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:
- 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, investors would love to find a rental property to get started in real estate investment. 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 cash 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 or otherwise 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
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.
- They 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, but 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 important thing to remember about this lease-purchase strategy is that the investor has the “option,” but not the obligation, to buy the home at any time up until the lease expiration. The homeowner benefits by getting out from under their mortgage payments and the investor benefits by getting the home for the second part of the sandwich lease strategy. The escrow with insurance and taxes continues uninterrupted.
The Top Layer
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. The fee is much lower than a down payment, and they get the home they want to own.
The Monthly Lease Payment
The investor sets up the monthly lease payment for the tenant buyer higher than the lease payment to the homeowner. This creates a positive monthly cash flow. If both leases expire in five years, there are three possible outcomes during that period:
1. 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.
2. 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.
3. 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.
This investment strategy is a little complicated due to the two lease negotiations and the three parties involved. The homeowner gets out from under their mortgage payment. The investor gets a low or no-cash deal with monthly cash flow. A possible profit through the sale at the end of the leases. The tenant buyer gets the home they want. Time to repair their credit or change other conditions that made it impossible to buy the home outright.
There are other terms in the sandwich lease with both owner and tenant that should involve an attorney with real estate experience. The investor may want to structure the lease to the tenant buyer with some sharing of repair expenses. This assures the tenant will take better care of the home during the lease. Other considerations relate to what the tenant can and cannot do to modify or improve the home.
There is no better strategy than the sandwich lease to get an investor into a position to enjoy the cash flow and appreciation benefits of rental home investment. For the cash-strapped investor wanting to get into real estate, the sandwich lease strategy could be the path with low cash invested and reduced risk as well.