By Andy Techmeier
In the Phoenix market today, buy and hold is a great strategy… but who wants to be a landlord??? You might be saying, “Well you can just get a property manager.” Odds are if you do that, you won’t have a lot of cash flow and are speculating on when you can cash out. Well either way we are all hoping this market turns around so our properties will get appreciation and we can make some money, but wouldn’t it be nice to make money every month while you’re waiting for that day to come?
In this article I’m going to talk to you about lease options and why they are such a good fit to maximize return, and minimize hassle. Now, at least in Phoenix, is the best time for buy and hold, and lease options are a great way to create cash flow and long term wealth.
So you just bought a property and want to rent it. You have good credit and were able to get a loan with 10% down, and let’s say this property is worth $100k. Now because you’re an investor you bought it with some equity, let’s say you got it for $90k. So you put $9k down plus $3k for closing and finance the rest which brings your month PITI (Principle, Interest, Taxes, and Insurance) payment to about $600 per month with a 30 year fixed mortgage. Quick disclaimer, these numbers are conservative estimates that actually allow for possibility of better return. It’s always better to under promise and over deliver! Rent for this house and the neighborhood runs about $800 per month… great right? Now we’re talking no HOA’s, but you still have all the other expenses as owner and landlord of this house. When you consider maintenance, up keep, management, and also possible future hiccups with tenants that would call for legal action you’ll be lucky to break even. So at this point if you paid a 10% management fee and had no additional expenses, your cash on cash return on invest would be 12% ($120 per month x 12 months, then divide that number into down payment, $9k, plus closing cost, $3k, (120×12)/(9,000+3,000)) but that’s not real because you will have expenses.
With lease option things get much, much better. First and foremost the renter is now a buyer. They are leasing with the option to buy down the road. This is good for two reasons; 1. They will put up option money to have the right to purchase. And more importantly, 2. They are now owners of this home and will act accordingly, not only in behavior by taking better care of a property they own, but bearing the responsibility of maintenance and repairs for their house. It gets even better! Because you are giving this renter the ability to own their own home you can charge a premium for the monthly for this added value. Why rent down the street for $800, when you could OWN this home for only $1900 down and $950 per month? All of this information shows you how a lease option is a much better way to create cash flow from a buy and hold property, but there is one more thing. We determine the selling price today. This house that is worth $100k can be sold on the option for $115k. Considering you bought with equity, you have a guaranteed return of 27.7% ($25k of profit/$90k you paid) just on the capital gains alone! Now let’s take a look back at the monthly return. Your cash flow goes up from an unrealistic $120 per month, to a very realistic $350 per month. Because of the option money and last month’s deposit you get about $3k when they buy. This means your new cash on cash return is 47% (($350×12)/$9,000)!
This is a great scenario for both buyer/renter and seller! There are some other aspects of this strategy that I’d like to tell you about, so if you like this article or have questions. Please comment with any questions so they can be answered and let us know if you like this and would like more.