When Kim and I were new investors, debt leverage didn’t bother us one bit. We didn’t consider many deals to be too risky. We were young. We were hard chargers.
That was nearly 30 years ago. Today, Kim and I are in our sixties. We’re focused on safety – we don’t want to lose all our gains. We seek to avoid bad decisions that can allow our little empire to be stolen from us.
There are a lot of gurus out there who sing the virtues of debt leverage. They rightly claim debt leverage magnifies growth, but they fail to tell the full story. Debt leverage is a double-edged sword. It cuts BOTH ways. Sure, debt leverage magnifies growth, but it also magnifies loss. Ask yourself this question: What’s the FIRST word in bankruptcy?
As you will learn at The Power of Pure Options, Options allow us to capture the same benefits most other investors capture, but we’re able to do it without using risky debt leverage.
Master Lease with Option – verse – Debt Leveraged Purchase
Right about now you may be scratching your head wondering how Master Leases combined with Options can be a safer way to structure a creative real estate investing deal. Well, seeing is believing.
Normal Purchase Structure
Due to relocation, a seller is selling her house. You agree to pay $250,000. You get a non-owner occupant mortgage. You put down $50,000 (20% down) and agreed to make 360 payments of $1,330.61 at 7% interest.
The property rents for $2,500. Your expenses (taxes, insurance, repairs, vacancies, management) run 40% of rents, which totals $1,120. After paying the mortgage payment and the expenses you net $349 in monthly cash flow.
Each month, no matter what, because you own the property, you’re responsible for all expenses and upkeep.
Master Lease with Option Structure
Same property, same situation.
The property owner bought the home five years ago for $150,000. She got an owner occupant mortgage. She put 10% down ($15,000) and agreed to make 360 payments of $561.91 per month at 2.9% interest.
Because you’re unsure which way the real estate market is headed, you choose to not be on the hook for ownership and a new mortgage.
Instead of buying the house, the owner agrees to rent you the house. Built into the lease is your right to lease the house to a tenant of your choosing. This is called a Master Lease (AKA Wrap Lease or Sandwich Lease).
The owner agrees to be paid a monthly rent of $1,562, giving her a gross monthly rental profit of $1,000.
The owner owns the home, she is responsible for making the mortgage payment, paying the property taxes, paying the insurance, and paying for repairs.
You rent the home to your tenant for $2,500 per month. From this you subtract your rent payment to the owner of $1,562. This gives you a monthly net cash flow of $938.
Comparing this to buying the property, which would you prefer to make each month, $938 or $349? This is a $589 difference in monthly cash flow!
Our deal does not stop there. The property owner also agrees to give you the right (Option) to buy her house anytime in the next 10 years for $250,000.
Do you see with this Option structure you’re able to capture all the property’s appreciation over the next 10 years without having the risk or ownership or market swings? Let’s say the property increases in value 3% per year. This would equate to an appreciation amount of $87,338.
With the Master Lease and Option, you were able to dramatically increase your monthly cash flow. In addition, instead of betting that appreciation will occur, you wait for it to occur and only then do you exercise your right to buy the property and pocket the profit.
If you were given the choice, which structure would you choose if you were the one doing this deal?
Listen carefully, can you hear Mr. Option singing, “How do you like me now?”
