Lease option deals can be excellent for profiting on rehab properties. Many “junker” properties can be bought cheap, but this requires cash. If you obtain a bank loan, you will be required to put more money down, especially if the property is in serious disrepair.
Furthermore, you need cash to fix up the property. You also have to pay monthly interest payments while waiting for your subcontractors to finish the job and for the new buyer to qualify for his loan.
Rather than purchase the property, lease it for six to nine months with an option to purchase. If the property is not habitable, offer the owner a discounted rent with most or all of it applied toward purchase. (Makes sure, of course, your lease gives you the right to make improvements.)
Compare this strategy to borrowing money and making interest payments while you are fixing up and holding the property for resale. You can save yourself extra closing and financing costs by leasing with an option, fixing, the exercising your option rather than buying, fixing, and selling.
Better yet, fix up the property, then sell your option to another investor. If you are not into fixing properties, find a subtenant who has handyman skills. Let me share a personal story that fits right into this strategy.
The story of Dr. “X”
I found a vacant property owned by a prominent college professor who lived out of state. The property had a finished basement, but literally had no upstairs! The entire first floor had been cleared out and used as a place of worship. The professor, the former leader of the church, had taken out the loan on the property and had been making payments for over a year after he had left town!
The property needed about $10,000 worth of work to get the upstairs back to speed, none of which I was willing to pay for or do. (Sorry, these hands only get dirty in the kitchen.) The rents for similar houses in the neighborhood (with an upstairs) were $650. I offered to lease it from him for two years at $400/month with an option to purchase price at $40,000.Without so much as cleaning the house, I placed an ad in the paper:
EL DUMPO!
RENT-TO-OWN
$0 down, U-Fix
555-5555
Needless to say, my phone rang off the hook (and onto the floor and out the door)! Rather than look for a tenant to pay me option money, I was looking for someone with skills to do the fix-up in exchange for option consideration. The first tenant, who claimed to be skilled (Boy am I a sucker!), moved in and started paying $600/month.
After six months, he did no work, stopped paying, and I evicted him. I advertised it again – same ad. I also made the same mistake of letting in a tenant who did no work, but paid me $625/month for a year. After I evicted him, I had learned my lesson, which is:
Nobody moves in until he does the work!
This time, I found a guy who was in the drywall business. He did the work and a beautiful job! He paid me $650/month for six months and exercised his option to purchase at $54,000, less a “repair credit” of about $4,000. This was truly win-win–I got paid, and I didn’t break any fingernails.