Many of you likely know what a sandwich lease option is… and many others are probably wondering: What the heck is a sandwich lease option?
As far as I’m concerned, sandwich lease options are an incredibly compelling real estate investment strategy. In fact, I think lease options are the best strategy for all market conditions — because they offer control without ownership.
What is a Sandwich Lease Option?
With a sandwich lease option, you make a nice profit upfront, and then an even bigger profit when your end-buyer closes the deal, usually in about a year. In between, you earn positive cash flow by charging a rent that’s more than your lease obligation to the seller.
And, if by chance the deal falls apart in the end, it goes right back to the seller because you never owned it in the first place! I mean, you didn’t even have full responsibility as a landlord while enjoying the sweet earnings that come from this REI strategy.
Pretty awesome.
How to Close a Sandwich Lease Option
So, the sandwich lease option is a great way to control a property for profit for very little money… but it can be a little difficult to close the sale transactions. You generally have 2 problems when your name does not appear on the title:
Problem #1: If you become involved with an unscrupulous seller, they may try to take the profit you have built into the deal. See, when they learn that you have a future sale for more than they sold it to you for, they might approach your tenant-buyer and offer slightly better terms for the same price and close the deal without you.
Not cool.
But, there are 2 ways you can deal with this and it’s best to use both:
- Be completely transparent with the seller about what you’re doing. Let them know before you enter into the first purchase option that you will be bringing in a tenant with their own purchase option. After all, that’s why you’re in the deal. This should weed out any seller who intends to go around you at closing.
- Cloud the title. Now, this gets a little tricky to explain because state laws vary considerably. But, a common way to do this is to record a Deed of Trust or Mortgage with a performance rider. The performance rider requires the seller to pay the difference between your buying and selling prices. However, some state laws require monetary compensation to record a deed or a mortgage. There’s nothing illegal here — it’s just complicated by different laws in different states. Be sure to use the services of a competent local real estate attorney to set up and complete your first several sandwich lease options.
Speaking of transparency, you want to be fully transparent with your tenant-buyer too…
With the options in place and a good relationship with both parties, you can have the seller directly contract with the buyer for closing and have your profit paid as a referral fee on a HUD-1 form…
Problem #2: Using this method also helps you get around the FHA seasoning requirement. As it stands now, for a buyer to qualify for an FHA guaranteed loan with the current seasoning requirement, the borrower must have made at least six payments on the FHA-insured mortgage that is being refinanced; at least six full months must have passed since the first payment due date of the mortgage that is being refinanced; and at least 210 days must have passed from the closing date of the mortgage that is being refinanced.
Why is there an FHA seasoning requirement anyway?
To protect people from scams. See, way back when [stop me if you’ve heard this before… ;)], a mortgage broker, Realtor and inspector got together to artificially inflate the price of a house and sell it multiple times, eventually leaving the FHA holding the bag as a loan insurer when they stopped making inflated mortgage payments… and walked away with huge profits from multiple sales.
Of course, not all lenders require a seasoning period. As a real estate professional, you should have a relationship with trusted and knowledgeable mortgage brokers who can arrange for your buyer’s mortgage through a lender who does not have this requirement.
With those business relationships in place, you can also use an escrow company or a closing attorney to do simultaneous closings. Why? You never have to have money in the deal when both deals close simultaneously, and you collect your check for simply putting it together.
So there you, closing sandwich lease option problems solved…
Maybe you’ll think about doing a sandwich lease option on your next deal.