Lease Options: A Powerful Property Investing Strategy

As a property investing strategy, lease options may be one of the least understood yet have one of the highest profit potentials. This is a technique that is common in the United States and is catching on fast in the UK because it allows you to control and profit from properties you do not actually own —and you can do it even if you do not have much cash.

Let's begin with a few definitions. An option is a contract that gives the holder a right or option to buy or sell specified property at a fixed price for a limited period. A lease option is a lease under which the lessee has the right to purchase the property; generally, contracts covering let-to-own agreements are lease options.

Here is an example of a simple lease option transaction: You find a property for sale for £75,000. You can afford the monthly payments, but you have a poor credit rating and cannot get a loan and you do not have much cash for a down payment. So you offer to purchase the property under a lease option.

Your lease option proposal looks like this: You agree to buy the property in two years for a price you determine today and rent it between now and then. When negotiating the purchase price under a lease option, typically the buyer offers a little more than the current asking price, but less than what the property is expected to be worth at the end of the option period. In this case, let's say the per annum capital growth rate is 10 percent. That means in two years, the property is expected to be worth £90,750—but of course, there is no guarantee that growth rate will continue. It might be higher or it might be lower. So you offer £83,000—more than the property is worth today but less than it will likely be worth in two years.

In the meantime you will lease the property for £675 per month, which is slightly higher than the market rent rate. Of that monthly payment, £200 is credited to your down payment for the deposit on the property. In two years, your credit rating will have improved and you have a deposit of £4,800—more than five percent of the offered price. So at that time, you exercise your option and buy the property for £83,000, which (if market appreciation has performed as expected) is under market value, so you have equity from day one of ownership. The seller has benefited from receiving above-market rent for two years, which has covered his payments and likely provided him with positive cash flow, and then selling the property for a price higher than his original asking price. And during that two years, he received all the tax benefits of owning investment property. Everybody wins.

What if the market has declined and the property did not appreciate as expected? No problem—an option binds the seller but not the buyer. You can either walk away from the deal or negotiate a lower price. And if the market appreciated at a faster rate and the property is worth more than £90,750—that is a bonus for you, because the seller is obligated to your agreed-on price of £83,000.

There are a number of different ways to use lease options. If you do not already own your home, use a lease option to buy a personal residence. Or you can use a lease option to acquire control of an investment property that you then let to a tenant. If you have a property you want to sell, consider selling it under a lease option.

You must carefully attend to the details with lease options, but once you know how to set them up, they can be very rewarding.

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