What Is A Sandwich Lease?

A sandwich lease may seem a bit complicated at first. It also doesn't necessarily work well in all areas. However, when it does work, it is a great way to invest in real estate without much cash.

This technique has been used for a long time, but is still relatively unknown among investors. Essentially, you lease a property with an option to buy it, and then turn around and rent it out to someone else, also granting them an option to buy it. Their rent is higher than yours, of course, and their purchase price is as well.

A Sandwich Lease Example

You find a seller that has had some trouble selling his home. He has already moved, and has no immediate need to sell. He wants $132,000 for his house. You offer to lease the home for two years if he will also grant you an option to purchase it for $132,000 at any time within those two years. He likes the fact that you are offering full price.

You are honest and open with him about your intentions. You explain that you intend to improve a few things and sell the home for a profit. You will want the right to sublet the home as well. Here are the terms you finally agree to:

- The purchase price will be $132,000 - if you buy.

- You pay an option fee of $2,000. It is non-refundable if you don't buy the home, but applied to the purchase price if you do.

- You will pay rent of $1200 per month (the going rate).

- $200 of each rent payment will be applied towards the purchase price if you buy the home.

- You will be responsible for the first $100 of any necessary repairs each month. This means the seller won't have some of the usual headaches of being a landlord.

For the sake of this example, we will assume you are doing this in an area where real estate prices are rising quickly. This is where the technique will work best. If you have a list of potential buyers you are already in contact with, it works even better. Ideally, you want to have the place leased the day that you close on your lease, so you have no holding costs.

Your buyer is looking to lease a place because he may be transferred by his company. He would like to buy if he isn't transferred. You have the right place for him. Here are the terms you negotiate:

- The purchase price will be $142,000 - if he buys. You explain that at the current rate of appreciation, the home will be worth $150,000 in two years, which is when he will likely be buying it. Of course, he doesn't have to buy it. An option is just the right, but not an obligation.

- He pays you an option fee of $4,000. It is non-refundable if he doesn't buy the home, but applied to the purchase price if he does.

- He will pay rent of $1500 per month.

- $300 of each rent payment applies towards the purchase price.

- He will be responsible for the first $100 of necessary repairs each month. This means any costs beyond that are passed on to the seller as per your contract.

The lease period must be the same or a little shorter than yours, of course. Now let's look at the possible outcomes.

First of all, these kinds of leases are not that uncommon in some area of Florida, Arizona and California. Investors experiences in these places has been that the lessee often doesn't buy the property. What happens then?

You have no obligation to buy either. So if your renter doesn't exercise his option, you can let yours lapse as well. But where are you financially? You were paying $1200 per month, and collecting $1500, so after two years you have collected $7,200 profit. You also lost your $2,000 option fee, but kept the $4,000 fee you collected, adding another $2,000 to your profit. The owner is paying the insurance and taxes, and the renter the utilities, so you had no substantial costs.

Your total profit was close to $9,000 if the property was rented out at the same time that you signed your lease. You had a temporary cash outlay of $3,200 for the option fee and the first month's rent. But your renter gave you $4,000 for the option fee plus $1,500 for his first months rent. If you had to get a cash advance on a credit card for a month, it would cost you just $40 or less in interest to make this a no money down deal.

What if your renter buys at the end of the two years? Your fee of $2,000 plus $2,400 in rent - $200 times 24 months - is applied towards the purchase, so you need $127,600 at closing ($132,000 minus the credits). Your buyer is credited $4,000 for his option fee plus a $7,200 rent credit - $300 times 24 months. This means he needs $130,800 at closing ($142,000 minus the credits). Closing costs will be around $2,000.

You make $3,200 at closing, plus you took in $2,000 more for a fee as you paid, plus you made $7,200 in rent beyond what you paid. That's $12,400. After $2,000 or so in closing costs, you have a profit of more than $10,000.

I recently heard from an investor in Florida who did a deal just like this with a condo unit. In about 18 months he made a profit of more than $15,000. In other words, this can be done. Where it is less common, it may be harder to convince the owner to agree, as well as the subsequent renter.

Naturally the owner could just do what you intend to do with his property, so why does he agree to this deal? Because you are the one that will take the trouble to do it. You are the one who has the renter ready. The seller just wants his problem resolved quickly - and you are the one with the solution - a sandwich lease.