not sure… at the same time as marketing it as a rental; we were in the process of re-financing it with our bankers. I am not sure exactly what the bankers came back with in terms of… the amount we were going to be able to re-finance it for, but… we had an individual contact us asking if we were interested in lease optioning this property, they would like to buy it; however they can’t get approved for a loan today… but they are willing to put down an option deposit and pay rent. I think he signed a 24 month lease on this particular property. But essentially they said… we want to buy it, we are going to give you a deposit down which is your option deposit; that deposit is non refundable. Then they are going to pay us rent for 24 months, at anytime from the day we sign that lease in the 24 month period to when it ends, they can exercise their option. That’s what it means… they can say we are going to buy this property for what we agreed upon on day one. The option deposit we received on this particular property was quite high. Mike, do you remember the number?

Mike: Yeah it was $24,000.

David: $24,000 wow that’s awesome. So they gave us an option deposit. That is a non-refundable deposit folks of $24,000. Then they are going to be paying us monthly rent… monthly rent in this scenario does not cash flow a ton. I think it is a bit over break even, which we like to cash flow it 2-3-4-500 dollars a month, just depends on the area and how much the option deposit is, what we are into the property, a couple of different factors. But in this particular scenario we are not cash flowing a ton; I think it is close to break even. However, we will profit on the sale at the end. So typically with these lease option type of deals you can make money in three ways. You can make money on the option deposit, you can cash flow each and every month on the rent, you amount you collect versus the amount you have to pay your note, your loan, your lender. Three, you can make money on the exit; whenever you sell the property because you are collecting more money than you paid for the property or what you owe on the property. In this scenario like I said; we have got 24,000 up front on the option deposit that is non-refundable. We are not making much on the cash flow, call it the break even. But we will get paid an additional 15-20,000 on the back end of this property when it sells. So essentially what we did was… we marketed the property up, so that way we could get the option deposit and still make money on the exit. So I can’t remember what we paid for this property; I think it was around 65,000 I believe. Then we paid Brad 5000 to exit the deal, is that right Mike?

Mike: That sounds close; I thought it was 57,000 plus the 5000. I thought we were…

David: Let’s call it 57. We are not exactly sure.

Mike: Something like that.

David: I will have to look at my notes here but… 57,000 plus the 5 puts us at 62.

Mike: Uh huh.

David: And then we put the property out there… I believe it was like 100 or 110 as a lease option. Now with a lease option… we typically try to sell the property at retail; you can even go a little bit above retail sometimes because you get to factor in the time value of money and the time that it is going to take them to purchase that property. So if retail price today was say 90-95… in 24 months… that is assuming they didn’t exercise their option until the end of the lease… with the way that market is going that property would have been worth 100 or 105 or 110, so on and so far. It sort of varies on your neighbourhood and market and area. So in this particular scenario we determined that the retail value of the property in 24 months was a little bit higher than retail would have been today. The option deposit, again that is non-refundable, I have said that several times now, is actually taken off the amount they would have to pay ar the end. So on this particular property… we sold it for maybe 110, is that right Mike?

Mike: Yeah a little bit more than that.

David: A little bit more than that even?

Mike: Yeah.

David: Let’s just call it 110. What do you think it was?

Mike: I think it was 124.

David: Was it that high?

Mike: Yeah.

David: Cool. Let’s go with that number then.

Mike: I wasn’t trying to make you look wrong.

David: No… I don’t have my laptop in front of me here.

Mike: No worries man, i am just teasing you.

David: No, you’re good. So 124, they paid the 24 right there. So essentially at closing… in 24 months they are going to have to pay us 100,000. We are only in it for 72 so we are going to make another 26-27 thousand after closing costs and any additional fees for the sewer or the trash. Anything along those lines we have… insurance, taxes. So in this particular case you can always negotiate who is paying insurance? Who is paying taxes? I believe we are paying those for 24 months. But that is still a huge win for us to get paid on the front end, then again on the back end. Now everyone has got it on their minds for sure; what happens if they don’t exercise that option? Between now and the end of the 24 months. Well there is two scenarios, really there is three scenarios. One, we can renew and say we will get them another 12 or 24 or even 36 months, but we need more option deposit. Again this is non-refundable… and it will go towards the purchase. But we need another 5-10-15-20 thousand dollars in order for us to give you this option. Another scenario is we can just continue renting to them and they will lose that option. If they don’t exercise it then that option deposit is gone, but they can stay and keep renting. Another option is they decide they do not want to purchase the property anymore. Then we part ways, they move out and we clean it up and we do it all over again. We rent it or we decide to sell it on a lease option, collect another option deposit and do it all over again. So one thing I do want to mention is the goal with this property wasn’t even the lease option, it kind of fell into it. We were just trying to rent it and somebody came to us and said hey, I want to rent it… but I also want to buy it, I can’t buy today, I want to buy it later, but I want to move in today, I want to rent it. That is just what we decided to come up with, let’s do the lease option on it. One really crazy statistic is 82% of the United States population… can’t get a loan to buy a house. 82%… what do you think about that Mike?

Mike: It’s crazy.

David: It’s a big number.

Mike: Yeah it’s crazy.

David: 82%… so lease option is a really great exit strategy because it allows people to have pride in home ownership… without actually having to go to the bank to get that loan; if it is a credit issue they have 24 months in this scenario to fix their credit. If it’s an issue with income, they have 24 months in this scenario to increase their income. Whatever the banks are telling them that they need to do or fix or… whatever they need to do in order to get approval for this loan; they have 24 months to do so. So we make it very clear to them that… we want them to buy this house. But if they don’t exercise that option… it is not like we are really going to be that upset because we didn’t want to sell it in the first place, we wanted to own it as a rental. So either way… either scenario that comes to play here; we are going to be okay with. Another crazy statistic is that… roughly 15-20% of… lease options… this is a nationwide statistic… actually have the option executed… 15-20%. So you have 82% of the US population that can’t get approval for a loan and you have 15-20% of the people that decide… after they get into a lease option scenario, that they are actually going to purchase that property, AKA exercise their option. So with those statistics, facts and numbers being presented… we want them to buy this property. The goal is for them to take the possession of this property, we want them to be a home owner, we want them to be happy. But it is only a 15-20% chance that they will. In this scenario if they don’t exercise… we will probably just re-new and say give us another option deposit and you have another 24 months.

Mike: And so… when we re-new though… if they are unable to exercise the option, not willing to at that point; we can even adjust the price at that point.

David: Right.

Mike: That option has expired so… say the market goes up… and that property is now worth 150,000 we could say okay, you gave us a one option, you can exercise now… for another $10,000 we will renew the option, the credits will still apply, but the new purchase price in two years will be $150,000, or 155, or whatever we call it, to make up… for that appreciation that occurred over the time during the previous lease option. So there are so many neat ways to do it and… probably one of our favourite episodes we recorded with Jimmy and Bob from Joint Op properties, check out Liqueur and Lease options. That episode… I know we had a great time talking with them… their whole business is based on this… it is a really interesting technique for kind of being a landlord but not being a landlord.

David: Yeah absolutely. We love lease options… and we are going to start doing more of them.

Mike: We are definitely more interested in them.

David: Right.

Mike: I mean you hear about it and it’s neat, but once we are actually doing a couple of them… it really is a much more appealing way to go about… holding rentals.

David: Right. So one of the things I do want to highlight on this particular case study is… well a couple of the main points. One is we didn’t really have this exist as our… strategy going into it; we were just going to re-finance the property and just rent it. The lease option presented itself to us. We are always open to creative way to do deals; in this particular scenario it was a much higher profiting deal for us… we decided let’s pivot and do a lease option. Now typically on properties that we buy hold, do small rehabs or even larger rehabs and rent… we typically try to re-finance and… we have coaching students that we teach… if you buy right… in the outro of the podcast it states ‘you make your money when you buy, you get paid when you sell’. If you buy right… you can re-finance the property and have a tenant in place, and you can get most of your money back. Not always all… it just depends, but in this scenario we were going to get 95% of our money back… after we re-financed it… rented it and re-financed it. Well after the lease option deposit, the option deposit; we actually got… if you consider the re-finance plus the option deposit, we got over 100% of our money back on this particular deal because… add the re-finance amount which is 90-95% because you buy right, then you add the additional 24,000… we will actually take possession of the property, get a tenant in place and get 100 plus… again is it is 100 plus percent of our money back… so now we own an asset that is bringing in money, then when we go to sell that particular property we will get paid again; another $25-30,000.  So awesome case study… we are going to do more and more of these. But it just goes to show you that there is definitely lots of different ways to do deals… sometimes you have to pivot. Mike, do you want to add anything to that?

Mike: I got enough, I am really excited about… again holding our rentals, then the lease option strategy. I really do… I think I said it just before this; it is really neat way to hold rentals that… it is really a win:win. Again, I think we have mentioned in the past we are all about win:win stuff. This is a way that we can rent a property, give someone the feeling of home ownership or purchasing that property, that wouldn’t normally be able to purchase it, and potentially buy that property. So it cuts down on our maintenance cost, gives them that home ownership feeling and the ability to hopefully buy that property in a couple of years… again, I think it is just a win:win way to invest and… really excited about it.

David: Absolutely.

Mike: I encourage you guys are in that position and able to start building your rental portfolio to consider lease options.

David: Right. One thing I am going t do with this particular case study is I am going to put it up in a short little video as well, and we will post it to the Discount Property Investor Facebook page. So if you are listening to this podcast and you want to learn more about this particular case study; check out the Discount Property Investor Facebook group or page. You can learn more about it at that point in time. That’s about all we got on this particular case study guys. Mike, do you have a quote for us by chance?

Mike: I don’t… my computer just froze up here.

David: No problem.

Mike: So I think you mentioned the quote we have every time…

David: … you get paid when you sell so… that means pivoting, pivot. Thanks guys.

Mike: Thanks for listening.

Thanks for Listening

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