Sandwich lease options are also sometimes used for tenants who agree to rent a property before agreeing to buy it. But these rent-to-own agreements are non-traditional and can be risky for the person in the middle of the two leases.
Definition and Example of a Sandwich Lease
A sandwich lease occurs when someone leases a property from an owner and then subleases that property out to someone else. The person in the middle has two contracts: a lease agreement from the property owner, and then a lease agreement with the new tenant. Here’s an example. Say Donna is struggling to sell her home in a down market and doesn’t want to give it up for less than she believes it’s worth. She leases it out to Karen, who agrees to a three-year, rent-to-own option. Karen pays $2,000 upfront just for making the agreement, and then $1,500 every month as rent. Part of that rent goes toward her final buyout price of $250,000. Karen then leases out to Susan, who moves into the home. Susan agrees to similar—but higher—terms than Karen did. Susan will pay $2,000 every month with the option to buy after three years. The final price she’ll pay is $300,000. Part of Susan’s rent also goes toward her final buyout amount. At the end of three years, Susan purchases the home for $300,000. Karen gives Donna the $250,000 as promised and pockets the remaining $50,000 as well as the profit from the monthly rent increase.
How Does a Sandwich Lease Work?
The middle person uses the sandwich agreement as a long-term investment strategy, but not all owners want this kind of relationship. In the first contract, the lessee signs a lease agreement with the owner. The contract will need to state that the tenant can serve as a lessor themselves. The agreement will have a monthly rent, any upfront costs, a final buyout option, and terms. These terms can be any time frame, but usually are longer than a typical one-year leasing option. It can be three years, five years, or whatever both parties are comfortable with. The second contract is issued by the lessee, who is now the lessor. To make a profit, the new lessor needs to charge more rent, ask for a larger purchase price, and assess higher fees. It’s also important for the lessor to have shorter terms, so the original owner and new lessee don’t cut out the middle person for final buyout negotiations. So while the first contract might be for three years, the second contract could be for two years, for example. Because the lessor is now acting as a landlord, the second contract will need to outline any maintenance, repairs, or other home responsibilities for both parties. The lessor could pay for any costs like a traditional rent agreement, or they could outline terms for the tenant to handle those because they plan on buying the home at some point in the future.
Pros and Cons of a Sandwich Lease
If you’re trying to break into the real estate investment market, a sandwich lease might be a good idea. But if you don’t have the time or funds to cover some of the potentially expensive costs, you may want to look elsewhere for investment ideas.
Pros Explained
Can be profitable if you have the capital: If you’re negotiating with the property owner, you need to have enough money to pay for a property you don’t plan on living in. This includes rent, fees, utilities, and any maintenance costs you’ve agreed to cover. You may succeed if you have haggling skills: You’ll need to convince a property owner that this will benefit them. You’ll also need to make sure they know that you’ll act in a landlord capacity and handle any property-related issues. And you must ensure that both contracts allow you to make a profit. Otherwise, it’s not worth it. You can profit if you’re in it for the long haul: You’ll make a profit every month you collect rent as well as at the time of the final payout, as long as you negotiated a higher sale price with your tenant than you did with the property owner.
Cons Explained
You could lose money: There’s a chance a tenant could back out of the agreement, which means you’re paying for a property you’re not living in. Your rent agreement and final buyout costs associated with your new tenant need to be more than what you’re paying the property owner. If you can’t achieve that, you won’t profit.It may be hard to find suitable properties: If you can’t find a property owner who’s willing to put a place under a sandwich lease or you can’t get the profit you want, you may want to look elsewhere for investing ideas.
