Ultimate Guide To Purchase Lease Options
There are several different property deal strategies that can generate good profit margins and the Purchase Lease Option is probably one of the best, although they are also one of the most complicated to understand. For this reason, less experienced property investors tend to steer away from this strategy, although it has the potential to be very successful, when it is well executed.
I personally have acquired over £1.2 million worth of property over the last few years from this strategy and over 40 properties that give me a profit each and every month!
What is a Purchase Lease Option?
A Purchase Lease Option is an agreement where an investor is able to manage a property rental on behalf of the landlord and then has the option to buy the property at a later time. It is sometimes referred to as a lease with an option to buy, which gives greater flexibility than if you have a lease with the obligation to go through with purchasing the property.
You can activate the option to buy the property at any point during the agreement, you do not necessarily have to wait until the end of the lease period.
Technically, a Purchase Lease Option involves two separate agreements, one regarding the lease and one for the purchase, but the two agreements are written into one contract. It includes:
- Monthly payment amount
One part of the contract covers the lease i.e. how much you will pay to the landlord on a monthly basis to lease the property and generate money from renting it out.
- Length of agreement
It should also include how long the lease agreement is for.
- Purchase amount
The agreement also covers the price that you will pay if you choose to buy the property at the end of the lease.
- Consideration fee
A legal requirement is that there must also be an upfront payment as part of the option, which could be as little as £1, to comply with the law. This financial exchange makes the agreement legally binding and is called a ‘consideration’.
Benefits of using a Purchase Lease Option
No large financial outlay
There are numerous reasons that property investors choose a Purchase Lease Option, with one of the key benefits being that it does not require a large outlay. If you negotiate the consideration to be a small amount such as £1, this is a property deal that you do not need to invest much money into, not initially anyway.
Compared to putting down a 25% or higher deposit, this gives you a way to start making money in property without having money behind you. The property owner benefits by getting a guaranteed monthly payment without the hassle of managing the property and they will usually be grateful to have someone take the burden away from them.
This type of agreement provides you with all of the options, while the property owner will probably only agree to this as a last resort after experiencing problems such as voids, or not being able to generate a profit because of repairs and other costs.
No mortgage required
One of the other advantages of a Purchase Lease Option is that you will not need to take out a mortgage, unless you choose to go ahead with the purchase later, by which time you will have had more time to build up a deposit.
Generate money from rent
You will be making money from renting the property out each month, in the same way that you would if you owned the property but without the financial outlay of buying it.
Pay the agreed amount even if value increases
The other big advantage of this type of deal is that there is a good chance that the property value could increase during the lease period, but you will still be able to purchase the property at the amount agreed. If the value of the property does increase, you will immediately have equity in the property. This will help you to obtain a better mortgage rate when you purchase the property.
More time to assess the investment
The lease period also gives you the time to assess whether the property will be a good investment as a purchase, by having a better idea of the projected profits you can generate from renting the property out. If you decide that it is not worth buying the property, you simply hand the property back to the owner at the end of the lease, as per the contract agreement.
You can sell the Purchase Lease Option
If you decide that you do not want to buy the property but it still represents a good deal for someone, you could sell your Purchase Lease Option to another property investor, making a fee on top of the rental profit you have made during the term of the lease. If the property increased in value by £5,000 for example, you could charge this for exchanging the Purchase Lease Option to the buyer, who would still be buying the property at market value.
Purchase Lease Option scenarios
The details of the agreement can vary from one agreement to another and will largely depend on your negotiation skills and how keen the property owner is to get the rental responsibilities out of their hands.
Scenario 1 – Equity
To provide an example scenario, let’s say you have made the following agreement:
The property is valued at £150,000 and this is the purchase price agreed.
- Lease will last for three years.
- You pay the owner £400 per month.
- You receive £600 in rent each month.
- Over the lease, you spend an average of £60 pcm on maintenance etc.
At the end of the lease, the property is valued at £165,000.
This means that you have £15,000 in equity if you purchase the property.
You have made a profit of £5,040 (before tax) over the three-year lease period.
You can decide to buy the property and continue to generate profit from renting it out. The other option is to sell the property, if you do not think it is going to be a very profitable rental property, based on the three years of managing the rental.
Scenario 2 – Sell your lease
Alternatively, you could decide to sell your Purchase Lease Option to another property investor who wants to rent it out (or anyone else who wants to buy the property), charging them a fee of £15,000 (or whatever suitable fee) to take advantage of the value increase in the property.
Scenario 3 – Walk away
If the property has dropped in value and you do not want to go ahead with the purchase, then you have the option of walking away and starting on a new project instead. You have made over £5,000 in the rental income, which you can put towards a deposit on a different property that have you calculated that you can make more rental income from.
How to negotiate a Purchase Lease Option
The Purchase Lease Option strategy is one of the least common strategies in property investment and many landlords will not even know that it is a possibility for them. For a Purchase Lease Option to be attractive to a landlord, they will usually be facing challenges with the property that are making their life difficult. Some example situations:
They will be experiencing problems such as bad tenants, ones who either do not pay on time or do not look after the property very well. The tenants could be contacting them all of the time to complain about maintenance issues or just generally taking up their time with lots of discussions about the property.
Not making enough profit
Another reason that the landlord might be open to negotiating a Purchase Lease Option is if they are not making enough rental profit to make it worth their while. Maybe they are spending too much on maintenance or have not been able to find the right type of tenant for the property. With a bit of work, you can make some slight improvements to the property that will enable you to request a higher monthly rent payment, giving you a bigger profit margin. Or you may be able to manage repair costs better than they do, for example, using your own tradespeople.
Cannot sell the property
Many property owners become accidental landlords, where they inherit a property or they are unable to sell a property for the value that they want for it, so they keep it to rent it out. They do not really want to be a landlord, or have the responsibilities that come along with that, so they will be happy for someone else to manage the property letting, as long as they can cover the mortgage, or have a guaranteed monthly payment.
You might be able to find this type of landlord by looking at houses that have been on the market for a while, usually where they have dropped the price a few times and still not had an acceptable offer.
One of the reasons they may not be able to sell the property, or at least not for the price they want, is because there is negative equity in the property. For example, they bought a property for £160,000 and a few years later, the property is valued at £140,000. If they were to sell the property for the value, they would have to find the extra money to pay the mortgage loan off.
Change of circumstances
A property owner might be willing to agree a Purchase Lease Option if their circumstances change, such as they need to re-locate for work. If they do not want the hassle of managing the rental of the property but they also want the option of moving back in the future, a Purchase Lease Option could be a good solution for them.
Other changes of circumstance such as getting divorce or losing their job could leave them in the predicament where they are best taking a Purchase Lease Option, either because there is negative equity, or they cannot find a buyer willing to pay the asking price.
How to find Purchase Lease Option opportunities
Now that we have highlighted the reasons that people are most likely to agree to a Purchase Lease Option, we can now look at where we can find these people and how to market to them.
The first step in the process is to find an area where properties are most likely to have negative equity. Some quick Google searches will reveal that the North East of England has been heavily impacted by a decrease in house prices in recent years. Even if house prices have increased again in the area, you should still be able to find property owners who bought at the wrong time, i.e. just before a fall in value.
The impact of COVID-19
Throughout the health pandemic, the property industry has faced a number of challenges, with the first lockdown preventing viewings or sales being completed. Many experts feared for the future of property investment, with no sales going through for the months of lockdown. However, with the government’s introduction of the stamp duty holiday from July 2020, this helped to encourage people to buy and take advantage of the potential savings.
The average house prices grew month on month from May 2020 for the next seven months before a recent slight dip. So, you might think that this means that lots of landlords will have equity in their property but while some areas have seen steady house price growth, others, such as some parts of the North East have seen house prices decrease over the years.
According to the Property Reporter, the City of London has seen property prices decrease by 12% over the last year. This is largely attributed to the fact that the lockdown restrictions changed people’s idea of where they ideally want to live. Suddenly, the sought-after city center location, close to work and the buzzing nightlife is just a small property with no garden space or local beauty points.While buying property in the City of London might not be part of your Purchase Lease Option strategy due to the cost of property in this area, this change in demand for location is worth taking note of. If the pattern of homeowners looking to move out of the city to a more rural location continues, this could mean that other cities are affected in similar ways, which could open up more opportunities for Purchase Lease Options, with landlords who are unable to sell their property in the cities.
Marketing to find Purchase Lease Options
There are a few different ways that you can send marketing and connect with homeowners who may be open to a Purchase Lease Option arrangement. Both online and offline options work, such as:
You can pay to display ads on Facebook and/or Google that will target people who have been searching for options to resolve their problems. The ads can also target people who are in landlord groups, or who have property investment listed as one of their interests, for example. The paid ads will send them to your website to find out more information about how you can help them to resolve their problem.
Direct mail to areas
Sending a letter to a list of properties in an area that you know has been affected by negative equity could also work well. You can also focus on streets with the type of property you are looking for, in terms of price range and also number of rooms, location etc. If your strategy is to find properties that you can rent to students, you will obviously be targeting areas that are close to universities.
Use property portals
Looking on websites like Rightmove will allow you to find properties that are priced at higher than their value. Look out for properties that are priced higher than similar ones in the area.
Some sites also show you how long properties have been on the market for and you can target both advertised rentals and sales. You can use Zoopla to find the last purchase price of a property and also the estimated current value or look for rental prices that look high on properties that are staying advertised for a while.
Zoopla is a really good tool for finding properties for Purchase Lease Options, you can try different postcodes in the search function and it will even tell you the value change over 3, 6 and 12 months and 5, 10 and 20 years. So, if you spend some time researching areas, you will be able to find properties that have fallen in price since the date that the owner bought it.
How to pick the right Purchase Lease Option
A good Purchase Lease Option involves more than just finding a property that has negative equity in it, you also need to make sure that the rental profit is going to make your efforts worthwhile. You will need to carefully inspect the property to check you are unlikely to be paying out for a lot of maintenance.
Some Purchase Lease Option contracts stipulate that the property owner will pay for maintenance that is over, say £100. So, if you are looking at a property that looks like it could have a lot of problems, you need to agree something in the contract, so you are still able to generate a good profit over the lease term.
What should the Purchase Lease Option agreement include?
Firstly, it is always a good idea to use a solicitor to help draw up the contract, to avoid any legal problems further down the line. For example, the owner could decide they do not want to go through with the sale at the end of the lease, so you want everything to be legally accurate.
As we mentioned earlier, there are two separate parts to the agreement:
- The lease agreement (including your monthly payment, arrangements for repairs and other conditions).
- The option agreement (how long the agreement is for, the purchase price and how much you are paying up front).
The owner will be looking to cover their mortgage at a minimum, so you will need to decide what you are willing to agree as a monthly payment to enable you to make enough money. You should do plenty of research regarding the rental prices in the area, to ensure you will be able to find tenants willing to pay the amount you need to make it worth your while.
Remember, you may not want to buy the property in the future if the house value does not rise, in which case you will need to approach this agreement as though you are doing a rent-to-rent, where your main priority is to generate money through the rent.
You need to see the Purchase Lease Option as a possible additional bonus outcome, rather than a guaranteed capital profit, or profit from selling the Purchase Lease Option to someone else.
Other factors to be aware of with Purchase Lease Options
As well as making sure that the agreement is legally binding and that the contract includes everything you need, an important part of making the Purchase Lease Option strategy work is having a good relationship with the property owner.
This could include giving them regular updates about the condition of the property, keeping them in the loop about the type of tenants who are living in their property but not contacting them so much that they feel they are still too involved. The whole reason they agree to a Purchase Lease Option is so that they can take a back seat, so just update them with good news, unless you need to contact them about something that is unavoidable.
Finding a good Purchase Lease Option agreement is a win-win situation but it can involve quite a lot of work in finding landlords who are willing to agree to your conditions.
However, once you fully start to understand and build up experience with the strategy, it can be a very profitable one. You might even come across a property that is ideal for a Purchase Lease Option, rather than actually going out specifically to find one, so keep this option in mind now that you know more about it.