As a real estate investor, you’re likely looking for ways to continue acquiring properties while investing less money of your own. This strategy allows you to continue controlling properties and generating income without having to spend your cash (and a lot of your time) saving for down payments and going through traditional lending processes.
Table of Contents - Finance Corner: Sandwich Lease
If this sounds appealing to you, you may be interested in the sandwich lease. With a sandwich lease, you first lease a property from the owner. Then, you lease the same property to a tenant who is interested in eventually owning a home. In this analogy, you as the lessee and lessor are the delicious filling between the owner/tenant bread slices.
Sandwich leases are ideal for investors with low amounts of capital who are looking to enter the real estate market. You can start a sandwich lease with no down payment, and you don’t have to involve a bank.
How a sandwich lease works
To initiate a sandwich lease, you first need to locate a seller in a position where they need to move on from the property but are unable to sell and are uninterested in leasing themselves. You then sign a lease-purchase agreement giving you the option to buy the property in the future, usually three to five years. The sale price is agreed upon in the contract. You will make the monthly payments and provide an option premium to help them relocate. Your monthly payment needs to be low enough that you can comfortably rent it out for more each month, which provides you with your income.
At the same time, you’re working to secure a tenant/buyer interested in a rent-to-own situation. If the tenant likes the property, you sign a lease-purchase agreement with the tenant/buyer. This agreement is the same length as the one you have with the owner. The tenant has the option to buy the home before the agreement expires if ready. The price outlined in the agreement is higher than the price in your agreement with the owner. You charge the tenant/buyer the same option premium that the owner charged you so that this exchange costs you no money out of pocket. The monthly rent is set at a higher rate than what you’re paying on the property.
In the interim, you are generating a profit each month from the difference between your rental income and house payments. When the property finally sells, you’ll collect the difference between the two prices outlined in the agreements.
Everyone likes a sandwich (lease)
Sandwich leases benefit more than just the investor. If the owner has had trouble selling the property or needs to move quickly, they can move out of the home without making any more payments. This assumes that the owner is comfortable with the investor subletting to another tenant and that the owner does not want to manage the property as a landlord or lessor themselves. They can move on without having to worry about the property until it’s time to sell.
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This situation is also ideal for the tenant/buyer, who is interested in buying a home but is not in a strong enough financial situation to do so. The tenant may need time to rebuild credit after a financial setback or hasn’t saved up enough for a down payment. Whatever the case, the lease scenario allows them the opportunity to move in and eventually own a home they may not otherwise be able to access.
Naturally, the sandwich lease system is beneficial to you as the investor as well. With the sandwich lease system, you make a decent profit upfront and an even bigger profit when the tenant/buyer closes the deal. In the meantime, you’re generating income from the rental by charging a higher rate than your lease obligation to the seller. You’re providing an essential service to the owner and the tenant and will be rewarded for your efforts.
Risks of initiating a sandwich lease
Initiating a sandwich lease can be labour-intensive and comes with some risk. You need to be a strong communicator and negotiator to secure an agreement that’s in your favour. A successful sandwich lease requires both finding and obtaining the right property to lease and finding the right tenant at the right rate to sublet the property. Initiating an agreement with the owner without having a tenant in place could end up costing you your money.
Your work may not end with the upfront negotiations. You may also have to manage and maintain the property and serve as the main point of contact during the tenant’s stay. While rent-to-own agreements usually put the onus of maintenance and repairs on the tenant, it’s something to keep in mind.
For a sandwich lease to work successfully, all parties need to do as they’ve agreed. If the owner does not vacate the property on time or leaves it in a poor condition, you could risk losing the tenant/buyer you have lined up. The owner might file bankruptcy or may not be making their payments on the property, causing it to become foreclosed. This would prevent you from being able to sell it to the tenant/buyer.
If you are unable to deliver the property to the tenant/buyer, even if it isn’t your fault, you may need to repay more than just the option payment. The tenant likely invested their own money in making improvements to the home. Assuming the tenant performed all of their obligations under the agreement, they may be able to sue for the money spent on upgrades. They may also be able to claim fraud since they paid for a home that they believed would be theirs.
If the tenant/buyer does not make monthly payments or no longer continues their obligations under the agreement, you still have obligations to the owner. You could be left paying for and eventually buying the home yourself.
Sandwich leases are an excellent option if all of the right pieces are in place. With a willing seller and an eager buyer, you can add a property to your portfolio with little money and maintenance.
Lease Option Contract - Sandwich Lease - What is a Lease Option - Part 4
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