Lease Options & Subject To – How to Make Money 3 Ways
Lease Options and Subject To are ways to invest in real estate by taking control of properties with very little to no money down.
When I started investing in real estate for passive income in 1991, I did not have a lot of money for downpayment, credit or even a job. But I believed that where there is will there is a way.
At the time, I heard of this little known strategy about Lease Options and I decided it was the way I was going to start building my rental portfolio.
Within 18 months, I had accumulated a total of 16 properties, from single family to an 8 unit building, using a combination of Lease Options and Subject To. My net passive income from this rental portfolio was close to $9,000 a month. That was a lot of money at the beginning of the’90s!
Lease Options give the investor the right to lease a property with the option to purchase it at a future date, at or before the end of the lease period. The investor basically has control of the property without formal ownership (kind of the same way as it works for wholesaling.)
But how do you make money or cash flow from a Lease Option? By creating a “Sandwich Lease.”
You (the investor) lease with an option to buy a property from the seller and in turn you create another lease option with a tenant buyer. For instance, if you lease the property from the seller at $1,000 a month and you turn around and lease it to a tenant buyer for $1,200 a month, you now have $200 cash flow a month from that property.
Subject To Deals
Subject To works pretty much like a Lease Option, however you have much more control of the deal.
In this case, the title actually gets transferred to you and then in turn you give a Lease Option to a tenant buyer.
Subject To is a term that was created since it defines also the stipulation that the existing mortgage stays in place. On the sale contract it is worded “Sale subject to existing mortgage staying in place.”
Combining Lease Options with Subject To
The ideal scenario is when you can combine a Lease Option with a Subject To, because when you are on title for the property, you have much more control and you can also refinance it instead of purchasing it (therefore downpayment and closing costs are built into the equity and the loan, instead of out of pocket.)
Also sellers might be reluctant to give you a “Subject To” at the beginning of the transaction, since they don’t know you yet and they are afraid to lose the property or have to go through foreclosure to get the property back. Therefore I make an agreement with an escalation clause: after 6 months of a “Lease Option” that we will switch to a “Subject To.”
Also note that it is much easier to refinance than purchase a property as far as qualifying for a loan, since now you have a history of ownership and can use rental income to qualify for the loan.
Making Money 3 Ways with Lease Options and Subject To
Now you probably wonder, how do you make money 3 ways with Lease Options and Subject To?
- When You Purchase – you time the execution of the Lease Option with the execution of the 2nd Lease Option from your tenant buyer. For instance, if your deposit for the Lease Option with the seller is $10,000, you get a deposit from your tenant buyer for $15,000 and the $5,000 difference is your money to keep.
- During the Lease Option Period – by creating a Sandwich Lease Option or a Subject To and then a Lease Option, you earn monthly cash flow for the spread between what you pay the seller and what you actually receive from the tenant buyer.
- When You Sell – at the time that you sell the property to your tenant buyer, you are going to keep the profit between what you agreed to purchase the property from the seller and the amount you agreed to sell it to the buyer on the Lease Option. For instance, if you agreed to purchase the property at the end of the Lease Option agreement with the seller for $100,000, but the Lease Option you have with your tenant buyer is for $120,000, then your profit at execution and closing of the deal is going to be $20,000.
By now I am sure you realize that with this strategy you can not only create passive income, but also immediate and future lump sums in cash.
It’s a strategy that I hold dear, since it is how I really started in real estate investing and it’s still part of my investing master plan.