The lure of the sandwich lease strategy is the low cash barrier to entry. There are many investors who have considered rental real estate investment. But they have stayed away due to lack of cash to buy a rental home. The advantages of rental real estate investment are attractive
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- Value appreciation over time.
- Equity growth through appreciation and paying down the mortgage.
- Positive monthly cash flow from rents.
- Tax deductions for expenses related to the property, including real estate taxes.
- Depreciation deduction reduces taxes.
- Insurability of the asset.
With all these benefits proven over time, investors would love to find a rental property to get started in real estate. When they do not have the cash for down payment and closing costs. There is another way to get into rental investment with little or no money and even a lower risk profile. It is the “sandwich lease strategy“.
To understand the sandwich lease strategy, thinking of it as a sandwich helps. The bottom layer of bread is a distressed/pressured homeowner who needs to sell their home, but cannot, for a variety of reasons. The middle of the sandwich is the investor. The top layer of bread is a tenant who wants to own a home but cannot buy one currently.
The Bottom Layer of the Sandwich Lease Strategy
The investor seeks a homeowner who needs to sell their home to move for employment or other reasons. The homeowner is presented with an alternative to selling through leasing the home to the investor. There are several reasons why homeowners may be open to this approach:
- They do not have time to sell before needing to move.
- Homeowners do not want to own and manage their home as a rental when they cannot sell.
- They do not have enough equity in the home to cover the costs of sale and do not want to bring cash to the closing table.
There could be other reasons, from medical to personal. Although, the main consideration is a need to get out from under the mortgage payments so the owner can afford rent or ownership elsewhere. The investor offers the homeowner an exit with some extra cash in their pocket for the move.
- The investor offers to lease the home for the monthly mortgage payments as monthly lease payments.
- The lease is executed with an option to buy the property on or before the lease expiration for a pre-negotiated price.
- The homeowner is paid an option fee which is negotiated. This is non-refundable and the homeowner can use it any way they want.
- The lease-purchase agreement is usually for a three to five-year period.
The key point in the lease-purchase strategy is that the investor has the option, but not the obligation, to buy the home before the lease ends. This benefits the homeowner by freeing them from their mortgage payments. Meanwhile, the investor can acquire the home, completing the second part of the sandwich lease strategy. The escrow for insurance and taxes remains active without interruption.
The Top Layer of the Sandwich Lease Strategy
While negotiations to lease-purchase the home are in play, the investor is advertising to attract tenant buyers seeking to buy but unable to do so for credit, cash, or other reasons. The goal is to have a tenant buyer ready to move in as soon as the first lease-purchase is in place.
The investor executes another lease with option to buy for the tenant buyer(s) at a pre-negotiated purchase price. It is set up on the same time period as the lease with the homeowner(s). The investor charges the tenant buyer an option fee, generally the same amount as the fee paid the homeowner. This makes the deals mostly cash flow neutral. The tenant buyer is happy to pay the fee, as it is much lower than a down payment, and they get the home they want to own.
The monthly lease payment for the tenant buyer is set up higher than the lease payment from the investor to the homeowner. This structures the deal with a positive monthly cash flow.
If both leases are set to expire in five years, then there are three possible outcomes:
- Both leases go to expiration with the tenant not willing or able to exercise their option to buy. The investor has choices:
- They can let both leases expire, and the original homeowner gets the home back.
- The investor can find another tenant buyer or regular tenant and continue the arrangement with the original homeowner by extending the lease-purchase.
- The tenant buyer breaks their lease and moves out. In this case, the investor still has a lease in place with the homeowner, so they find another tenant buyer or regular leasing tenant with a new lease set up with time left to match the lease-purchase with the homeowner.
- At some point during the original sandwich lease strategy period, the tenant buyer exercises their right to buy the home. The investor does the same, and two closings happen with the investor taking profits based on the appreciation in value and the pre-negotiated buy and sell prices.
Overview of the Sandwich Lease Strategy
The sandwich lease investment strategy is a bit complex and involves two lease negotiations among three parties. It benefits everyone involved. The homeowner gets relief from mortgage payments. The investor secures a deal that requires little or no initial cash, providing monthly income and the potential for future sale profits. The tenant-buyer can secure their desired home while improving their credit or other conditions to eventually purchase it.
Legal Considerations
It is advisable to involve an attorney experienced in real estate for negotiating the terms of the sandwich lease with both the owner and tenant. The investor can arrange for the tenant-buyer to share repair costs, which encourages better maintenance of the home during the lease. It’s also important to clearly define which modifications or improvements the tenant is allowed to make.
Benefits for Investors
Despite its complexity, the sandwich lease is a great strategy for investors seeking cash flow and value appreciation from rental properties. It provides a way for investors with limited cash to enter the real estate market with lower risk.