Rick’s approach is a solid starting point. All lease options are a product of negotiation which gives deal makers a lot of room to be creative. Let me make these additional comments:
I always like to determine in percent form what the lease costs (think of a NNN lease payment as an interest only mortgage payment if you also own an option to purchase.) So a very important distinction and tool for our toolbox is this - A lease is used to negotiate CASH FLOW AS IT RELATES TO BUYERS AND SELLERS PERCEIVED EQUITY and an option is used to negotiate APPRECIATION AS IT RELATES TO BUYERS AND SELLERS PERCIEVED EQUITY.
Let’s look at an example scenario:
You find an opportunity where a park cash flows to the seller before the mortgage payments 100K per year and you can lease/option the park for 1M.
Park’s current owner also owes 500K and pays 7% interest, 20 year amortization, balloons in 7 years, monthly payment is 3876.49 = 46,518 per year
Park owner currently Cash Flows: 100K - 46,518= 53,482
You convince park owner to lease you the park for $40,000 per year (NNN - you pay for everything including his/her mortgage) - don’t forget to remind the park owner that the debt is also being reduced via the amortization schedule which gives him/her more equity as time goes own. You may also want to have your option price go down over time to mimic an amortization schedule - all part of the negotiation process.
What does this mean in % form? If you don’t have to put up any money then in essence the seller is giving you a 500,000 loan for 40,000 per year = 8% interest only and you will be “assuming” the 1st mortgage @ 7% - but the seller gets the debt reduction unless your option goes down every month too.
Now what happens if you have to put up a 100K? Now you are “borrowing” 400K @ 40,000 = 10% interest only. I would work hard to convince the seller that the more money you put down the lower the lease payment needs to go - just like any other type of financing. Or, what if you give the seller 100,000 and 40K goes towards prepaid rent for one year and 60K goes towards the option? Do you see the art? Now don’t go scaring the seller with all this stuff - learn how to show him the picture without him watching you paint.
Now, by understanding these techniques you will have a better idea when you should simply buy and when you should lease with an option. AND, you can also use this to understand when you should sell! For instance, I have sold lots to “home owners” for twice what the lot was worth based on the rent - why did the homeowner buy? Because their “tin can” became real property as soon as they bought the lot and for many the premium they paid for the lot came back to them because the home with the land was also more valuable. In fact, I would venture to say that none of them really even thought they where paying a premium because most of the world does not understand how this works. The goal is to know when retail asset prices exceed the cash flow value that the lease provides.
Let me give you one last really good example of this phenomenon in today “buyers market”. I know a very wealthy man who hasn’t owned his personal residence for many years because he understands this principal. Let’s say you want to upgrade your personal residence and let’s presume you find a really nice $1M home that you can buy in today’s market for 750K - but you also find out that the seller has the property listed with the realtor “for sale or for rent” because the seller needs to stop the bleeding somehow and the rent payment would be $3000 per month and the seller pays taxes and insurance. Do you see how powerful this knowledge can be? A $36,000 per year rent payment minus taxes and insurance may only net the seller 15,000 per year or even less! 15,000 / 750,000 means that if you could lock in an option @ 750K the seller would be in essence financing you at 2% (you could even offer a small premium since the financing is so cheep)! One thing to be careful of - make sure the seller does not lose the house in a foreclosure since he/she could be seriously subsidizing the deal). This technique is a very valuable one anytime asset prices far exceed cash flow valuations. By learning this it will help you to know when to buy, when to lease, and when to sell.