A sandwich lease is a subleasing strategy that allows (usually beginner) investors to get in the real estate investing game without a lot of capital. The real estate investor acts as a middleman between a property owner and a tenant buyer in a sandwich lease deal.
How a sandwich lease works
You as an investor look for homes being sold as a rent-to-own or lease option transaction. When you find the right deal, you sign a lease with the option to buy and then immediately sublease your interest in the home.
Here’s an example of how a sandwich lease works: You find a rent-to-own home online and then get into a contract with the owner, which will become the master lease. You sign a three-year lease for $2,000 a month. You put down $3,000, which gives you the option to buy the house anytime within the three years at a prearranged price of $180,000. You would be the lessee here, and the seller would be the lessor.
There’s usually more to these deals, such as a certain portion, say 25%, of the rent going toward the purchase price of the home, as would the down payment if you buy. If you choose not to buy, you can just walk away, but you’d lose the option money and the 25% extra rent you had been paying.
What makes this a sandwich lease versus a standard rent-to-own situation is this next part: You never move into the home but instead find someone who will enter the same sort of deal with you — only for more money. (You could also have this person lined up ahead of time by working your network.)
Here’s how this might work: You find a tenant buyer who wants to get into a rent-to-own or lease option deal. You are still the lessee, but you’re going to sublease the house. You have the sublessee sign a similar contract to the one you signed, only for more money. They would sign, for example, a three-year lease for $2,500 a month and put down $4,000, which gives them the option to buy the house anytime within the three years at a prearranged price of $225,000.
How you earn money
You earn the spread between what your sublessee pays you and what you pay the lessor (the owner). Each month in the example listed above, you’ll make cash flow of $500 a month in rent in addition to the $1,000 you’ll make on the option fee. If your sublessee doesn’t buy the house within the three years, they move out, and you keep the rent and option money: $19,000. If your sublessee does buy the home, say in three years, you earn $26,000 ($45,000, which represents the spread between the $180,000 and $225,000 purchase prices, minus the $19,000, which goes toward the home’s purchase price).
Why people want to rent-to-own
The rent-to-own market consists largely of people who want to be homeowners but don’t qualify for a mortgage. The thinking is that they will be mortgage-ready during the option period, typically between two and five years. Maybe they will have saved enough money by then, raised their credit score, or expect to make more money in the future. When the renter can get a mortgage, they can then buy the home. But if they don’t become mortgage-ready at the end of the option period, they can walk away.
Be upfront with the home seller about your intentions
Some investors, not sure whether the seller will agree to sublease, just do a sandwich lease deal anyway. This isn’t recommended. If the rent-to-own contract you sign prohibits subletting and you do it anyway, the seller can cancel their deal with you, since you breached the contract.
If you sneak in a clause that allows you to sublease without discussing this with the seller before they sign, you’d be allowed to do this, but that isn’t a good way to do business, not to mention that kind of behavior could earn you a bad reputation in the industry. It’s good business practice to explain to the seller what you plan on doing and make sure they’re on board with it.
The Millionacres bottom line
The sandwich lease can be a good way for beginners without a lot of money to get their start in the business. But doing a sandwich lease is not always as easy as it sounds. Getting into a rent-to-own deal with a motivated seller shouldn’t be too difficult, but getting a good deal could be, and that’s the only way to make money: You’d need to find someone to sublease from you, for more than what you’re paying. That requires you to strike a very good deal initially in order to make a profit. Finally, you’d need to get the owner’s permission to sublease.