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PS. It is definitely their responsibility to come up with the call price at the end of the lease. And if they are maxed out and cannot afford it, your goal of helping them will turn into a nightmare for them.
If I was a homebuyer I would love you!!!!…..But as an investor I’d say that you are taking a MASSIVE BLOW!!! However, it really depends on your goal of the lease option…If your goal is to add capital value or cashflow or both. Although to me it seems like you are avoiding both potential Cap and cashflow return gains by being far too generous to the option holder and ignoring your potential profit for the risk involved (for instance you could buy and hold and still make that capital gain or even better in a stagnant market-in less than five years) . I really want to caution you with these figures because I think you are taking a massive risk with your absolutely minimal cashflow return relative to the pittance of capital growth you will realize; thereby seriously degrading your CoCr. You see, if you have a rental of only $210 and a purchase price of over $200,000 with closing costs included, you are receiving a cashflow only on a ratio of approximately 0.8-0.9:1 like most negatively geared properties, and so what is the investing sense of paying the bank (out of pocket) for 5 yrs so someone else will be able to afford a home. You may be providing a solution for someone else, but you are definitely not profiting yourself from it, because the negative cashflow from this deal will diminish your overall profit from the option call after 5 years, not to mention the negative affect of the small asking price and option fee you charge. If your ratio were more like 1.4 x every 1000 (of purchase price) rather than a meager .9, then you would be having recurring positive cashflow, plus you would solving someone’s housing difficulties. I think you need to either pass the deal, or re-negotiate the terms-particularly the amount of rent that is credited to the option. That would mean you would need to start fogetting about quickly providing the LO tenant a 20% deposit quickly and start thinking seriously about the potential risks you face. If I was making the terms on a five year basis, I would increase the option fee by about $3000 and increase the asking price by about 10%, then I would retain $280 rental, while crediting $80, thereby making my position cashflow positive…I would then source a tenant who could utilize FHOG and leave the rest of the deposit saving to the LO tenants whom i’m sure would be confident they could put aside 10% of their salary towards the deposit every week/month etc. over the course of the 5 yr lease. Hope you don’t go ahead on the current terms
sincerelyyidn
Celivia, thanks for asking;
Yes it does mean the risk is larger than usual for the option *buyer*…..but that risk is manageable to the extent that you both work meticulously with them to make it both affordable, sop they don’t rescind on the option early, and a very real possibility that they will one day own the property they intend to purchase at a later date from you. This is not a widely used strategy and is thereby very under-regulated which from an investors’ standpoint is favourable, but I do think you bring up a great point about the risk managability of the whole thing. It concerns me also
kind regards, Yidn
thanks for your advice paul, greatly appreciated
regardsyidn
I would have assumed that there is no need to re-value a property after a contractual lease-option expires, as the contract already dictatess the strike price and the client would therefore have to take a loss, or alternatively, negotiate a renewal of the LO if you were amenable to the idea. Please correct me if i’m wrong, but just as a put option is exercised at the contractual date and value for a stock, as opposed to the market value or inherent value of it on that strike date, so too a market fluctuation downwards for an option strike price in property would be negated. Please don’t take my word for it, I am as much of a novice regarding lease-options as you.
Thankyou everyone for you comments!
In response to Celivia’s doubting the win-win nature of the lease-optioning strategy I propose to undertake, I respond by saying that I would discourage any client to be entering an agreement they do not understand fully, and which does not benefit them after I have disclosed my profit intentions, the reasons for the risk-management nature of the rental mark-up, and the great benefits they will ascertain from the deal; namely the capped sale price held under the call option, regardless of capital appreciation over the term of the option. And regarding redrawing equity- that will be under my title and will be refinanced under my mortgage I assume, & not the title that is transferred after a presupposed call option is exercised. I think this will thereby not affect the worth of their property if they wish to transfer title after my redraws. Furthermore, their greatest *WIN* is that they have found a property which is not merely a transitional premisis to rent out, but a place they ultimately will like to buy and live in permanently for whatever reason, aesthetically appealing; cannot be financed under conventional means, age etc.; I am hoping to negotiate a balanced outcome for the client by fully dislosing my intentions in regards to the benefits I am seeking as an investor; namely the ability to duplicate my property investments through redraws of equity within the property I still have under my title, and to increase my DSR for this purpose through the rental mark-up, all in exchange for an affordable and desirable property they may own at their leisure and at an affordable rental level that they would otherswise be unable to own under conventional means. BTW, I thankyou for your pertinent questions Celivia, Dr X , Paul and Richard, you have been most helpful!
thankyou
Yidn
