Lease with purchase option

[Rogerp]

This is my first time on so I hope this gets through.

I have an opportunity to lease a property at $600 p/w. The current market rent on this property is $450p/w. The deal is that the contract price is fixed at $390000 (the current value is $370000). Each week $150 of the $600 is taken off the contract price and in 5 years i purchase the property (in this case for $390000 less $39000 being the contributions). Hopefully the property will be valued at $450000 which will give me enough equity to purchase the property. If in 5 years the value is not $450000 the deal can be extended another 5 years under the same arrangements, therefore in 10 years i will pay $390000 less $78000 and by then i would expect the property to have gone through any expected down turn and recovered. The $600 is increased by cpi but the $150 remains the same, rents would also increase by cpi (maybe).

Does anyone out there have any views on this type of arrangement? How should the contract be arranged so that i will protected incase the current owners get into trouble? Can anyone recommend any lawyer that may have dealt with a similar deal etc?

Any opinions would be greatly appreciated.

Thanks Roger

 

[Katalyst]

Lease Options

Hi Rogerp

I was interested in your post re: Lease Option arrangement you are considering.

One way to protect your interests is take out a Caveat on the property. The Lease should refer to the Option which gives you exclusive rights to buy the property.

You mentioned that the Lease component is five years.
Please check whether the Landlord is bound by the Residential Tenancies Act. If so they would be responsible for the maintenance and upkeep of the property.

Also be aware what the provisions are for extending the 5 year Lease. You may find that your rent will be higher as will the purchase price for the new 5 year period. This is OK so long as you understand the agreement and consent to it.

I would be concerned about paying rent attached to CPI. If war breaks out and inflation goes up, up, up, then your rental may become too financially onerous. I would be asking for a fixed repayment each week for the term of the agreement.

As for teh current market value have you sought an independant Valuer for confirmation?

The Lease Options I arrange provide the Buyer Tenant with fixed payments over a 7 year term with the exclusive option to purchase at anytime within that 7 years. The Buyer Tenant takes over all outgoings as if it were their own home. We don't attach the CPI for obvious reasons - too much messing around and payemnts can become to variable! And yes you could also renegotiate another 7 year term to ride out the market fluctuations, however 7 years is generally sufficient. In our arrangements the Option carries with it a value consistent with the build up of your deposit credits.
A Caveat is placed on the property for the Buyer Tenants protection should the Landlord sell from underneath. However, I haven't found a Landlord that would do that yet!

Roger I hope this helps a little. Am happy to answer any further questions you may have.

Regards,

Andrew

 

[Rogerp]

Thanks for your response Andrew. I would like to pick your brains a little more if thats ok.

How does a caveat work? Does the current mortgagee need to give approval prior to a caveat being taken out? If the owner wants to use the property equity to arrange further finance would a caveat on the property stop this from happening without my approval? If the owners get into financial trouble and the banks force them to sell and at the time i am unable to purchase the property do i lose everything? Wouldn't i be better off attaching the property to a entity that stands alone and is not effected by any other dealings the current owners may have? That way the property can not be used for any other purpose.
Or am i just over concerned?

Thanks again

Roger

 

[Katalyst]

Lease option

Hi Roger

Feel free to pick my brain.

"How does a caveat work?" -

You go to your solicitor and pay him to place one on the title of the property. In victoria this will cost approx $80. Not sure of the cost in ACT. A caveat means that if the property is sold then you are entitled to your share. In this case the value of the option (which will be identical to the deposit saved from the $150 each week). Again this would be determined by the sale price at the time. Your solicitor can advise you more on this as I am no legal wiz.

No approval is needed from the mortgagee to place a caveat. It is however courteous to inform the Mortgagee, before signing, of your intention to protect your interests by way of a caveat.

Re: further lending by the vendor.
It is my understanding that the caveat would not impede further lending. When the title search is performed the caveat will be recognised and the lender may enquire about the nature of the caveat befoer approving the loan. I will double check this point and get back to you.

To comment on the forclosure of the property is difficult without seeing the Lease option agreement that is in place and knowing more about the vendors property dealings. However, it pays to ask the vendor/landlord if the property is collateral for other properties. He may wonder why you ask. And he may not tell you. Best to explain your concerns upfront and seek reassurances. Never assume anything! And always get it in writing, if you can.
If you are not satisfied with the deal you must be preapred to walk away from the deal. Don't let the emotions get in the way. If you do it could cost you later. This is easier said than done but please bear this in mind.

I would suggest researching the vendor more closely.
Ask if he has references for other such property transactions like the one being presented to yourself. Has he done this before? If so go and speak with these people and find out how their dealings were with the vendor/owner.

What do you mean by, "...attaching the property to a entity that stands alone and is not affected by any other dealings the current owner may have"?
I don't understand your question.

The vendor owner will be concerned with your repayments covering the mortgage so he is not out of pocket. This will be true so long as you keep up your payments on time. Ideally, the owner would have the property as a stand alone but we should not assume this.

In the strategy I use with Lease Options my buyers will be purchasing a property that is stand alone. When this is not the case, greater due diligence (research) is required on my part before recommending the property to the Buyer Tenant. In the event of forclosure the Buyer Tenant is safe because I stand in between the Buyer Tenant and the vendor/landlord. I simply go and arrange another investor to take over. Or I can take over the mortgage.

Me being in the middle also provides a form of insurance for the Vendor/landlord. If the Buyer Tenant were to up and walk away I would be responsible for finding a replacement and covering the payments until I have placed another Buyer Tenant.

Again, I would urge you to research the person who owns this property, and the person who is making this arrangement with you, if they are seperate people. Get some history first before making any agreement. Go in with your eyes wide open - then you can see to block the punches and dodge the knock out, if there is one.

Always get a solicitor to review the contracts!!!!!!

Having said this, always find a solicitor who is a property investor and one who is knowledgable with Lease Options. There are heaps of solicitors who have no clues when it comes to Lease Options. Just make some calls and ask them their property investment experience and expertise with Lease Options.
You could always ring the Law Institute and ask for 3 referrals stating the expertise you seek. And you could ask your friends if they know a solicitor who you could approach. The first visit to a solicitor is usually free, so why not check a few of them out.

Lease Options are a great way to buy a new home so long as everything is layed on the table and each party has weighed up the risks. Roger, there is always some element of risk with any property transaction. The key is to know about it and how to minimise it as much as possible in a fair and reasonable way.

Here is something to think about when purchasing any property. John Wesley was a famous English Preacher a century or so ago. He was asked the following question, "If you had 3 years left in which to live and dispense your preacher duties what would you do?". His reply, "I would spend the first two years preparing!".

Preparation is the key to great success.

Hope this helps a little more.

Andrew

 

[Mike]

Hi Andrew,

With your Lease Option system are you acting as the vendor/landlord in your relationship with the tenant-buyer or are you a broker who finds an investor to buy a suitable property for your tenant-buyer client?

In the event of forclosure the Buyer Tenant is safe because I stand in between the Buyer Tenant and the vendor/landlord. I simply go and arrange another investor to take over. Or I can take over the mortgage.

Andrew, mortgages are not assumable in Australia so how can another investor 'take over'? I can only assume you share joint ownership of the property with the investor and the mortgage is in your name so if the investor pulls out you can easily replace them with another investor by adding their name to the title. Could you explain how you do that, please?

Regards, Mike

 

[michaelg]

Roger,

Ask the owner of the property to sign a statuatry declaration that they have informed their lender of the arrangement (to cover your interests), have this document part of the lease-option agreement.

Ask if the owner can draw down of the mortgage (what happens to you if they decided to draw down $20k for a holiday, then default?)

There is a big risk that if the owner defaults on the mortgage that you could lose all your funds. That is the risk of vendor-financed deals. Your legal advisor will point out all the problems, but if you want the deal you need to explain to them that I know there are problems, but your there not to just point them out, but present solutions to me.

And don't sign anything until you are completely clear on the deal. Also take the time to READ the contract, don't just leave it up to your advisor, read what penalties may apply, for late payments or early refinaning, or what ever.

Just a thought
Michael G

 

[Rolf Latham]

Hi all

To my simple non legal understanding a caveat is an instrument that prevents further dealings on the property without the caveatees consent. If this holds then

1. A caveat will not by itself protect the financial interest of the option purchaser, whereas a second mortgage would. A second mortgage gives rights to recover financial entitlement on mortgagee sale, a caveat does not

2. The mortgagee will be required to be informed and permission obtained under most circumstances because the quality of the security has been potentially degraded AND under the provisions of most loan contracts, the borrower is in default unless this is done.

3. Many residential loan contracts specifically prohibit leases longer than 36 months, again the logic being this brings an impediment to selling the property in case of default because of the smaller market such a property would attract.

Best thing in my view is to know the person you are buying from/through well AND get good legal advice.

Im sure it will all work well.

Ta

rolf

 

[Katalyst]

Mike

The loan is never assumed.

I suppose I have used incorrect language when stating the "investor takes over". I can source an investor to purchase the property as per a normal sale (not assuming the loan).
Or I can purchase the property.

I am never the landlord unless I have bought the property.
I do however manage the property.
I don't share joint ownership of the property.
I do however have a Lease Option agreement with the owner of the property and then sublease to the Tenant Buyer with another Lease Option.

The banks have been fully informed and have expressed their satisfaction of our processes.

I have the capacity to approach owners directly to arrange a Lease Option or I can source a motivated investor to purchase the property for me. Whoever owns the title I can establish a Lease Option with them and then sublease.

Hope this shines a little more understanding.

Cheers,

Andrew

 

[Kevmeister]

Andrew,

In acting as a "middleman" between the tenant-buyer and the owner of a property, what kind of profit do you expect to make from a deal?

Do you try and have a 50:50 profit partnership with the owner, or what?

What advantage is their to doing this this way, other than not having to keep finding deposits for finance?

 

[Katalyst]

Answer for Kev

Kev

Hi There

There are a few ways to make a profit.
It really depends on which way the Lease Option agreement is structured.
I don't have 50:50 profit partnerships.
The vendor will usually have a range of $200 - $500 net profit per month per property that is Kataylized.

Suffice to say that the vendor is cash flow positive and so am I.

Cheers,

Andrew

 

[Mike]

The banks have been fully informed and have expressed their satisfaction of our processes. - Andrew

Thanks, Andrew, for your reply to my previous question. Regarding the above quote, what level of finance can your investor get from your lender? 80%, 85%, 90%...? Is the interest rate higher than a normal homebuyer could get from one of the 'big four'?

I do however have a Lease Option agreement with the owner of the property and then sublease to the Tenant Buyer with another Lease Option. - Andrew

Andrew, since, in most circumstances, you will not exercise the option to buy the property, do you take the Option to protect the interests of the tenant-buyer? Any other reasons?

Andrew, can the tenant-buyer have the property revalued anytime during the seven year lease and use the new equity from capital growth to refinance into a new first mortgage so they become sole owner of that property?

Last question - Would your lender give a first mortgage loan to an investor where the tenant-buyer only has option rights? I'm trying to determine whether your lender views your arrangement as less risky with you as the middleman who can continue the arrangement no matter if either the investor or tenant-buyer defaults in any way. If that is the case, then can I assume that without you as the first option holder the investor is unlikely to get a loan from your lender?

Regards, Mike

 

[Mike]

I have an opportunity to lease a property at $600 p/w. The current market rent on this property is $450p/w. The deal is that the contract price is fixed at $390000 (the current value is $370000). Each week $150 of the $600 is taken off the contract price and in 5 years i purchase the property (in this case for $390000 less $39000 being the contributions). Hopefully the property will be valued at $450000 which will give me enough equity to purchase the property. If in 5 years the value is not $450000 the deal can be extended another 5 years under the same arrangements, therefore in 10 years i will pay $390000 less $78000 and by then i would expect the property to have gone through any expected down turn and recovered. The $600 is increased by cpi but the $150 remains the same, rents would also increase by cpi (maybe). - Roger post #1

There seems to be something wrong with this arrangement.

Firstly, Roger thinks he is paying current market rent for the property but how can that be when the vendor's cash flow profit must be built-in to that figure? The $150 extra is Roger's equity contribution since it is being used to reduce the principal of the loan.

Secondly, the problem with the above arrangement is that if Roger walks away from the deal ie does not exercise the option to purchase he has no recourse to recover the capital he has put into the property. Remember, the first mortgage is in the name of the vendor, not Roger. As Rolf said, a Caveat won't help in this situation.

Thirdly, Roger must have paid the vendor an Option fee or consideration up front to make the Option legal. Roger didn't mention it but this Option fee must be credited to the agreed purchase price of $390,000 should Roger exercise the Option to purchase. In fact, the Option Fee plus the initial Option Exercise Price = the agreed Sale Price. The Option Exercise Price reduces over the term of the Option as the principal on the vendor's mortgage is reduced. Roger should get a monthly statement stating the new Exercise Price.

A caveat will not by itself protect the financial interest of the option purchaser, whereas a second mortgage would. A second mortgage gives rights to recover financial entitlement on mortgagee sale, a caveat does not. - Rolf post #7

I agree Rolf, but how likely will the vendor get approval from the lender to allow Roger to take a second mortgage? What amount should this be? $39,000 being 5 years contributions? It seems to me that if Roger has no recourse to get his capital back in the event he decides not to exercise the Option he should not make those payments in the first place and wait till capital growth alone makes it possible to buy the property. Meanwhile, the extra $150 payments could be placed in an interest bearing account. Downside of this is the so-called market rent of $450 will go up if I'm correct in saying that the rent figure is conditioned by the extra $150 reducing the principal loan. I believe this to be the case because the $150 off the principal reduces the interest payable by the vendor. Without the extra $150 the interest liability is greater which must be passed on to Roger for the vendor to maintain his monthly cashflow level. Is sueing the vendor to recover the extra payments a feasible option?

Interesting thought overlooked by Roger...If he doesn't add the $150 per week extra will the Exercise Price still reduce in line with the principal loan reducing if it is a fixed Principal & Interest loan? Theoretically it should because the vendor's cashflow profit is calculated on a margin above the interest payment. Let's say the Option Fee was $3,000 then the initial Exercise Price will be $387,000. Over 5 years, without the extra $150 payments, the Exercise Price could be whittled away to $380,000.

Regards, Mike

 

[michaelg]

Mike,

I don't think it works the way you suggest. The lease-option is geared to favor the vendor not the tenant.

Why would the vendor tie up borrowing capacity and "capped" growth, if not for a darn good reason?

For the opportunity of buying a property with a small down payment (option premium), the vendor gets a positively geared property, sold above market.

Its like car finance, if you paid cash, you get a discount, if you choose finance, you buy it slightly more expensive + interest.

And remember, its a lease + option. The option is the vendor's price for fixing the sale price. This is a risk to the vendor, not the buyer. So if Roger walks, he kisses this money goodbye, but he did have the choice of buying.

As for the lease, any money that is equal to market rent or below is just that rent. So that too is unrecovable.

As for the extra funds, the "rent credit" which contributes to the purchase price, this is where the contract needs to be read. More than likely this money is forfiet is Roger decides to pull out before the agreed time.

Think about this, the vendor has planned a schedule to make money, this is based on funds and time. If Roger decides to break the agreement prior to the completion of the contract then penalties should incur. One possibilty , loss of funds.

Vendor finance, is not a charity, it is a business. The vendor is expected to act professionally and maintain a certain level of trust, to the extent of maintain the contract terms. The buyer is then equally to comply to the terms they agree to.

Buying a property via vendor financing is a big decision, which is why buyers should always read the terms and seek independant legal advice. If they believe the term is too long, or they cannot commit to the full term, then don't, that is, don't enter into such an arrangement, because, put simply, its not the right thing to do.

Michael G

 

[Glenn]

Andrew,

Just got to say mate, looooove the word "Kataylized"

Glenn

 

[Kevmeister]

Here is my perspective on the offer, from a numbers perspective only. Many others have pointed out the intricacies of the deal etc, and admittedly I have no experience in that area.

I *assume* that if you don't exercise the lease option, the option fee and the rent credits are both *forefeited*, which is my understanding of a typical lease option.

TAKING THE LEASE OPTION

If you take lease option, at $390K, first five years:

Monthly payment = $2600 (funny, that - see below).

(Assume CPI 3%). Payments are then $2600 (Yr1), $2678 (Yr2), $2758 (Yr3), $2841 (Yr4), $2926 (Yr5).

After 5 years, total payments (allowing 3% CPI) = $165,636.

HOW MUCH $$$$ do you pay up-front for the Option? This forms part of the 5-years costs. I haven't considered that here.


BUYING TODAY

If you bought today, at $370K, P&I loan 25 years, assuming 6.5% interest rate:

Calculated Monthly payment = $2600.

After 5 years, total payments = $156,000.


COMPARISON

After 5 Years on P & I loan at standard payments your loan balance would be: $327,890.

After 5 Years on P & I loan at the same payments as the Lease Option, your loan balance would be: $317,274.

After 5 Years on Lease Option you can buy for $ 390,000 - $39000 = $351,000.


If you could *buy today* at $370K and apply the same payments as for the Lease Option you would save yourself $33-34K roughly over the lease option. Note that loan costs and purchasing costs aren't taken into account here because they will be roughly the same whether you buy today at $370K or in 5 years at $351K.

Another question is who is responsible for rates under the lease option?, since as a tenant-buyer you would presumably not be liable whereas as an owner you would be. Building insurance, land tax (?) and other charges fall into the same category and haven't been factored in here.


Other considerations

What is the growth rate of the suburb containing the house? This is the critical factor. Let's say it averages 5%. In 5 years time the property will be worth $472K roughly ($102K increase). At 1% growth the property is worth only $389K after 5 years ($19K increase).

If you cannot afford to buy today, and instead choose to wait 5 years time (but do *not* take up the lease option and simply remain an "ordinary" tenant), you pay only market rent in the meantime (ie. $450 per week with CPI increases) so in comparison to the lease option you have "paid out" $39,000 less than with the lease option - I'll assume you "save" that money instead.

The $39K you save over 5 years will actually earn interest, so at 4.75% interest you'll have $44K after 5 years (you'll actually have to pay tax on the earnings but I've ignored that).

Assume 5% growth:

If you buy today at $370K: in 5 years house = $472K, loan = $317K, no savings (all paid into mortage), net worth = $155K.

Lease option: in 5 years house = $472K, loan = $351K, no savings (all paid into lease option), net worth = $121K.

Wait 5 years: in 5 years house = $472K, loan = $428K ($44K saved used as a deposit), net worth = $44K.

Assume 1% growth:

If you buy today at $370K: in 5 years house = $389K, loan = $317K, no savings (all paid into mortage), net worth = $72K.

Lease option: in 5 years house = $389K, loan = $351K, no savings (all paid into lease option), net worth = $38K.

Wait 5 years: in 5 years house = $389K, loan = $345K ($44K saved used as a deposit), net worth = $44K.


My conclusion

Buying the property today is always going to be the best solution so long as there is a modicum of capital growth (eg. even 2%).

If you can *absolutely commit* to buying the property under lease option, then it is still better than not buying at all, in terms of increasing your net wealth, *unless* there is 1% growth or less, in which case just saving your money and buying in 5 years will result in a bigger increase in your net worth.

Waiting to buy later (and not committing to the lease option) with even a small amount of growth means you cannot hope to save as quickly as the property is increasing in value. This, of course, is why most people borrow to buy their homes - because usually they have no hope of saving at a sufficiently quick rate (whilst still renting) to outstrip the property growth rate and "pay cash" for the property sometime in the future.

Finally, if you take up the lease option and *do not exercise* that option, you are more than likely pissing money away. At least $39,000 plus your option fee. So, whilst this is called an "option" I don't really think of it that way. The *only* time it will be of some benefit to you to not exercise the option is if the property market collapses. For example, if the property on which you hold the option is suddenly worth $300K in 5 years you get this comparison:

Had you bought today at $370K: in 5 years house = $300K, loan = $317K, no savings (all paid into mortage), net worth = $-17K.

Lease option: in 5 years house = $300K, you don't buy the house, no savings (all paid into lease option), net worth = $0K.

Wait 5 years: in 5 years house = $300K, loan = $256K ($44K saved used as a deposit), net worth = $44K.

In this case by not exercising the lease option you are not as badly off as the home buyer (not hugely different, however). And this example is based on a 19% drop over 5 years. In this case waiting would have been the best option, therefore buying cheaper later.

 

[geoffw]

Kevin,

You've done some good analysis. You've done some good work there.

Though, in this situation, I'd be taking the deal- especially if there was a good possibility of growth.

It would be a "nothing down" deal. If I bought, on a commercial property, I would have to provide a minimum of 20% deposit (perhaps higher)- there's no mortgage insurance on commercial properties. Buying into a lease option would enable me to leave my equity for other purposes- perhaps building the business, or perhaps buying other properties.

A commercial purchase may well have a ten year term. That would also constrict cashflow (principal payments would exceed interest payments, and would not be deductible).

I'm not sure of the tax situation of rhe $150pw "capital repayment". That could also make a difference.

I would be worse off for this deal, but I would be in a much better situation for other deals.

 

[Kevmeister]

Hi Geoff,

Thanks for your kind words.

For what it's worth, I didn't say I would or wouldn't take the property...

I was merely pointing out the relative merits of taking different choices, and how capital growth affects the outcomes that we achieve in making those choices.

Roger has not provided sufficient information (eg. what is the cost of buying the option) to fully analyse it. He hasn't stated what suburb the property is in so we don't know potential growth. He hasn't stated whether he has actually got a 5-20% deposit to get his own place without resorting to a lease option. He hasn't stated whether his income would be suitable to service that level of debt.

So I simply stand by my original comment which is:

If the area has good capital growth, buying direct will produce the most profitable result. If that can't be done, then the lease option is still better than *not* buying and continuing renting.

I still believe the absolutely critical point is that the due diligence is done now, and if the lease option offer is taken up, this infers that the lease option will be exercised. The only time it won't be exercised is if the bottom drops out of market, at which time achieving finance might be difficult anyway (without a massive deposit).

One final point is this: what is the possibility of getting a clause in the lease option contract of buying at market value if the market value drops? (Even though this is probably contrary to what options are usually about).

Best recommendation to Roger is to review previous year's growth figures for the area he is buying in, perhaps look at some of Residex's predicted growth figures for the area, and make a decision based on that.

 

[Mike]

The lease-option is geared to favor the vendor not the tenant. - Michael G post #13

I disagree, Michael. A property deal has risks and rewards for both vendor and tenant-buyer. To sell a wrap or lease option the wrapper should demonstrate to the tenant-buyer why the deal represents a win-win outcome for both parties.

Why would the vendor tie up borrowing capacity and "capped" growth, if not for a darn good reason? - Michael G post #13

The benefits to the Landlord/vendor are:

(1) A committed long term tenant who carries the cost of all maintenance, property insurance etc. No property management fees to pay, no vacancies.

(2) A higher income return while the deal lasts. No rent reviews, since the interest rate spread is calculated beforehand any rise in the first mortgage payments to the vendor will be met by the tenant-buyer. Tax benefits such as capital allowance and depreciation still apply.

(3) A fixed mark up on the sale price is pre-agreed so your Internal Rate of Return is known in advance. This doesn't depend on approximate capital growth figures.

The benefits to the tenant-buyer are:

(1) As effective owner of the property they can refurbish it to their taste and add value to it.

(2) By paying market rent they can access any capital growth above the agreed sale price.

(3) No 'rent' increases if the interest rate on the first mortgage is fixed.

(4) They improve their creditworthiness when they refinance into their own first mortgage.

The above benefits show that a wrap or lease option is a worthwhile transaction because it has obvious benefits to both parties. Now, in the early days of wrapping a wrapper might have a monopoly over a particular area and the tenant-buyer would have no choice but to agree to that wrapper's terms if they wanted to become a home-owner. Despite the monopoly it is unlikely that the tenant-buyer could be exploited with onerous repayments since repayments are usually determined as a percentage of the tenant-buyer's gross wages. In fact, their current rent is usually a strong indicator of what repayments they could afford.

This is why I have strong reservations about the $150 extra per week above the market rent that Roger must pay. It is obvious to me that the $150 is compensating the vendor for the fact that he cannot obtain the FHOG up-front using a lease option. We know that in some States the $7,000 FHOG can be received immediately using a Vendor Terms or Instalment contract. At $150 per week, the vendor will receive from Roger approximately $7,000 after 47 weeks. A further problem is that the extra amount continues until the vendor is cashed out. If the extra amount is not a burden to Roger then it will help him cashout the vendor sooner. But if it does cause financial hardship then Roger should not accept those terms.

My conclusion above is based on the understanding that the market rent charged to the tenant-buyer incorporates the vendor's interest rate spread which is their cashflow profit. That assumption is based on the fact that Roger said the extra $150 payments would come off the contract price when he cashed out the vendor in 5 years.

Regards, Mike

 

[Rogerp]

Thanks for all the feed back. After anaylising all the data i am still unsure. It seems though that if i was to put aside what my actual weekly out of pocket expenses will be (e.g. $600 less rent i would receive $420-$430 + management fees + vacancy, as i am not the owner i don't pay for maintenance, rates etc. On the other side i have no tax benefits), approx $250 and save that amount or use that amount to reduce another property then at the end of the day i should have more value.

To give you more detail:

The property is a 3br attached townhouse in Braddon.
It is 1.5km from the centre of Canberra.
I pay a $2000 up front fee that eventually comes off the contract price.
I don't have enough of a deposit to purchase this property in the normal method.
There are a large amount of units coming onto the Canberra market over the next 2-3 years. Growth will be minimal.
The experts predict unit/apartment prices to fall and this will probably have a flow on effect through to townhouses and houses.
Rent may fall as vacancy increases.
Current market value is between $350000 and $370000.
The contract price will be $390000.
I pay $600 p/w.
I sublease for $430p/w, but this may fall in the future before climbing again but my payments will be fixed at $600 with the vendors requesting a 4% increase per year on the rental component ($450), so my payments go up irrespective of what the market does. But i have insisted that it be based on a fair market rent (not below $450).
$150 p/w goes towards reducing the contract price, so in 5 years my credits = 150x52x5+2000 ($41000). I have to come up with $349000.

The vendors say no way it won't be worth $450000 in 5 years so i will have enough equity in the property to borrow the balance.

As the vendors are so certain that the property will appreciate to at least $450000 i have asked them to not fix the contract price but to include a formula as the contract price. The formula being, in 5 years we carry out an independent valuation and what ever that is the contract price be set at an amount that will give me 20% equity, e.g. if the property is valued at $450000 then the contract price will be $401000, $11000 more then what the vendors are currently asking, so you would expect that the vendors would be happy to agree to that if they are so confident. I am waiting for a response.

With this extra detail does anyone have any further comments to make. Is this deal worth doing or not? Assuming it actually costs me $250 p/w, can i invest this amount any where else and get a better return? If so where?

From what i can tell this lease/purchase deal appears to better then what is being offered by other organisations, e.g. if a property is valued at $350000 they would offer a 7 year lease and compound $350000 by 4% p/a. It would cost 2% as a deposit. You get upto 50% of the rent as credits towards reducing the contract price plus the deposit. The lease/buyer pays for all expenses and does not get a tax benefit although half of all expenses goes towards credits.

If i assume that the lease/buyer calls up the option after 5 years below are the calculation assuming the value at the time is $450000.00

The option available to me:

Contract price $390000.00
Credits $41000.00
Borrow $349000.00

Other organisation

Contract price $465000.00
Credits $67000.00 approx
Borrow $398000.00

Look forward to comments.

Roger

 

[michaelg]

Mike,

I stand corrected

In Roger's case if the spread is to cover the lack of a FHOG deposit, the terms can be modify to have a "probationary" period where the cash on cash return is high initially, then dropped after the equity risk has diminished. It could even be something Roger could suggest in the negotiations.

Michael G