15. Sandwich Lease Option


OVERVIEW

  • A sandwich lease is technically subleasing or subletting which allows you to make money on the property you don’t own.
  • Meant for advanced investors with little available capital
  • Initial investment requires 5% to 10% of the total property value for acquisition and closing costs
  • Potential to generate as much as 30% to 80% cash-on-cash return
  • Medium to High risk due to legal legwork needed to execute

HOW DOES IT WORK

A sandwich lease is technically subleasing or subletting which allows you to make money on the property you don’t own. The land lord rents out a property to a tenant and then that tenant rents it out to another tenant. Most of these sandwich leases happen after the original tenants who have signed a long term lease in a rental have unexpectedly needed to leave or move. The investor makes money when they can charge a higher rent or price that what the land lord is charging. One caveat though, not all land lords allow sandwich leases but you can execute this through a legal contract option. The process is done by:

  1. Targeting a property that is already for sale/rent. Negotiate with the owner to give you a lease option that allows you to buy the house at the end of your lease agreement. Include the sandwich clause on the contract that gives you the right to sublet the property.
  2. Once you have the property, look for a tenant that will agree to a rent-to-own arrangement and sublease the home in a separate lease agreement. The tenant pays you a non-refundable advance that gives them the right to purchase the property at the end of the lease. After closing the deal and the tenant moves into the house, you then use the rent money to pay down your land lord.
  3. Once the deal is closed, you then buy the house and resell to your tenant to exit the property.

Usually, the sandwich lease option is executed after a year or two years from the signing of the contract. But it can be longer or shorter depending on your agreements with both parties. Make sure you have a clear exit strategy so you will not be bound to these contracts.

When doing a sandwich lease, you must be completely honest with the land lord on your intentions to execute this kind of deal. If you intend to flip the home without the owner’s knowledge, they can potentially sue you. Make sure you screen your potential tenants to avoid getting ones that can damage your property before your deal closes with the owner. Say goodbye to tenants that have poor credit and most likely will not qualify to loan for purchasing the property.


RISK

Generally, there is medium to high risk in executing this deal. You essentially serve as the middle man which means you must be able to manage relationships with two groups (land lord and tenant sides). At the same time, there is a high risk of committing legal mistakes during the deal that can affect your return on investment. You will need an attorney that can identify clauses you should include in your agreements and who will represent you in these negotiations.

Here are some other potential risks that can affect the deal:

  1. Almost all risks associated with an ordinary rental apply to sandwich leases which would be turn over expenses, nuisance tenants that don’t pay on time and are destructive etc. The upfront advances and deposits will help ease this risk.
  2. Overestimating the cost and rent generated from the property owner versus what you can really sell and rent it for to a tenant. This will lose you money and affect your overall return.
  3. Hidden clauses that can jeopardize the deal. Make sure that all agreements are transparent and your contracts are carefully reviewed by your attorney in accordance with local laws and regulations.

WHO IS IT FOR

The strategy is well suited for advanced investors who have vast experience in handling acquisitions and tenant management. To be able to make this investment work, the investor should be aware of real estate contracts and options. A knowledge of local real estate taxes is necessary. This is the right investment for those who are low on capital and can’t invest directly but want to generate consistent cash flow


EXPENSES & MARGINS & RETURNS

Sandwich lease options are not capital intensive. Generally, time is the actual investment needed in this deal more than cash.

  • AVERAGE INVESTMENT: As much as 5% to 10% of the total property value for acquisition and closing costs which could range from $8,000 to $15,000 only.
  • RETURNS: Depending on the market, you can average to gain as much as 30% to 80% cash-on-cash return since you’ll only need to put in a minimal investment.
  • EXPENSES: Expenses are usually care of the sublet tenant. For safety, the nonrefundable down payment that you take should be at least 5% of the total home value to pay for vandalism or theft from a nonperforming tenant.

In this oversimplified example, let’s say that you find a home for sale in your area that has been vacated by the owner’s for months. After tracking them down, he will only close the property at $100,000 to make a deal. By talking to your mortgage broker, the home estimation is likely to be $140,000 with an average rent of a similar house at $1,000. You propose to the owner to sell to you after negotiating for a sandwich lease option that allows you to sublet within 1 year and pay for the property expenses at $500 monthly (mortgage payments and taxes). You offer that you pay a $15,000 non-refundable advance as safety to allow this clause. He accepts and closes the deal.

Your next step is to look for tenants. After the initial screening, you got a sublet tenant that is willing to buy the house from you at $140,000 after a year through a rent-to-own scheme at $1,000 per month. The agreement also covers that the tenant pays you a non-refundable $15,000 advance which you will pay to the owner. After 1 year, the sublet tenant secures a loan to acquire the property and exercises his option. The property owner receives his $100,000. The buyer gets his dream home at the ideal market value. After closing costs (paid for by your rental income), you went home with approximately $40,000 in revenue!


PROS / CONS

What are the benefits of investing in sandwich leases?

  1. Flexibility. Allows you greater control over an investment without having total liability since the owner of the house still owns the deed of possession until all agreements are finalized. Unlike other real estate investments that will chain you to the property, this strategy allows you to have less skin in the game and you can easily leave by just paying contract penalties.
  2. Little to no expenses for damages and maintenance since this is handle by both the owner and sublet tenant.
  3. The nonrefundable advance can cover the cost of renovations and cleanup should there be damages when the sublet tenant decides to void the contract.

What are the downsides of investing in sandwich leases?

  1. Time consuming. The acquisition process alone is not that agile since looking for vacant home owners that are willing to agree on this deal can take months or even years.
  2. This strategy is bad for depreciating markets as lower values can make the deal unpurchaseable – eroding all your projected profits.
  3. Expensive entry and closing costs. The associated costs for looking for properties, hiring an attorney to do all the paperwork and managing the deal can kill all the profits you have generated.
  4. High risk for lawsuit should any of the parties involved (sublet tenant or owner) balk on the deal.

SHORT CONCLUSION

The sandwich lease option is a great investment for advanced real estate investors that are currently low on capital. There is no large monetary investment needed to be able to generate consistent cash flow. It allows you to use someone else’s home as your asset. However, it involves a considerable risk so treading lightly with your real estate attorney can mitigate any potential red flags.


NEXT STEPS

  1. Take your time in learning real estate finance. If you can, start building a team that involves a real estate broker, attorney, mortgage broker and expert loan officers. These can help you assess deals and protect you from any liability during the contract and purchase of the home.
  2. The best way to lower entry and exit costs is to acquire a real estate license for yourself.