The Sandwich Lease Option is another lease option strategy that some real estate investors have had success with. However, there are more risks here than a straight lease option refinance so it may not be an appropriate strategy for a novice investor.
Still, if you’re having trouble coming up with investment funds or perhaps if your credit isn’t good enough to secure your own first mortgage on a property, then this strategy could be for you.
Let’s take a look at how the sandwich works.
Two Leases with You in the Middle
The way the Sandwich Lease Option strategy works is as follows.
1. You find a distressed homeowner.
There are plenty of homeowners who are in dire financial situations and need to sell their homes. Often, these people have very little equity in their homes and are simply looking to get out from under their burden of debt.
If they had more equity in the home, perhaps they would be good candidates for a lease option refinance, but in this case, they don’t.
2. You offer to lease their home from them
You come in and offer to take on their monthly mortgage payments, along with property tax and insurance. You offer to enter into a three year lease, with an option to purchase the home at an agreed-to price that is below current market value. Why? Because they’re problem is cashflow, and in order to relieve their cashflow burden, they would be willing to sell at a reduced price in three years.
The homeowners agree. They move out – usually to a rental – and pay their rent with your lease payments. They still own the home, but they don’t have to worry about their cashflow.
3. You offer to lease the home to a new tenant-buyer using a traditional rent to own contract.
If the original homeowners are the first slice of bread, and you are the meat, then we need another slice of bread to complete the sandwich!
You now control the property but you have not invested anything in it yet. Before the original homeowner moves out, you advertise that you have a rent to own property coming available and start qualifying rent to own tenant-buyers.
Ideally, you will have a tenant-buyer ready to move in when the original homeowner moves out so that you don’t have to cover any gaps.
To make this work from a cashflow perspective, you’ll need to ensure a couple of things. First, the “rent” portion of the rent to own payment from your tenant-buyer must be greater than your lease payment to the original homeowner. Second, the “monthly credit” portion of the rent to own payment – that is, the cash that will go towards the tenant-buyer’s down payment – must still be kept separately in its own bank account.
Finally, the agreed-to purchase price that your tenant-buyer will pay is going to be higher than the agreed-to purchase price you have with the original homeowner.
For example, let’s suppose you agree to pay the original homeowner a monthly lease payment of $500 and you agree to a purchase price of $150,000 in three years, even though market value is $175,000.
Then you lease the property to your tenant-buyer for a monthly payment of $800 that covers what you owe to the original homeowner, and puts extra cash into the future down payment. Then you agree to sell the home to the tenant-buyer for $200,000 in three years. You stand to gain some good profits.
So far, you have two leases on the property. The first is the lease you pay to the original homeowner. The second is the lease with the rent to own tenant-buyer.
4. Sell the property to the tenant-buyer
At the end of three years, you exercise the option you have with the original homeowner and purchase the home at a reduced market price. In the example above, this would be for $150,000. At the same time, you will then turn around and sell it to your tenant-buyer for $200,000. Voila!