Lease Option

rodimus

rodimus

Hi all,

I have a house that I built 4 years ago for 190,000 including land.

It is worth about 260,000 - 270,000 now. I calculated the capital growth is about 18,500 per year increase.

I owe 170,000 to the bank, paying $1200 per month at 6.7%.

I want to do a lease option.

1) How do I set the sale price for 3 - 4 years down the track? Say if we have a lease option for 4 years, and depending on WHEN the tenant exercises the option, the house market price is different at different years. Say if the tenant exercises the option at year 2, should the purchase price still be based on the 4 year projection? Or have different price level for different time of exercise?

2) How much rent should I charge above market to make sure I don't fall short. I just realize that I am actually giving the tenant/buyer a loan, since I am paying the mortgage to the bank still. So I shouldn't just charge them a little bit above the market rent price which would mean I could be losing out. ALso I still have to be paying the council rates, water rates, park rates, etc.

3) Also, if they have no deposit whatsoever, should I charge more rent per week to cover it?

The area's current rent for 3 bedroom houses is around $300- 330.

Has anyone done lease options before? PLease give me some guidance, thanks v much.
 
Why do you want to lease option?

Your property would be cashflow positive anyway.

I've done a few, but would never do one again as you end up giving away too much.
 
Seems like a lot of effort for little gain. First thing I'd do if I were you is to review that interest rate because 6.7% sounds high for residential.
 
Hi ,
I am considering doing this because I need the extra cash flow to enable me to get more loan, also extra cash each week is good right?
Also means I got a tenant who takes good care of the property n will buy from me without me paying agents .

If I charge $450 pw rent, is that too low?
Should I go to $500+ pw?

The property is slightly negative geared because I have to pay rates and there is a land strata to pay because the road was built by the developer not council.
 
Hi,

I don't try to predict the market price and capital growth in the market as some markets can be flat for years and then the buyer could not benefit whatsoever, I'd suggest you look at what your trying to achieve on the home by selling it in this manner and what you think someone would be prepared to pay for the opportunity to not settle in full now. You could even put it out there and see what offers you get. If its your first transaction in this manner perhaps team up with someone experienced but the positive cash flow works well if your trying to rebalance a portfolio. It's not for everyone's investing methodology but for me this far outweighed being a landlord with standard rentals to the point that I converted all my negative geared houses to rent to buy arrangements over the last few years. Negative gearing ties you to your day job more and more whilst positive cash low investing releases you from your day job more and more and lease options are one way of creating that in a house you would otherwise not be able to do it with.

Cheers
Sheree
 
P.s. never never never allow someone to move in on rent to buy or vendor terms sales of any sort without some up front money before they get the keys.... Never never never... :)
 
I agree with Sheree, i.e. never, ever let a vendor finance buyer into your property with no up front money.

Also, I notice you're in Melbourne. If the property you're thinking of selling is in Victoria be aware that Stamp Duty is payable on Lease/Options in Victoria, when they are setup. With vendor finance Instalment Contracts in Victoria, Stamp Duty is not payable until Title transfers (usually some years down the road). That's why Instalment Contracts have become a lot more popular in Victoria of late.

For us, we still believe that our long term wealth is the equity we have in real estate. This has caused us to develop our business model so the cash flow from our vendor financed properties supports our buy and hold portfolio and our lifestyle. Just another idea ;-)

We usually charge a premium of around 7% above market for our VF properties.

Some people work out what the cash flow would be if the VF buyer's interest rate was 2% above yours. This is one way of setting the amount of positive cash flow.

Cheers, Paul
 
Good point Paul on the stamp duties, IC's are the way to go in Melbs thats for sure. And yes you need to put that cashflow to work somewhere... we all have our preferences on where I suppose.

Paul, did you mean you do 7% on top of the standard rate, or your doing 7% as the full interest rate in the current market? Most of our IC's around the 7%'s for our houses atm... I'm sure you meant the latter...? lol

Cheers
Sheree
 
Hi sheree and lofty

Thanks for your advice!
How much deposit do u ask for as a minimum standard? Most people say they have only about $2000 they can put in.

Lofty when you said 7% premium above market value, do u mean if my house is valued at say 280k now I should set the option exercise price at 7% above the present value? What if the buyer exercises the option 3 years later won't you be losing out on another 21%? Can we do increment sale price as each year passes , depending on which year they exercise.
 
Sorry, I should have been a bit clearer. My reference to 7% was in answer to the original question, 'How do I set the sale price for 3 - 4 years down the track?', i.e. we mark-up our VF purchase price about 7% above market.

In relation to the article on Stamp Duty, it's a Qld based article. Different States have different rules regarding when Stamp Duty is payable, e.g. NSW - up to 90 days after exchange of contracts; Qld - up to 30 days after exchange of contracts; Vic - at transfer of Title.

A gradually increasing selling price was tried in the early 'naughties' by some vendor financiers. It caused some massive problems and court cases. You are selling the property now and with that sale, as with all sales, the buyer is then able to take advantage of any capital gain (or loss). Pick your sale price and stick with it.

Regarding Deposits, I ask the question, 'How much have you been able to put aside to get started?' And sometimes you get a pleasant surprise ;-)

Cheers, Paul
 
Hi Paul
So u only expect your property to grow 7% in the next 3 years , isnt that underestimating it?

Also when u sign the lease option , does it mean:
- the buyer tenant pays all rates, strata, insurance etc?
- you will get more bank loan because you can show you get more "rent" per week than if u rent out in a normal way? Do u have to declare to your new lender that these properties are lease option? Wil that scare new lenders away?
 
Hi Rodimus

The 3 years hasn't really got anything to do with it. You're selling it now and just spreading the payments out over three years. When Meriton sell one of their apartments with some vendor finance, they don't expect to share in the new owner's future capital gain. It's the same here.

With Lease/Options we add an estimate of the Rates, Strata & Insurance costs into the On-going Option Fee payments. If you get the estimate wrong, that's your loss. This is because all State Residential Tenancy Laws do not allow you to directly charge a tenant for these costs. With an Instalment Contract these costs can be passed directly onto the VF buyer.

Traditional lenders will normally baulk at a rental figure that looks to high. We just submit a normal rental appraisal. We declare that we are buying the property for investment purposes where-by it's understood that we will be renting the property.

Cheers, Paul
 
Yes i think Paul answered it all for you Rodimus, Victoria has different stamp duty laws regarding IC's that mean duty is payable on transfer, but with lease options its due at time of signing.

Therefore i do IC's only in VIC, and Leases Options or IC's in the rest of the country within the laws for that state. eg cant do IC's in SA and on... governments like to keep us on our toes

Get as much of a deposit as you can, the more they commit the more they are committed to the house. 2k is barely a bond and 1 months rent... that will get you a rental house. If you want to rent to own it its a better opportunity so show me a better commitment ;)

And re the price, your not setting it to try and second guess the capital growth so you get all the capital growth - why would the buyer do it then, generally you acquire the property below market and sell at a premium for your profit with the financing built in, just like people pay a premium for a washing machine from the good guys when they can have it now and get finance with it, same for a house... where that line is drawn is up to you and the buyer to negotiate and agree on - overprice it and noone will want it and it will just sit there. There needs to be value for both parties.

Cheers
Sheree
 
Oh ok, I guess I got a different concept about the sale price. I remember I learned from Paul and Danny McKenna in around 2003 that when they do lease options, they actually project the sale price to the next 3 - 4 years or something like that. THeyt had a slightly different system where part of the monthly payment actually goes into the purchase as a deposit, so the buyer is paying down the loan and only has to take out a smaller bank loan if they wanna exercise the option....hmmmmm

Sheree, can you please tell me more about installment contract? Can you give me a simple example with prices on how the deal works?
 
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