Purchasing lease options is a lesser-known investment approach utilised by property investors to manage real estate inexpensively whilst ensuring robust income.
On the contrary, investing in rental properties is a well-established and universally recognised method.
Such an investment offers a plethora of benefits, such as consistent income, value increase, reductions in mortgage, amplified returns due to leverage, and tax incentives, among others.
So.. which is better? Lease Options or Rentals?
If you’re seeking an affordable and rapid expansion approach with healthy income, lease options are the superior choice. However, if you’re aiming for complete control of your investment, enhanced tax benefits, reduced potential for loss, and the opportunity to tap into your equity, then traditional rental property investment is the way forward.
However, delving deeper into the distinct components of each investment method and discerning which stands out over the other (and crucially, which suits you best) is essential. We’re set to explore all these facets, so let’s get started!
What Is Lease Options?
A lease option is a contract that provides a tenant the opportunity to buy the leased property either during the lease term or at its conclusion. This arrangement also restricts the landlord from selling the property to other potential buyers. At the term’s end, the tenant has to decide to either proceed with the purchase or relinquish the option. This is commonly referred to as a rental agreement with a purchase choice.
A lease option provides a potential purchaser with greater leeway than a typical rent-to-buy contract, where the tenant is obligated to purchase the property at the lease’s termination. The property’s price is predetermined by the tenant (the prospective buyer) and the landlord, generally based on the present market value. This arrangement enables the tenant to lock in the current value for a future purchase.
For this privilege, the landlord usually imposes an initial fee, which could be around 1% of the property’s selling price. If the tenant opts to acquire the property after the lease, this fee contributes to the initial deposit. Lease options are particularly beneficial for those improving their credit rating or lacking adequate savings for an initial deposit. Nonetheless, several aspects of lease options should be weighed up.
Common Strategies with Lease Options:
Offer Lease Option to Prospective Tenant-Buyer
In this case, you hold ownership of the property and form a lease option agreement with a potential tenant-buyer. You receive the option fee and secure a long-term tenant. This mirrors the traditional “rent with a view to purchase” deal occasionally promoted.
This is merely a different approach to letting and selling a property you own. It’s not the specific lease option investment focus of this piece.
Acquire Lease Option from the Property Holder
This represents the other facet of the lease option deal. In this scenario, you act as the tenant-buyer. Consequently, you remit an option fee to the property owner and secure an extended lease agreement. This approach is the central theme of this piece.
Your aim should be to obtain a lease that permits you to sublet the property to another tenant. Ideally, you should also secure a lease with a rent that’s below the market rate. It’s sensible to persuade the owner that such an arrangement is fair, given the longevity of the lease you’re offering.
Subsequently, seek out a tenant prepared to pay the going market rate and lease the property to them. The margin between the rent you’re charged and what you charge your tenant becomes your profit.
This process can be replicated across various properties, forming a steady stream of income.
This method epitomises the quintessential lease option approach, favoured by investors who might not have the resources for an outright property purchase but are keen to venture into the rental market.
Starting this doesn’t demand substantial capital or impeccable credit history. Nor does it require a robust income since bank loans aren’t involved. The primary necessities are a reasonable option fee and a cooperative property owner.
Note: An alternative to this method is known as the sandwich lease option. In this variation, after procuring a lease option as described above, rather than offering tenants a conventional lease, you provide them with a lease option to purchase the said property.
What’s the Typical Option Fee in a Lease Option?
The general guideline for a lease option fee stands at 1% of the buying price, but there’s usually room for negotiation. Although this fee isn’t returnable, it can frequently be offset against the property’s purchase should you decide to go through with the buy.
Option fees can vary widely, spanning between 1% to 5%. Thus, adept negotiation capabilities are crucial to secure a favourable deal.
Naturally, discussions will also encompass the term of the option, commonly ranging between 1 to 3 years, though longer periods are more advantageous. The lease’s tenure generally mirrors the option’s duration.
you need a thorough comparison of lease choices against investment in rental properties. Both strategies tied in outcomes, hence no clear winner. Though I dislike inconclusive endings, your preference is pivotal. Opt for lease options if you seek economical entry into real estate with rapid growth and substantial cash flow. Conversely, opt for rental property investment if control, reduced risk, location flexibility, and resale value are paramount.