What's the problem with Lease Options?

[whitt]

That's not enough for me. Unless someone can show me how they earn $5,000/week from this method (my optimum), I'll do Buy & Holds. At least the income is there forever.

With buy and hold at some point in time you are limited as to your buying power. The market may not boom like previous years and it is unlikely you can easily find 10%+ yeilds.
As normal buy and hold have low yeilds this will affect your DSR and banks will limit your buying unless you trade or inject cash.
Lease Options have high yeilds and your buying power keeps on going.

[KevinR]

With buy and hold at some point in time you are limited as to your buying power. The market may not boom like previous years and it is unlikely you can easily find 10%+ yeilds.
As normal buy and hold have low yeilds this will affect your DSR and banks will limit your buying unless you trade or inject cash.
Lease Options have high yeilds and your buying power keeps on going.

Good point. I guess I was looking to my business profits to provide the deposit injections, but this could do just the same.

[whitt]

As a bonus if you have bought under value, when the tenant buyer cashes you out you then get a cash sum to do as you please. With buy and hold you need to refinance to use the equity.

[Ivanhoe]

"Dream VERY BIG, start small, break it into small steps and try and SYSTEMITIZE the whole thing so that it can grow itself." - ChrisAshenden quoting another investor.
I did some numbers following this advice, this is how it worked out:
We are going to buy 10 houses a year and LO them (we'll trade some too, but let's ignore it), spread $100, equity $40.000 in each deal (diff. between purchase price in and out).
By the end of year 1 we'll have $1000 pw NETT replaing current salary - so we can go full-time.
Note: I will have run out of servicability if I was buying B&Hs by this moment, unless I did some MASSIVE trading to generate deposits.
Year 2 - same pace, $2000 pw (we have 20 deals now), first buy out happens, bringing $30.000 NETT. Cool.
Year 3 - more LO's are cashing out, let's say 2 a year, generating around $50000 of extra cashflow + $2700 pw (less $100 from 3 cashouts), per year - around $140k, $3600pw - you employ people to find properties and manage existing stuff.
Year 4 - do your numbers yourself.

And it's only lease options, you can do slops AND trading AND B&H (you are going to reinvest your extra cashflow in capital growth properties, right?)

Two questions:
1. Is 10 LO's per year achievable? YES if you believe in it.
2. The key is BUYING WELL. So if your are doing SLOP seminar from GBI as I will next weekend, don't forget that it is SLOP AND trading seminar!
See you there!

[KevinR]

As a bonus if you have bought under value, when the tenant buyer cashes you out you then get a cash sum to do as you please. With buy and hold you need to refinance to use the equity.

Correct me if I'm wrong, but when a tenant cashes me out I have to pay tax. When I refinance, that money is tax-free.

I'm entering property to reduce my tax obligations (legally, you understand), so paying more than I have to messes up my profit potential.

[whitt]

Correct me if I'm wrong, but when a tenant cashes me out I have to pay tax. When I refinance, that money is tax-free. .

Yes you will most likely pay some tax on profit, but hey a profit is just that a profit.

I'm entering property to reduce my tax obligations (legally, you understand), so paying more than I have to messes up my profit potential

Most serious investors ignore tax benefits. They should be treated as a bonus. The government can change rules or you may stop work and your tax refund disappears. Use pre tax figures

[SuperDad]

Hi all,

Before I ask the following question, I know some of you might say "do the GBI course". Well, if I ever get into LOs, I will do the GBI course.

Anyway, my question. Does the LO process proceed as follows: Purchase property, find leasee, sign them up? Or rather, does the process run as follows: Find a leasee, establish what they want, source a property they like, purchase property, sign leasee up?

To me, it seems that the second scenario is the better business model. If this is the way LOs are normally done, then great. If not, then ask me to explain why I think the second scenario is the better model.

Paul.

[KevinR]

...Most serious investors ignore tax benefits. They should be treated as a bonus...

Not me - I'm on the top tax rate. Every point gained is gold.

[whitt]

Anyway, my question. Does the LO process proceed as follows: Purchase property, find leasee, sign them up? Or rather, does the process run as follows: Find a leasee, establish what they want, source a property they like, purchase property, sign leasee up?Paul.

Most do first option or both at once. They build a database of buyers making it easy when you have gone through and found a Lease option property

[SuperDad]

Kevin,

While I won't be ignoring the tax benefits if and when I am entitled to them, I won't see the money gained from such benefits as income. Consider a hypothetical example: I have a property that is $50 CF+ per week before tax but, because of depreciation, reduces my tax such that I get a further $50 in the hand per week. I would not see this $50 "tax benefit" as income, but rather as a tax free loan to pay for maintenance down the track. Why maintenace? Because the "income" has been derived as a result of a depreciation claim. What is depreciating? The building and chattels. These will need to be replaced at some stage, and where is that money going to come from? taxableMy "depreciation fund", which I have safely stashed away.

Interestingly, there is a genuine benefit to reducing one's taxable income, which is that it might qualify one for some (or more) money under the government's family assitance package. Take my case. I have three children, and a wife who earns $72K. We are entitled to $76 per week in Family Assistance. As we have found out, the banks consider this $76 per week to be income! Now, suppose we purchase a property that is producing $20000 per annum income, which is $5000 per annum CF+ive before tax, but $5000 per annum CF-ive after tax. This reduces my wife's income by $5000, to $67,000, and so we will be entitled to a further $1200 of family assistance. Further, the banks will not consider my wife's income to be $67,000, but still $72,000. Also, they will take into account 75% of rental income ($15K), which will cover expenses. So the example, as I have construced it, increases our serviceability by $1200 per annum.

An interesting twist, I think.

Paul.

[SuperDad]

Most do first option or both at once. They build a database of buyers making it easy when you have gone through and found a Lease option property

Thanks Whitt.

Paul.

[Monid]

As for purchase price, let's do some numbers (i'll keep it simple)
House: Market value $200.000
CG: 10% a year, we ignore compounding
Market rent: $250 pw
Investor's purchase: $160.000
Bank's interest: 8%
Insurance+rates: we ignore (to keep it simple)
Deposit: $2000

Scenario 1: Lease-Option
T/B will pay $330 pw (10+% yield for investor), $260 rent, $70 option fee, so in 5 years their equity will be
70*5*52=$18200+2000=$20.200 - magical 10% deposit. Their house would be worth $300.000 and they will need to get $180.000 loan

Scenario 2: 100% finance. 8%
After 5 years they will have accumulated 15000 but their weekly would be $355.
IF they payed $355 pw on Lease option, they would have $24700 credited towards their deposit! (their $2000 would pay for LMI)

Scenario 3. They pay $250 rent and save $100 pw. In 5 years they would have $26000 saved, but they now need to borrow $274000 from a bank to buy very same house - $421 pw interest only (90% LVR) compared to $276 pw interest only our lease option client has to pay while enjoying their 60% LVR (and hopefully not using this equity to buy boat, xr8 and go to Fiji for a month-long holiday)

So, who's better off?

I'll make a more detailed response later on, but a couple of questions immediately arise for me.

1. In Scenario 1 whats in it for the investor? Is it simply the $40000 they make by buying under value and then reselling at market value?

If so why is this better than simply flicking the property immediately rather than waiting x number of years to realise your main profits?

2. Also in the current market is assuming %10 capital growth justifiable? I am aware that this is the long term stat, but of course long term stats and yearly stats are quite different especially after a boom.

3. This is minor but in the 2nd scenario were you calculating on the purchase price of $200000 or $160000? Since presumably if the tennant went shopping for a house and settled on the same one they could have bought it for $160000 not $200000.

David

[Monid]

David, you are missing some core points:
1. Price is FIXED for t/b - normally it's registered valuation. So all capital gains go to t/b, not investor.
2. Rent is normally a fraction higher, and that's what investor keeps. ongoing option fee is credited towards deposit, so investor's equity REDUCES with each payment (LO is a way to convert equity into cashflow, really)
3. T/b build up their equity MUCH faster (the ongoing option fee is MUCH higher than principal if they bought using 100% finance
to be continued...

Thanks Ivanhoe
In regards to 1. I understand that some people who do LO's have a rachett clause in the contract that allows them to gain some of the capital gains which is what I was refering to.

In regards to 2. Are you saying that all the tennant pays above standard rent for the area (Or actually I guess the mortgage costs?) becomes their option fee?

It seems that there are other systems in use:

I have a property in Pakuranga leased for $800 a week with rent credit of $49 per weeek. Another one at $700 a week with $50 rent credit. My cash spread is over $200 per week each property.
Rents would be about $400 a week each. That's why I love lease options!!

I guess one of the things I'm unclear on is what people mean fundamentally by a lease option as opposed to something like rent to buy or wraps or something else (I'm aware of earlier threads on this, but I find they don't make the distinctions any clearer to me). The way you describe it Ivanhoe it does seem to me to be a lease option, in effect they are paying some fee to fix the current price as purchase price if/when they decide to exercise their right to purchase. I'm still interested in seeing what you think the upside for the investor is in this scenario, but I can see what is in it for the tennant.

Cheers
David






Cheers
David

[Ivanhoe]

Hi David!

1. In Scenario 1 whats in it for the investor? Is it simply the $40000 they make by buying under value and then reselling at market value?

cashflow, healthy DSR and LVR, CASH (backend) first three allow you to continue borrow from inexpensive 1st tier financial institutions.
As for flicking, it's not THAT simple (try it in current market and you'll see) - you will sell at a discount, not RV (you want to sell quickly, right?) taxes, gst in/out, holding costs, advertising, expensive finance (try walking in any major bank's office and tell them you need short-term finance and will be claiming GST - then tell us the answer - for me it was "sweet!" but it's another story)... the end result is that you will pocket 10-15k gross, NOT 40k. The funny thing is that if you put this money into property and increase LVR, your DSR will change only insignificanly - my estimate is around $11 pw, but here I'm starting loosing it a bit - I have not done GBI course yet, remember. (Can anyone help with impact on DSR extra 10k would have in a 200k deal, please????)

2. Also in the current market is assuming %10 capital growth justifiable?

Heck knows. In my example it was just and example. Notice that as investor you do not rely on CG THAT much (relying on it is speculation and level 3 investing too). It's not what YOU believe, it's what general public believes, and it's: "It's good to be homeowner!" - and for some people you are fairy santa Genie mother Teresa whatever, because without you they will rent till they rot (period)

3. This is minor but in the 2nd scenario were you calculating on the purchase price of $200000 or $160000? Since presumably if the tennant went shopping for a house and settled on the same one they could have bought it for $160000 not $200000.

200k but it is irrelevant and insignificant - each deal will be different, my number were for demonstration of the clockwork ONLY!

Thanks Ivanhoe
In regards to 1. I understand that some people who do LO's have a rachett clause in the contract that allows them to gain some of the capital gains which is what I was refering to.

your game, your rules. it means whatever you decide to do and it is acceptable for another party - go for it! (unless it's something IRD and courts will frown at). So....
Your game, your rules, but keep it simple (stupid)!

In regards to 2. Are you saying that all the tennant pays above standard rent for the area (Or actually I guess the mortgage costs?) becomes their option fee?

Your game your rules. You can structure it the way you want - I'm in research phase, so ask people who have done 10 LO's in last 12 month (helooo!!! anyone?)
If you gove\\ WAY out of whack with average rent you may have problems with TT. I'm risk averse, that's why I'm aiming at ongoing option fee accumulating in deposit TB can you to cash you out (sooo in my example we thay need 20k for 90% finance, they have 2k, sweet, they need another 18k, see how it all stacks up nicely after 5 years? - if anyone takes you to court it's proof you were not setting them up to fail)

What's in it for investor? Because you can grow it REALLY big - DON"T do SLOP course and forget about LO's if you are planning to do 1-2 deals a year - find yourself another nich, i.e. B&Hs standing on their own is very cool too.
Don't forget the bunch of nice houses which are bought at 80% but they are still negatively geared and rented and proped up by cashflow from your LO business because your B&H and LO trusts are structured to maximize tax advantages of trusts... (call Garth @ companysolutions to find out more, please mention me when making an appointement)
Read thru ChrisAshenden's opsts, it's all there, just dig a bit deeper!

[Ivanhoe]

As for LO's and wraps and whatever - there's many ways to skin a cat, some are faster, some do not work, some will get you sued for not treating cat as human being...
They are all rent-to-buy, wraps do not work in NZ - you cannot get finance anymore.

The way you describe it Ivanhoe it does seem to me to be a lease option, in effect they are paying some fee to fix the current price as purchase price if/when they decide to exercise their right to purchase.

Precisely!