Guaranteed Cash Flow?

Copyright 2006 Ron LeBlanc

Ok, we all know there are really no guarantees in this life except death and taxes. However there are ways to set yourself up in real estate investments so that you have as close to a guarantee as can be had.

It seems that one of the hardest things to do in real estate is to have a property in positive cash flow. The general rule of thumb is the 1% rule. You should be collecting at least 1% of the value of your property each month in rents. That means that for a $200k property you should be collecting at least $2000 a month in rent.

That seems kind of hard to do in most major markets right now because your typical home can be well over $250k and rents just don’t come that high. You would want to have $2500 a month rent for a property like that. Or stated another way, you need $2500 a month cash flow. Aha! Is there a way to get more than the market rent?

Yes there is a way you can get substantially more for cash flow each month. It is called the lease option or lease with option to buy. Allow me to explain. Most people consider the jump from renting to home ownership just too big. Others have no way of qualifying for the mortgage. Some people think they have to have 20% down payment – let them think it!

Let’s say you’re looking for $2500 a month and the market rents are no higher than $2100 or $2000. There is a way to make that real estate investment cash flow. You can seek out people who are credit-challenged or for some other reason can’t or don’t want to commit to a mortgage at this time. You explain to them that with a small down payment – basically anything over $2000 or so, they can have a legal option to buy that house in two years! The monthly rent will be $2500 of which $400-$500 is put toward a down payment in the future.

Many people are willing to do this option. They have a secure legal option to buy and no obligation to do so. In fact if they don’t – so much the better! Here’s why. You have it in the lease that should they fail to exercise their option, it can either be extended or they may forfeit all their accumulated down payment. Statistically, most will fail to exercise the option, so you keep that money!

The people who live in that property are also not traditional renters – they are owners. That means they are far more likely to take care of a place they are purchasing an option on. It is even in the lease agreement that they are responsible for al maintenance – after all they plan on it being their property.

If they miss any rents, then you can have them forfeit their down payment money or even evict. Traditional renters can be nearly impossible to evict, but in this lease option, you can have the sheriff there in a couple days.

So to summarize, you get cash in hand at the beginning with what ever they put down. You also have “guaranteed” cash flow. How is it guaranteed? Just make sure that you get enough in the option addition that you cover your monthly expenses. The option to buy is paid for by some extra monthly payment. So, if your expenses are $2150 and you collect $2500 each month, you have positive cash flow.

The last part of it is the sale. You have it in the lease that the purchase price will be determined by mutual consent at a point 6 months out from exercising that option. Unless there is some huge market and economy downturn, you will have at least minimal appreciation on your property.

So if you’ve been keeping track, you have cash up front from the option consideration, positive cash flow each month, and then your appreciation after that. As long as you look for lease option people instead of people really just wanting to rent, then you have your tenant and positive cash flow.

I admit it is tough to do this where property values are high, such as my home of Boulder, but if you look at less fancy or pricey areas, you should be able to find a way to lease option with guaranteed cash flow.