“Hey, what do you think of setting up a sandwich lease? My friends want to go into real estate this way. Have you tried this?” — A question I got from a reader a few days ago.
Well, actually, I’ve never heard of a sandwich lease until just now. So I looked into what the heck it is, did some research, thought about it, and realized that even though a sandwich lease sounds tasty, it’s a big pile of garbage.
And if anyone approaches you with this “real estate opportunity” run far far away.
Sorry reader. Your friends are either shifty or dumb. But the plus side is that I’m dedicating a whole post just to you. Here’s what you need to know.
What is a sandwich lease?
This delicious-sounding premise is simple. It’s a spin on rent-to-own homes. Here’s how it works:
This is how it works:
- You sign up for a rent-to-own home, some call it a lease-option home – where you agree to purchase it at the end of your lease for a decent price.
- Meanwhile, you rent that home out to someone else for more money than what you pay.
- Then over those years of renting (usually 5-year contracts) you find someone to sell it to for more money than your rent-to-own contract states.
Sounds great! You make money on the rental portion AND you make money on the sale AND you don’t have to spend any of your own money.
The EVEN BIGGER attraction
The big reason that people are interested in these is that you can buy AND sell a house without actually putting up a downpayment.
Flipping a house can net a large payback and if you have no actual down payment or “purchase” you are making a return of infinity percent!
Let’s run some quick numbers using an example $88K house I was thinking about buying:
Let’s also say you lose 5% in transaction costs – so $5K, and maybe you had to pay a month’s full of rent for some reason.
Sweet. So you made $7K profit on the sale, and $6K in rent over the five years.
Tada! That’s $13K profit when all you’ve had to put in was a month’s rent of $1200.
That’s 1083% return in 5 years!!! And, since you don’t need to put in any of your own money, you can just keep doing this over and over and over again forever.
YAY! A perpetual free money machine!
So why is a sandwich lease stupid?
Free money sounds nice right?
Well there are three gigantic issues with this and the reason I wouldn’t touch a sandwich lease with an 8 ft Kielbasa sausage.
Gigantic issue #1 – Where are you finding these suckers?
I get that the allure of rentals already sounds too good to be true. You buy a house – even a cheapo one – and then make 8-25% of the house’s value back every year forever. Plus, if you’re not into it anymore, you can probably sell the house for more than what you paid.
So if real estate investing is already such a unicorn, this sandwich lease perpetual money machine doesn’t sound so far-fetched. Right?
Except that rental markets are very money-efficient. And charging more than market-value in rent just doesn’t fly – unless you find someone with no internet and no concept of what numbers are.
Rent-to-own monthly fees are already higher than your typical rent – so I don’t know how you’d find a tenant willing to pay 10-20% above your rate.
At the very least, you’d have to put in a lot of time into finding something below market-value for yourself, and then finding tenants – which sounds like a big time commitment and a big leap of faith.
And then, you’ll have to find another sucker to pay a higher sale price on the exact day you want to sell! That means two separate suckers to make it all work out.
Can you make it happen? Sure. but it seems like a gamble – which leads to my next point.
Gigantic issue #2 – Stacking Risk on Risk
My readers know that I don’t shy away from risk. I am very much pro controlled-risk.
- You control the risk of having lots of stocks in retirement by having a bond-based emergency fund to dip into during a recession.
- You control the risk of having rentals by having a line-of-credit or extra savings for repairs.
See, risk is easy as long as you mitigate it and control it.
Sandwich leases are totally uncontrolled.
- You sign up for a monthly fee (rent) and hope to find someone to pay more.
- You have a contracted date that you will purchase the house for a set price and you hope to find someone to pay more.
- You have to pay closing fees, so you HAVE to sell it for more than your contract or you lose money.
The infinite money equation can go negative too!
The biggest killer in all this “hope” are the dates. The timing has to be perfect or you lose a lot of money.
Recessions happen, home values go down, jobs disappear, and people break contracts. There’s no such thing as perfect timing.
Investments based on time limits are gambling with losses.
Leveraged real-estate investments with time limits are gambling with bankruptcy.
Gigantic Issue #3 – You’re doing real estate investing wrong.
Here’s my real issue. Say the stars, the moons, and the rainbows all align and you find two suckers to pay more than what you’re paying and get the timing perfect so everything works out
In other words:
- you’ve just purchased a house for a low price and
- have someone renting it for a ton of money.
Then why the heck would you ever want to sell it? Keep that thing forever!
Sure, you could theoretically be making infinite money with no down payment, but you could also just own that house and have infinite income for the rest of your life! I think I know what the obvious winner is.
Just save up for the damn downpayment!
Better yet, save up for the down payment first by living frugally, and then buy a leveraged rental property without any funny business!
What you should do instead: Resources for investing in real estate and rentals
There are good ways to buy a house when you have no money and sandwich leases aren’t one of them.
Or invest simply to build up the money to be able to buy houses easier.
Or just skip direct ownership and go for crowdfunded real estate.
TL;DR – Sandwich leases are stupid
But I’d love to hear from you. Is this something you’ve looked into?
And what’s holding you back from getting into rentals for realzies?
Leave me a comment!