What is a Subject-to Lease Option Strategy?

Subject-To Lease Option

Acquiring real estate “Subject To” is an investment strategy that allows investors to acquire a property using none of their own credit and with little or no money out of pocket by leaving the seller’s existing financing in place. Put another way, “subject to” is a way to control a property by having the seller of that property continue to hold their bank financing in their name, but give the interest, benefits, and responsibility of the property to the investor.

A lease option is a selling strategy where there is an agreement between new seller (investor) and a potential buyer to allow the potential buyer to rent the home for a fixed amount of time with the right to purchase it for a fixed price any time during the length of the agreement. The important thing to remember about a lease option is that the potential buyer has the ‘right’ to exercise the option to buy but is not obligated to do so.

Why combine the subject-to lease option strategies?

This buying and selling strategy combination allows a distressed seller to sell an otherwise unsellable property.  The investor is able to utilize the subject-to lease option strategy to purchase a property using none of his own money or credit and sell an option that allows him to take advantage of cash flow and the tax benefits of home ownership.  The buyer is able to get into a property with less of a down payment than if purchasing, live in the property, and later exercise the right to purchase if the buyer sees fit.

Subject-to Lease Option Benefits

The benefits of the subject-to lease option strategy for the investor are many.  First, this strategy is more advantages that the subject-to and renting strategy because the investor is generally able to collect a larger, non-refundable down payment than they could if they were just renting.  Also, while the investor is renting, they are renting to a potential buyer who has a sense of pride in ownership of the property.  Therefore, there is a good chance that they will take better care of the property than your typical renter, which makes the life of a landlord much simpler.  While renting, the investor is able to take advantages of the tax benefits of owning real estate.  Also, the investor is able to benefit from the tax advantages of owning a house.   Finally, unlike with owner financing, should the potential buyer decide not to purchase or default on payments, evicting can be quicker, simpler, and less expensive than going through the foreclosure process.  The bottom line is that this subject-to lease option strategy is more advantageous than simply renting the property.

Subject-to Lease Option Detriments

The detriment to this strategy is that the investor is still a landlord.  Even though the renter will have the sense of home ownership, things will still break.  A/C unit will malfunction, pipes will leak, and other things will break.  This means that the investor will always need to keep extra capital available for repairs.  Also, there is the risk of property appreciation.  For example, if the lease option is for 3 years, and the property appreciated in value by $15,000 per year, that $45,000 in extra equity goes to the buyer, not the investor.  Plus, while the value increases, the property taxes increase as well, which takes away from the cash flow of the investor.  Finally, anytime an investor purchases a property subject-to, they run the risk of the bank enforcing the ‘due on sales’ clause.  Though very rare, calling the entire note amount due can result in a potential financial disaster if the investor is unable to acquire additional financing.  Before utilizing this subject-to lease optionstrategy, check to see that is is legal.  In some states (like Texas for instance) lease option are illegal.

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