In today’s ever-changing economic and real estate climate, it is vitally important for real estate investors to understand and implement many types of investing strategies. This will help them pivot effectively and maintain a strong position should the real estate market unexpectedly turn.
Understanding wholesaling lease options is a versatile strategy for new and experienced investors alike. Whether real estate is your part-time or full-time job, this is a terrific option to add to your real estate investing portfolio.
By reading this ultimate guide on wholesale lease options, you’ll enjoy the following benefits:
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Let’s start by reviewing the definition of a lease option. A lease option is simply an agreement between an owner/seller and a tenant/buyer for the tenant/buyer to possibly purchase the subject property at the end of a predetermined lease period.
In a lease option contract, the owner/seller will typically be known as the “lessor” and the tenant/buyer will be known as the “lessee”.
The tenant/buyer will pay the owner/seller an option fee upfront (usually at the lease signing) for the privilege of possibly purchasing the property later.
Additionally, the tenant/buyer will usually pay an extra monthly amount on top of the standard monthly lease payment. This extra amount may go directly words the future down payment of the property.
The terms for purchasing the home, including price and timeline, are negotiated before the lease option is signed.
The tenant will typically live in the property for a predetermined amount of time and pay rent (plus the extra downpayment amount) before the option to execute a purchase comes up.
The lease option gives the tenant the first right to purchase the property before any other party at the end of the lease. The tenant does not have to purchase it, but s/he maintains the right of first refusal.
For most tenants choosing this situation, the goal is to become the end buyer of the property.
You may hear lease options also called “rent to own”, “rent option”, “sandwich lease option”, "sandwich leases" or “lease to buy” deals. Many sellers are open to lease options because it creates continued cash flow while lining up a potential future buyer with a current lease agreement.
For a tenant, a lease option can be an easier way to secure a property and eventually buy a house. The risk and guesswork of finding affordable permanent housing down the road is minimized.
Lease option deals help tenants secure housing who may not otherwise qualify for a mortgage or only qualify for mortgages with unfavorable terms. Good lease option deals also help these tenant/buyers secure housing in a market where home prices are continuing to rise quickly over time.
The tenant maintains flexibility while having a potential option to purchase the property at a later date in time. This also provides a degree of stability for the tenant. Lease option terms can be as short as 3-6 months, 12 months, or even 24 to 36 months in length.
For the homeowner or seller, a lease option agreement creates monthly cash flow while securing a potential future buyer. This can bring additional financial security to the homeowner/future seller.
Lease option deals can appeal to all types of sellers/owners. Traditional homeowners simply interested in lining up a future buyer for the property may find a lease option arrangement appealing because of the future buyer stability.
Tenants of a lease option will typically treat the home as their own, so the seller/owner receives the benefit of minimized maintenance expenses and potential tenant improvements.
A real estate investor seeking to build a larger portfolio of rental properties would also enjoy this arrangement given the creativity of acquiring more cash flow. For a real estate investor, a lease option is a lower risk way to secure a future real estate investment with no money or additional capital needed.
Lease option deals also work well in all types of markets. This creates more stability for investors if they have a tried-and-true strategy that can weather any market fluctuations.
The main difference between a lease option and a lease purchase is the obligation required of the tenant/buyer at the end of the lease term.
Basically, the option consideration portion of the agreement is the foundational difference.
In a lease option deal, the tenant/buyer has the option to walk away and not purchase the property.
In a lease purchase deal, the tenant/buyer must purchase the property at the end of the lease term.
A wholesale lease option deal is a combination of two tried-and-true real estate investing strategies: a wholesale deal and a lease option deal.
A regular wholesaling deal is an assignment of a real estate contract to a third party. The wholesaler collects a “finders fee” or “assignment fee” for locating the subject property for the third party investor.
Typically, a wholesaler never actually owns the property, but merely secures the subject property under contract and then flips the contract to another investor at the closing table.
A lease option is what we reviewed above: a situation where an owner/seller goes into a contract with a tenant/buyer for the tenant/buyer to potentially purchase the property at a later date after a lease term is up.
A wholesale lease option is when a real estate investor negotiates and secures an agreement with an owner/seller to purchase the property at a later date for a predetermined price at the end of the lease term.
The investor then can do a couple of different strategies:
Similar to a traditional lease-option deal, all parties can benefit favorably if the deal is structured fairly.
Owners/sellers may benefit both from the time saved in finding a qualified tenant/buyer and have the peace of mind of having a future potential buyer already lined up for the subject property.
If the tenant/buyer opts to not purchase the property, they make additional income from the option fee they get to keep while locating another tenant or buyer.
Qualified tenant/buyers may benefit from securing housing they may not have otherwise qualified for, as well as securing a right to purchase the property if they desire at the end of the lease term.
Wholesaling investors who match the owner/seller with the tenant/buyer can profit handsomely and quickly with the finder’s fee. This strategy is particularly useful for new or part-time real estate investors seeking to build up capital quickly while learning the investing business.
Another benefit of wholesale lease option agreements is that the investor does not need to secure financing in order to make the deals happen.
However the lease-option deal is structured, it is vitally important that all parties clearly understand the terms. For any real estate investing deal, the owner/seller should also plan to have additional savings built up in case a tenant defaults.
For more information on the downsides of landlording, particularly in 2020, watch the video below:
The matchmaking wholesaler of a lease option can make money through several different ways:
If the owner/seller is also an investor, s/he can make money through the monthly rental income, the option fee, and the downpayment money paid monthly by the tenant/buyer.
Typically, if a tenant no longer wants to purchase the property at the end of the lease terms, s/he will forfeit the initial option fee as well as any extra amount they were paying monthly towards the future downpayment.
This can mean that the tenant potentially forfeits thousands of dollars to the owner/seller, depending on the length of the lease agreement and the initial terms outlined.
It’s important to note that the option fee is not the same as an earnest money deposit. There are many rules and nuances between these different fees, but the foundational difference is that an option fee will typically not be refundable at all, while an earnest deposit can be refundable to a buyer in specific circumstances.
The property owner/seller will get to keep this option fee and any downpayment money already paid. This makes the deal a relatively low risk for the owner/seller. The risk of losing this option fee completely is a consideration that the tenant must weigh before entering the agreement.
Want to learn more about making your offers stand out? Learn about optimizing earnest deposits.
To properly wholesale a lease option, you'll need to get familiar with and utilize the following real estate contracts:
1. Option Agreement
2. Purchase and Sale Agreement
3. Rental Agreement
4. Assignment Contract
The option agreement provides the buyer/tenant (aka the "optionee") the right to purchase the property under the terms of an attached purchase and sale agreement. The option fee, option period, and specifies which other agreements are associated with the option.
A purchase agreement specifies the details of the sale and is only activated when the optionee exercises the option, or in other words, formally moves forward with the sale.
The lease agreement details the monthly rent amount, security deposit, terms of the lease, and other components regarding the rental of the house.
An assignment contract is used by the wholesaler to transfer their rights as specified in the above contracts to the new buyer.
Lease options can be tricky with many moving parts. It’s important for all parties to not only structure a sound deal but to make sure everyone fully understands their responsibilities and roles within the contract.
It is also important that the wholesaler and the seller/owner verify a clean title with a reputable title company. Clouds on title can create unnecessary delays in paperwork processing.
Additionally, properties that are pending foreclosure may not be suitable to enter into a lease-option agreement.
When the wholesaler works with the owner/seller, the option-to-purchase agreement and the rental agreements should include all of the rental and purchase terms, as well as include an assignability clause. This ensures the wholesaler can actually assign the deal to a tenant/buyer.
Do you have more questions about working with title companies? Learn more about how the title process works and how to partner with amazing title reps on your deals.
Understanding the contracts and required paperwork for wholesaling lease option deals is critical. It’s important for all parties to work with a real estate attorney so that everyone understands the moving parts, responsibilities, and consequences of the contract.
Structuring a fair and ethical deal for all the involved parties should be the top priority.
The following outlines two different step-by-step guides for wholesaling a lease option agreement:
The main advantage for the wholesaler in method #1 is getting paid much quicker.
The strategy is very similar to the method listed above except for the following:
If you utilize the wholesaling subletting strategy, make sure you gather accurate rental market data ahead of time. Rentometer provides a great estimate of average rents in your local market.
It’s quick and easy to gather real-time rental market data from Rentometer. Simply type in the address and beds/baths for a quick assessment of average rents.
As with any real estate deal, the investor should operate from a “win-win” mentality. This means making sure that all parties are aware of and agree to the terms of the deal.
Lease options are ethical when the tenant-buyer is aware of the term of the lease, the option fee (which may be forfeited if the tenant decides not to purchase the property), and the house purchase price/interest rate/terms.
The owner/seller should be aware of the assignment and of the tenant-buyer’s financial situation and agree to the lease and purchase terms if executed.
Many real estate deals that go poorly are often because unfavorable terms were written in or all parties were not aware of all terms. When in doubt, disclosure of the property condition and all contract terms is key!
It’s important for all parties to fully understand the lease option agreement. For tenant/buyers, asking the right questions and weighing the pros and cons will be especially helpful.
Are you a new real estate investor and unsure where to start? We’ve got you covered! Check out our
Wholesaling a lease option can be used in a variety of investing circumstances. It can also provide a new strategy for a distressed seller to consider.
Sellers will often want or need to sell their real estate for a variety of reasons. If a property needs to be sold but it isn’t moving off the market quickly, sellers may be open to creative solutions including lease options.
Wholesalers can use their traditional marketing methods to identify and locate potential owner/sellers and tenant/buyers.
Tapping into robust investing networking groups, REIA meetings, utilizing investor buyer’s lists, social media marketing, bird dogs, driving for dollars, signage, Craigslist, direct mail, using Google or Zillow, the Multiple Listing Service (MLS), door knocking and cold calling are all great methods for locating and screening potential deals and clients.
Wholesalers may also connect with local real estate agents and ask if those agents either have pocket listings that aren’t selling or ask if the agent knows potential sellers who would be open to other creative financing strategies.
Investors may also have success connecting with mortgage brokers. Many mortgage brokers have screened potential clients who didn’t qualify for a traditional mortgage. They may be in need of credit repair.
These brokers may be willing to pass on the names and contact information of these people.
If an investor works with a real estate professional to connect potential parties for a wholesale lease option deal, or if the investor is a licensed real estate agent him/herself, it is important that the investor understand the legal implications of the transaction.
Watch the video below to understand more of these legalities:
Wholesaling lease options can provide incredible flexibility, risk diversification, and creative exit strategies for real estate investors of all types and experience levels.
Since the process itself can be complicated, it is important to seek legal representation and ensure all parties have been disclosed to and are on the same page.
Once this happens, you will have a great strategy to add to your investing arsenal!
We hope you enjoyed the Ultimate Guide to Wholesale Lease Options!
What do you think about wholesaling lease options? Have you completed a wholesale lease option in your own successful real estate investing business? Tell us about your experiences and thoughts in the comments below!
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