The concept of the Lease Option is excellent in theory. A property owner leases a home to someone who cannot currently qualify for a mortgage loan. They do so with a specific and separately written agreement that tenant will acquire and purchase the home in a specific period of time. Normally the tenant gives a significant upfront deposit that is forfeited if he or she does not follow through with the purchase. If executed as agreed, both parties mutually benefit. The home owner / investor sells a house for a profit and gets an income stream immediately while waiting for the purchase to be complete instead of letting it languish on the market. The tenant does not have to rent while they recover from the economic event that left them unable to purchase and they get to lock in today’s price for a time period that may be several years.
Unfortunately in practice, lease options are often plagued with challenges.
Today I will share with you the top 5 reasons lease options fail and why working with professionals like a qualified credit repair organization and property management company can help all parties circumvent some of the pitfalls and increase the ratio of closed sales via lease options.
5. A bird in the hand is not necessarily better than 2 in the bush:
Many property owners become overeager to place someone in their property. With tax payments and overhead, it is understandable. It can be enticing to accept the potential tenant’s word that they can resolve their credit issues. Without a third party opinion, there is the belief that the problem can be resolved even if it is near impossible.
A property management company can work in tandem with a credit repair company to help choose the best candidate as well as bring in a lot of candidates through professional marketing so that home owners have more options. As a homeowner you will have a much better idea up front of how things will work out.
4. The hurry up and wait scenario:
I cannot count how many property managers have sent applicants to us for a pre-screen, and then never require them to enroll in our program. The owner may even say, they have to enroll, but I am giving them the keys on Monday. Monday comes and the tenant creates 1000 excuses as to why they have to wait to enroll. 90% of these applicants never enroll and usually fail at closing.
Whether it is credit repair, consumer credit counseling or bankruptcy, the rule should remain the same. If the applicant needs financial or credit assistance, you MUST have them enroll in that program prior to letting them take occupancy. Think of it as getting married to a gold digger without a prenuptial agreement. Just don’t take the chance.
3. No skin in the game:
Another misstep we often see is that the property owner says they want to pay for the credit repair for the tenant. As much as we like getting paid, we literally will not allow property owners or managers pay for the entire service.
Tenants that have their credit services fully paid for, almost never follow through. They have no cash commitment and already have the keys to the home. This is a recipe for disaster and almost always ends up in an unhappy relationship.
At Credit Repair Resources our lease option clients must pay their own initial enrollment fee. We are open to, and encourage, reimbursement for success in our program, but require our clients show the commitment to lasting success. Some owners create an incentive plan to encourage the tenant to become mortgage ready ahead of the deadline. If you work with Realty Trust Services, they charge a non refundable option deposit which really commits the tenant to the process. Depending on the negotiations money from this might be applied towards the cost of credit repair.
2. Unrealistic expectations:
Recovering from an economic event can be extremely challenging. Credit repair is one component of the process of regaining financial control. Life continues to happen and the best laid plans… well you know. Some property owners put tight time restrictions in place for their tenants. “You have 12 months to get yourself straightened out or you are out” is a common statement we have heard. The philosophy behind this is to motivate the tenant to take action.
The challenge with this ideology in regards to lease options is that many times the property owner is not being realistic of the resources and capabilities their tenants have. If you ask a tenant if they can save $3000.00 by this time next year, they most likely would say yes.
Even if this is realistic in the moment, the day they get their keys there are countless places they will allocate their funds before adding to the $3000.00 fund. Couple this with the cost of restoring their credit and you have a losing proposition.
Our suggestion: consult with your CRO partner to get a true picture of what it will take to turn their credit around based on the income and resources they have available. Create a timeline and plan that can be reached comfortably and you will be much happier in the end.
1. Communication and follow through:
That’s right, the single biggest reason we see lease options fail is the lack of follow through by the tenant and communication between the two parties about the progress. As much as the tenant wants to make good on their commitment, restoring credit takes time and consistent effort. In some cases it takes more than a year to fully recover from a major economic event. Staying focused can be difficult.
Although the property owner has a vested interest in their tenants’ success, they have their own life and responsibilities to attend to. Micromanaging their tenants should not be a priority.
A strong CRO partner will provide detailed updates on a scheduled basis. These updates should reflect the true status of the credit repair process, the execution of the tenant’s action plan and the affect it is having on their credit scores. This will provide transparency for all parties and hold the tenant accountable throughout the life of the agreement.
Lease options are an investment and every investment has its inherent risks. I hope the above information provides some insight on mitigating some of them.
Chad Kusner is President of Credit Repair Resources. He has more than a decade of mortgage lending experience and partnered with 20 year consumer litigator. Chad has spoken nationally on industry practices and serves as Executive Director for NACSO, the credit repair industry’s trade association. Credit Repair Resources was voted the Best Small Agency in America for 2012 by the largest ranking site on the internet and continues to prove itself as an industry leader. Feel free to contact Credit Repair Resources at CR760.com or (888)9-CRR760
If you are seeing all the great deals out there and want to get a great rental property before all the deals disapear, my advice is not so fast. The waters here are great for surfing but they are infested with SHARKS.
For instance it is not entirely unheard of to purchase a rental in Lorain County for $10,000 put $10,000 into it and be able to rent out the property for $700 per month. At first glance that means you will get your original investment back in 2.3 years. Not bad. We have seen better deals than that come across our desk and lesser deals (See our web form below join our investor list. ). However if you don’t know the area you might be in for some 30% plus vacancy that could significantly effect your profits. Or maybe you thought you could get 700 but after 6 months of trying you have to lower it to $450. Still not a terrible deal compared to many investments today but maybe not as good as you could have gotten.
1. Location, location, location.
Carefully consider exactly where you are buying. There are many out of town investors that look only at the numbers. However if you don’t know location you need to make sure you have someone who does helping you understand the benefits and drawbacks of a specific location. Some areas look great but simply are not desirable for a whole lot of reasons. Other areas don’t look good but actually are in demand.
One strategy for evaluating location is to consider the target market you think a home will be for. Is this home likely going to attract a you family based on the lay out and size? If this is the case then proximity to good local schools will be something for you to evaluate.
Other factors for your consideration are:
Also consider location in the cost of landlord insurance. Your zip code effects your insurance rate big time.
2. Get on the knowledge train…
Make sure you understand the processes and legal obligations involved in renting out a property. One small slip up in how you advertise can mean a fair housing violation for you. Fair housing violations are very very expensive. There are also numerous requirements for paperwork to cover your tail and make sure you you have expectations properly set with your tenant. Do you know what lead based paint disclosure is? Ohio law requires it in properties built before 1978.
Make sure you understand the true costs when purchasing a rental property. They can bite your arm off. One benefit of the current market is that the low prices of homes are making cash purchases a reality for many potential investors so the risk of jumping in is much lower. Even if costs eat you alive your return on investment will likely be better than than the stock market or a CD. Still it is very possible to lose money with an investment property and it is important that you do your research (hint- an investment property specialist can really help here- see below).
The following should be factored in:
Rental property insurance is an absolute must. If you are renting your property out then you certainly will not qualify for a standard home insurance policy. Vacant homes that are not rented are even a bigger insurance hassle and you want to make sure that you are on board with a good insurance agent. Email us for a referral (email@example.com).
Also you want to make sure that you are properly insured to protect your assets. Although there are many other asset protection strategies in the form of separate entities like trusts, LLC’s etc (contact us if you want an attorney referral for this at firstname.lastname@example.org). Our company has a $1,000,000 E & O policy and our Investment Property Management Company has $1,000,000 in insurance for repairs made to our clients properties as well. For a Landlord an inexpensive umbrella policy would help protect against the freak lawsuit that could otherwise wipe away all the assets you have worked so hard to acquire.
4. Maintenance and upkeep
You’ll need to inspect your property at specific intervals and make sure that the tenant is not destroying property faster than what you might expect from normal wear and tear. It is vital to make sure that a property is inspected reasonably soon after a tenant first moves in just to make sure they aren’t quickly destroying it.
Failing to maintain a property can result in injury to the occupants and then a lawsuit. Also an unmaintained property is difficult to rent out to good paying renters. It helps to have a reliable contractor on hand who can quickly do any work necessary (hint, hint… we can help with that- this is one benefit of professional maintenance. and you won’t have 1AM calls for help). For instance plumbing repairs and furnace repairs must be done immediately in order to avoid a certain and expensive vacancy.
5. Finding GREAT tenants
Promoting your property is an art in it self. Different areas need different marketing techniques to find the best tenant for the area. Also some areas will simply attract a different kind of tenant than other areas. It is important to understand various areas and the best marketing for each area as well as how to screen tenants(see our tenant marketing strategies article here).
With more than 45 years of investment property management experience our expert team can relieve you of the burden of managing your rental property while saving you some serious money! Call us today at (440) 220-7300 to see how we can help you!