Creating Cash Flow Without Ownership

A married couple I know recently decided to separate. So the husband needed a place to live. Ideally, he wanted a house in the same neighborhood to make visits easy for their teenage children. He also wanted a lease of just four or five months, since he and his wife might reconcile. And if they didn’t reconcile, it would still give him enough time to figure out what to do for lodging on a more permanent basis.

What he was looking for turned out to be difficult to find. The few houses for rent nearby required one-year leases. The few seasonal properties had monthly rents twice his budget. So I suggested he try calling homes being offered for sale by the owners.

“But I’m not looking to buy,” he responded. “My wife and I might get back together. And even if we don’t, this housing market might be another year away from a bottom.”

“I understand,” I said. “But we’re in a housing bear market, and there’s a lot of inventory. Some of those homes have been vacant for months. The owners might welcome getting some monthly cash and having someone there who could show the home to potential buyers. It’s worth a few phone calls.”

He agreed to give it a shot. Not 10 minutes later, he struck pay dirt.

He’d found a 5,000-square-foot home that backed up to a lake. And it was only about a half-mile from his wife’s house. So he called the number on the for-sale sign and asked the owner if she would consider leasing the property until it sold. After a quick discussion, they both decided the house was bigger than he needed. So she offered him a short-term lease on a two-bedroom home she had just bought in the same neighborhood. (Her intention was to move into the smaller house after selling the large one.)

He drove over to the two-bedroom immediately. It was the right size and location. They agreed on a rent a few hundred dollars less than he had budgeted. Within 10 days, he had the keys and a five-month lease – with the understanding that either party could terminate the lease with 60 days notice after the first three months.

It’s a perfect arrangement for him and the owner. But it only happened because homeowners are more flexible in today’s market than they’ve been in years. And that can create opportunities for you to structure low-risk, high-return deals – and even create cash flow without ownership.

Here are a few examples of what I mean…

A Lessee Who’s Making More Than the Lessor

One of my favorite single-family homes is a four-bedroom on a corner lot that a partner and I bought nearly four years ago. It’s in an emerging neighborhood three blocks from a popular downtown. We bought it for $153,000, and it’s now worth more than twice that. So we’re happy with our return on equity of over 250 percent. Yet the big cash flow on this property isn’t being made by us. It’s being made by the guy who leases it from us.

Enrique pays us $1,450 a month to lease the house – and that kicks off a few hundred extra dollars for us every month. Meanwhile, we give him the right to sublease… and he turns around and probably clears about $1,500 a month.

Here’s how he does it…

Enrique specializes in “special needs housing.” He leases to members of a substance abuse recovery program on a per-bed “all bills paid” basis. He charges them $125 to $150 per week, which includes utilities, Internet, and cable. If he averages six beds for four weeks a month at $150 a bed, that’s $3,600 a month.

If his utilities, Internet, cable, and other expenses are $650, he clears $1,500 a month. And he does it without having to qualify for a loan or having to pay taxes or insurance or major repairs. He gets the cash flow without the ownership.

Enrique gives one of his tenants a discount for being “house manager” and handling small daily issues – from coordinating trash removal to changing light bulbs. So, after the initial set up, Enrique might have to put in just three or four hours a week of direct involvement for that kind of cash flow.

It’s a good deal for the tenants, too. They don’t have to worry about credit checks or coming up with sizeable rent or utility deposits or the money for furnishings. (We, the owners, provide the appliances. Enrique provides the bedroom set, sofa, dining room set, and patio furniture.) What’s more, the property is kept spotless, and the few tenants I’ve met are delighted to be in such a well-cared-for place.

My partner and I don’t have the time or inclination to be in the special needs housing business. But working with a qualified operator like Enrique, we have a lessee who takes care of the property and pays a fair rent on time.

Sub-Leasing Opportunities Abound

Enrique has had a master lease with us on that house for about a year and a half. (A “master lease” allows the master lessee – Enrique, in this case – to sublease the property.) Prior to that, we had another master lessee for two years.

The prior master lessee was a professional group that cared for people on psychotropic medication. Once again, our experience was positive. They took good care of their tenants and the property and paid us on time.

Many other groups could be interested in a master lease for your property – from organizations assisting veterans and the disabled to those catering to students. Yet you don’t need to work with an organization to benefit as a master lessee.

If you live in one of the country’s many deflating bubble markets, there are probably a lot of vacant properties in your area. Some of these might be owned by people in other states who bought on speculation during the boom and are now stuck with them.

Take a house with a rental value of $1,200. The owner might be open to signing a master lease with you for $500 or $600 a month. That would allow him to at least pay his insurance and taxes and a little toward his mortgage. And you could do a straight sublease to a single tenant – not on a per-bed basis – and net $500 or so in cash flow per month. Do a few of these and you could create a couple of thousand dollars in free monthly cash flow without buying.

If you’re near a university, you might be able to (at least) double your net rents by furnishing the house and leasing it on a per-bedroom basis. In that case, be sure to let the owner know that’s the group you intend to lease to… and that you will be responsible for any damage. (And make sure you get good deposits and guarantees from the students’ parents.)

If you find a vacant multi-family, that can be an even better opportunity. If a four-unit would normally pull in $2,400 a month, the owner might be glad to accept just $800 to $1,000 rather than have it continue to sit vacant and prey to potential vandalism and code-violation citations.

Here’s a valuable tip for you: Many counties have lists of vacant properties and properties owned by out-of-state people. They also have lists of single-family and multi-family properties. With a little cross-checking, you can home in on vacant, multi-family properties with out-of-state owners.

If you’re not ready to buy in your market because you think it’s still far from the bottom, you can use master leases to create cash flow in the meantime. Try to get purchase-options on those properties at the best possible price at the same time, and you could end up owning one or two of them when the time is right. (Purchase options give you the right – but not the obligation – to buy a specific property at a specified price within a certain time frame. They are often executed in tandem with leases.)

When lining up a master lease:

  • Make the lease for as long a period of time as you can get. You might do it for a year, for instance, with the right to renew at a 3 percent or 4 percent annual increase for two or more years.
  • Opt for properties that need little or no repairs. If a property needs, say, $1,500 in paint and clean-up, offer to cover the cost upfront and then deduct it from what you pay the owner over time. In this case, you’d do the work and then deduct $125 a month from your agreed rate for the first 12 months. If the owner is a little reluctant, you might offer to “split” the cost – with no out-of-pocket expense for him. In that case, you’d do the work, then deduct only $62.50 a month for 12 months.
  • Have the master lease spell out respective responsibilities. Typically, the owner will remain responsible for taxes and insurance and capital expenditures. That means if the AC goes or the roof leaks, it’s his expense. But minor repairs – from broken windows to leaky faucets – would be your responsibility as the master lessee.
  • Take care of the property as if it were your own. It’s the right thing to do. It will also help forge a good reputation for you that will be helpful when you pursue other master leases and purchase-option opportunities. Since you won’t be living there, only accept tenants that will care for the property – and be sure to inspect it periodically.

Imploding real estate markets are creating exceptional buying opportunities around the country. But if you’re not yet ready to buy, remember that those market conditions can create great opportunities for creative leasing as well.

[Ed. Note: Justin Ford is a successful real estate investor with properties in five cities and three states..]

Justin Ford is an active investor in real estate and global stock markets. He is also a veteran financial writer. He has published, edited and written for over a dozen international investment newsletters, including launching the US version of the Fleet Street Letter, the oldest continuously published newsletter in the English Language. He is the author of Seeds of Wealth, a program for getting children to adopt good money habits from an early age. He is the editor of the Seeds of Wealth Quarterly Investment Update Bulletin. He is a contributing editor and author to a number of books on personal finance, including Michael Masterson's Automatic Wealth and Dr. Van Tharp's Safe Strategies for Financial Freedom.