I recently read a great real estate investing book that I highly recommend. It’s called Buy Low, Rent Smart, Sell High, by Scott Frank and Andy Heller. Before we get to the book, let’s talk about the lease-purchase.
A lease-purchase agreement is nothing more than a rental agreement that gives the tenant an option to purchase the home at a set price during the term of the lease. A typical lease-purchase agreement has the following terms:
- 2-3 year rental term
- An agreed upon purchase price
- An upfront non-refundable option fee the tenant pays (which usually goes to the purchase price if the tenant exercises the option)
- A monthly rent credit the tenant can apply to the purchase price if they buy the property
Of the four single-family rental units I own, one of them is set up as a lease purchase, and it is always my preference to get a lease-purchase tenant in the home rather than just a renter.
Now, back to the book
Unlike so many real estate investing books, this one doesn’t promise to make you a multi-millionaire in six months with no money down. It soberly walks through how to get started investing in real estate, setting up a real estate team (which is critical), finding good homes, obtaining finance, marketing your home, and so on. But what really sets this book apart is its discussion of the lease-purchase, which is the focus for the authors.
One of the great things about a lease-purchase as outlined in the book is that if done right, it can really be a good deal for both the landlord and the tenant. Here are some of the key points:
- The purchase price should be locked in for the length of the agreement:
I’ve heard from some tenants that in their previous lease-purchase experience, the purchase price was left open. That’s bad for both parties as it invites uncertainty, and is just awful for the tenant. The whole point of the option fee is to pay to lock in the price.
- The option fee should be reasonable:
This is another one where tenants tell me they’ve paid huge option fees upfront. I always wonder why. As a rule of thumb, we charge 1% of the established purchase price, and apply the fee to the purchase if and when the tenant exercises the option.
- The rent credit (or applied rent) should be fair:
The rent credit is an important part of the deal. Many lease-purchase tenants enter into the agreement because their credit history doesn’t enable them to buy now. What they need is a way to save for a down payment, and the rent credit earned each month the rent is paid helps them do that. A credit of just $150/month adds up to $5,400 over a three year lease term. As a rule of thumb, we set the rent credit at 10% of the rent.
Other Benefits of the Lease-Purchase
The lease-purchase has several additional benefits. First, tenants tend to take better care of the home, because they view it as their home. Second, the option fee provides a nice source of upfront money. Third, if the tenant does exercise the option, it enables you to sell the home without the costs of a traditional listing.
I should add that even if you don’t plan to use the lease-purchase strategy, the book is still worth a read as it covers many topics that apply to all landlords.
Let me know what you think of the book, and if you’ve used the lease-purchase strategy before, how did it work out for you?