Watch Out For These Lease Option Pitfalls!
So, a coaching client asked me the other day if Lease Option investing was actually “risk free” as so many of the so-called “gurus” claim it to be. Sorry to burst your bubble sweet-pea, but there “ain’t no such thing.” Here are a few of the pitfalls of lease option investing that you need to watch out for:
Is the owner making the payment on the mortgage?
When you’re in a “sandwich lease option” and subletting to a tenant/buyer, you want to make sure the seller is paying his mortgage.
If he doesn’t pay, you can get wiped out in the event of foreclosure. You can always make up his payments and deduct it from what you would otherwise owe him. We have a clause in our contracts that says if we have to make a mortgage payment we receive a credit of two dollars for each dollar paid. But this is still a PITA, so you want to find out early if the seller is not making his payments.
Most banks now have a 24-hour toll-free customer service line that permits you to enter the borrower’s loan number and social security number to verify when the last payment was made. You may also be able to check the mortgage balance online.
Finally, you should always get the seller to sign an Authorization to Release Information. This will allow you to call the bank and discuss the mortgage with bank representatives.
Did you make all required Federal disclosures?
I’m astounded by how many of these new lease option “gurus” forget to teach their students about disclosure requirements. Or maybe they don’t know the rules either – but I digress. Even if you are not the owner of the property, you are required to disclose.
Federal law requires that the lessor of any rental property constructed before 1979 disclose the presence of any lead-based paint or hazards known by the lessor and provide the lessee with all reports in his possession. This applies even if you don’t own the property and are just “sandwich” leasing.
In addition, the lessee must be provided with an EPA pamphlet entitled “Protect Your Family from Lead in Your Home,” and be given a 10-day period to conduct an inspection for lead-based hazards. It is advisable that you have your tenant sign an acknowledgment that you have complied with these requirements.
What about State disclosure requirements?
Disclosure is the name of the game in real estate today. When in doubt about whether to disclose something to the tenant, do it and do it in writing. Some states have extensive disclosure requirements on leases and sales.
Be sure to check with your local Board of Realtors. They will be able to fill you in on what your state requires.
Remember: Buyers have a short memory!!
It’s easy to find a tenant/buyer for your lease option properties. The cash they give you up-front is non-refundable and tax-deferred income. If the tenant does not exercise his option to buy, you keep his money and find a new one. Sounds rosy, doesn’t it?
What the “gurus” don’t always tell you is that tenant/buyers who don’t exercise their option conveniently “forget” that the money isn’t refundable. They often sue you to try to get it back. This is why it is important to make sure your paperwork is in order and that everything is clearly spelled out.
We recommend that you have all of your tenant/buyers sign a Disclosure Form. If you would like a free copy of the form that we use with out tenant/buyers you may request a copy on our CONTACT form. We’ll be glad to send you a copy via email.
So, there you have it. A few ways that you can protect your lease options.
Thanks for reading. Be sure to leave your comments and questions.
Great post Bill!
I’m a BIG fan of lease options myself… but I don’t do “sandwich lease options”.
I always go for the deed, buy the property, then use lease options as my primary exit strategy.
Thanks for pointing out the pitfalls.
~ Patrick
… aka P-Rid
Good point Patrick! LO’s are a GREAT exit strategy! And that’s the thing, they can be incorporated into almost any REI biz model – flip the lease to another investor, do a cooperative assignment with the seller, or an old-fashioned SLO if it’s a property you might want to hold on to. Sometimes it’s pretty cool to be the “man in the middle.”
Awesome post, Bill! I’m glad you’ve opened my eyes to the world of lease options because its a great additional strategy to have and we’re going to profit tremendously for adding this to the toolbox. We’ll some be signing a lease option agreement for the first time for a tenant-buyer on a recently purchased rental property. I’m not sure if she’s really going to buy it in 2-3 years, but if she does its cool….and if she doesn’t…also cool because then we won’t have to buy another house to replace it. That’s the beauty of all of this.
Great post Bill, and great job on the new blog!
🙂
Helpful commentary – For what it’s worth if people are searching for a Lead Disclosure Information , I used a fillable document here http://goo.gl/sxY7wj
Great share Elene. Thanks!!