Picking up with more nuggets of information from Joe McCall, we continue exploring active real estate investing as we look into his favorite strategy – doing lease options. He gets down to its two-part component of buying and leasing with a tenant while discussing its relation to wholesaling as well as holding titles and payment. Tapping into simpler things, Joe shares his thoughts about private lending and whether or not it is active or passive. He also compares the risks involved between the two kinds of real estate investing and gives his advice to those who are thinking about transitioning from being an active investor to a passive investor.
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We are having a conversation about active and passive real estate investing. We’re doing a comparison and contrast of each and if you haven’t read part one, be sure to stop here and go back to the first part of this episode and read that because it’s going to give you a great overview and introduction to the different strategies involved with active real estate investing. With that, we’re going to continue with our interview with Joe McCall.
If you missed our last episode, be sure to listen to Active Real Estate Investing with Joe McCall.
Enjoy the show!
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Active Real Estate Investing with Joe McCall (Part 2)
Let’s transition to what I believe is your favorite strategy and that is doing lease options, which is essentially a two-part component. You’ve got an option to buy and lease with a tenant. Tell us what a lease option is and why would someone want to use that strategy?
I love lease options for a couple of reasons. A lease option is where you lease a property with an option to buy it in the future. If you own a property, maybe you want to sell it but you don’t want to sell it as cheap as you would need to another investor. Maybe you want to sell it to a tenant buyer or you don’t want it listed to the MLS and pay all the commissions so you can sell your property on a lease option. I only recommend doing lease options on median-priced homes. In the Midwest, I only want to do lease options on homes that are between $100,000 and $200,000, that median price range. I don’t like doing lease options on lower-end rental properties because if a tenant was in there and they got their credit fixed and they could get a mortgage, they’re probably not going to want to buy that $50,000 house. They’re going to want to buy something in a nicer area with better school district.
I only recommend doing lease options on median-priced homes in good school districts, good neighborhoods and blue-collar working class areas. I was doing a lot of wholesaling, failing at rehabbing and failed before with the properties that I bought. The reason why I failed at those, it wasn’t as much that the market changed, it’s because I didn’t buy them right to begin with. Because if I bought them right to begin with, even though the market changed, I would have been fine. One of the things I appreciate about you and your podcast and what you’re teaching people how to invest in passive real estate is you force them to focus on the fundamentals like it’s got a cashflow. You can’t count on appreciation. It’s got a cashflow and the fundamentals need to be there. You need to be at certain cash-on-cash return or an ROI or whatever.
When I was buying them, I was counting on appreciation and I was okay with just $100 a month in cashflow because I didn’t think anything could go wrong. I didn’t think anything bad could happen. That’s the main reasons why and I was way over-leveraged on those homes too. I was wholesaling, but I was starting to get frustrated with all the leads that I was throwing away in my marketing because they didn’t have enough equity. I started thinking about, “What if I did lease options on these deals where if there’s 10% or 15% equity in it, maybe I can stay in the middle.” I can still buy it from the seller, get it under contract to lease option, stay in the middle and then find and sublease it out to a tenant who would rent it from me. As long as I can get $300 or $400 a month in cashflow, the spread between what I’m paying the seller and what I’m renting it to my end buyer, that’s pretty good. If I can buy it for $0.90 on the dollar and sell it for $1.10 on the dollar in three years, then I can make some money.
There are three ways to make money with lease options: cash now, cashflow and cash later. It’s a mixture of wholesaling and buy and hold. You’re getting some money up front from the tenant buyer that puts anywhere from 3% to 5% down upfront. You’re getting some cashflow, usually about 25% of the rent. Then you’re getting an equity spread at the back end, which hopefully is 10% to 20% of the deal and you’re not paying any realtor commissions and stuff like that. I started doing some lease options and then when the market was falling, I started finding a lot of properties that didn’t have any equity or maybe a little bit upside down.
What I started doing then was I would get them under a lease option contract and then sell or assign my lease option contract to a tenant buyer who would then take my place and pay me $3,000 to $7,000 assignment fee to take my place. I call those wholesaling lease option deals. Doing those wholesaling lease option deals, I was averaging $3,000 to $4,000, sometimes $5,000 a month while I was working my full-time job and I did that consistently for three months. That’s when I quit. I put in my two-week notice on my job and not looked back since.
For people who are not familiar with lease options, it starts to get maybe a little confusing and a little thick. Just for the sake of clarification, when you did this lease option, are you holding title or did you leave the title in the name of the existing owner?
It stays in the name of the existing owner, which is another huge reason why I like lease options because I used to do subject to where you buy a house taking over the existing mortgage. To do that, you have to get the deed transferred into your name. I think it was Rockefeller who said, “The secret to wealth is to own nothing and control everything.” In my opinion, lease options give you that. You can control property without owning it. I’m not on the deed. Therefore if the deal goes bad, it’s easier for me to get out of it because I’m not on the deed. I have an option to buy the property.
I assume in that case, then you’re leaving any existing financing on that property in place as well. If you are purchasing it for the same amount as the debt on the property, then it’s no down payment. If you’re buying it for a little bit more, now you have to come to the table with that difference.
It depends. I like to do it as A, B to C. I have the contract with the seller. Let’s say it’s $100,000 house and I’m going to give the seller a contract to buy it for $85,000 and that house will rent for $1,000 a month. I’m going to rent it from the seller for $700 a month. I’m going to buy it from the seller for $85,000 and I have five years to do that. I have an A to B contract where I’m going to lease option the property from the seller for $85,000 and $700 a month in rent. The mortgage stays in their name. I use a third party escrow company that will pay the mortgage. Then I turn around and I advertise that same $100,000 property for $110,000 to a tenant buyer, somebody that has good reasons for bad credit. I only do lease options with tenant buyers to people that have a realistic chance of getting a mortgage in one or two years. I’m not into the just churn and burn where I’m hoping they don’t buy it so that I can get somebody else in it. I’m not doing that and that tenant buyer works closely with my mortgage broker.
My A to B is $85,000, $700 a month in rent and then my B to C, I put a tenant buyer in the property who’s going to rent it from me and I’m staying in the middle. I’m going to sell it to them for $110,000 in maybe two years. Maybe $115,000 in two or three years. I’m going to rent it to them for $1,000 a month. That tenant is going to move and they’re going to pay me an option deposit of maybe $3,000 to $5,000 on $100,000 house. I keep that. It doesn’t sit in an escrow company. They’re going to pay me $1,000 a month and I’m going to pay the seller $700 a month. Let’s say the mortgage payment is $700 a month or let’s say the mortgage payment is $650 a month. I’m going to pay the mortgage $650 every month and I’m going to give the seller the $50 every month. My cashflow then is $300 a month.
The tenant buyers in the house, when it comes time in two years, maybe three years, when they’re ready to buy the house, there are two or three different ways to do that. I don’t want to get into those details, but we either do it double close or sometimes I’ll record a lien on the property and I’ll step out of the deal. There will be a new contract between my end buyer and the seller. There are different ways to do it or I might take the deed over for 90 days because of the 90-day FHA seasoning rule. That that’s how I make my money. I make some money upfront from the tenant buyer that puts in their option deposit money. I make the cashflow and then at the end, I make the spread between $110,000 and $85,000. That’s $25,000, no realtor commissions involved.
That was a good description and a great way to paint the picture. I’m sure some people heard what you said, “That’s interesting. That makes sense,” and some people are still scratching their head. I have two comments to make about that. First, there are people in the industry that will refer to what you described as a sandwich lease option. The second comment I have is that essentially what you’re doing is you’re arbitraging an opportunity. You’re getting involved in setting up a lease option with someone who wants to sell or needs to sell. Then you turn around a minute later and you start marketing that same property that you have under contract to a tenant who would like to purchase the property one day. You’re going to sell it to them for a higher price and you’re renting it to them for a higher price than what you’re paying the original owner. You being in the middle, you’re just taking the spread on the sales price if it ever happens and the spread on your lease and what you’ve leased it for. That’s another way to say what you just said. I know statistically that this used to be very low. The number of people that exercise their option to purchase the property from you, often it ends up expiring and going back to you and you keep the option fee. How often do you see people successfully exercise their option?
For me, anywhere from 50% to 75% actually exercise the option and buy the house.
That’s higher than I thought you’re going to say.
Yes, because I know exactly where you’re going. The reason why it’s so good is that I prescreen my tenant buyers so well. I only want people that have a realistic chance of getting a mortgage in one or two years. They have a good income. They have a good rental history. They have good jobs and the mortgage broker has told me, “If they just do these three things, they should be able to get a mortgage.” I never take somebody into my house that has $100,000 tax lien on them or who has a bunch of unpaid child support and they have judgments and liens. There’s no way they’ll be able to buy that house if they have recent collections from cell phone companies and stuff like that. When they’re in my house, I make them work with my mortgage broker who can help them get their financing.
The other reason is I’m only doing this in nice areas where people want to buy homes. Why you see the failure rates so high with most people that are doing lease options is because they’re doing them on lower-end homes. Homes that are under $100,000, in bad areas and bad school districts. In the beginning, the tenant buyer may want to buy that house, but by the time they’ve been there a year or two, they realize this isn’t all that great of an area. They don’t want to buy that house. The people that put the tenant buyers in their homes, they don’t prescreen them. They don’t care if they ever get a mortgage or not. I think there’s a better way to do lease options where you have better success rates by setting them up to win from the very beginning.
We covered the major points and major things that I wanted to hit on. Let’s start winding it down with some simpler stuff. Would you consider private lending to be active or passive? I know people have argued or debated this both ways.
I think it’s passive. I don’t do it myself. I’d like to someday. It’s much better to be the bank than to be the landlord, all day long.
A lot of people look at the time commitment involved in dealing with different types of investment strategies. “You do what you do. I do what I do. I have my preference.” Is this a full-time or part-time business for you and would this be part-time or full-time for most people if they want to start doing wholesaling or lease options?
For me it’s part-time. I’ll just say this. Ever since I quit my job, I’ve never worked more than ten to twenty hours a week in my deal business. I have my podcast. I do a lot of coaching and consulting. I have some software. I have some marketing services that we provide for clients and I love teaching this stuff. I spent a lot of my time teaching and coaching and doing my podcast. I outsource my deals with other people. I have students that I’m partnering on deals with. I have my business partner in the coaching business. We do deals together and working with the students in different parts of the country. We’re also doing some land flips. I’ve always believed in setting up systems. I listed all the things that you have to do in a deal, a wholesaling deal specifically in this instance. This was 2012, 2013. I was wholesaling a lot of deals to cash buyers, to turnkey real estate investors. I was frustrated. I had an acquisitions manager. I had an assistant, but I was still working hard.
I listed everything that you have to do on a deal and I asked myself, “How can I do none of this?” I want to start traveling. We have four kids. We homeschool our kids and I wanted to take them to Europe. We’re teaching them ancient Greek history, “Let’s go to Athens and see the Parthenon. Let’s go to Rome and see the Colosseum. Let’s go to Prague.” We did that. I started creating systems and processes where I could get other people to do this stuff for me. I’m splitting the pie, but it’s a bigger pie now and there are more pies so I can do deals in more parts of the country. I’ve always tried to set up my business where I can get a virtual assistant to do my marketing. I can get a VA to prescreen my leads. I can use this mail company to do my direct mail. I can use this software to do this marketing and stuff like that. Then for my boots on the ground, I can get a realtor. I can get another investor maybe to do some of the leg work. If I need somebody to go take pictures, I can find them on Craigslist.
I can go to WeGoLook.com. That’s how I do most of my deals now. It sounds like a lot, but instead of asking, I heard this three or four years ago from somebody, “Stop asking how and start asking who.” I started thinking, “That’s great. I can do that in my real estate investing business.” Even though my investing is more active, it’s still somewhat passive for me. I’m actively managing my team and my systems so that I can travel around. We’ve done that. Twice, we’ve been in Prague for three months, traveling around Europe, doing deals in the US. One time we got an RV and traveled for three months around the Northwestern corner of the US. We got an RV going to a bunch of different national parks. I enjoy that. It’s a lot of fun. I still worked two to three hours a day on my business, but because I only had a small window that I could work, I was extremely focused and disciplined.
I’ll say one more thing to this. I used to be in this mastermind called Lifeonaire. The whole concept of Lifeonaire is instead of being a millionaire, it is having a life on air. The whole concept was to create a vision for what you want your life to look like first and then design a business that supports your life. Most of us have it backward. They have their job or their business at the center of everything and life fits in around that. Let’s reverse that. Let’s create a vision for our life. Maybe you want to travel or you want to have the freedom to take any day off you want and go skiing for a week if you want. Then create a business around that that supports your lifestyle and your vision for your life. My wife and I are really intentional on that.
They refer to that as lifestyle design. I asked you about the time commitment involved. I look at things from a time perspective and risk perspective. You address the time part of it on the risk side of the equation. The more active you are and the more involved you are on the active part of this business, the active side, you’re dealing with hard money loans or transaction loans. You’re dealing with contractors. You’ve got scopes of work. Sometimes you have scope creep. You can deal with cost overruns. If you’re selling something, you got these long days on the market potentially. How much more risk do you think there is with active real estate investment strategies over passive? This is somewhat a loaded question and somewhat subjective. I could ask ten people and get ten different answers. What do you think?
People need to think about risks. There are risks in all kinds of real estate no matter what you’re doing in my opinion. How do I mitigate the risks? How do I lessen the risks to be as small as possible? In my experience though, I think there’s very little risk in the bigger picture of wholesaling, whether you’re wholesaling traditionally or you’re wholesaling lease options and stuff like that. I’m not buying the house and I’m just selling the contract. I’m selling the paper. I’m not dealing with contractors. I’m not dealing with insurance companies or banks or lenders or city inspections and realtors and things like that. I just have a property under contract. I have a few weeks to contingency to see if I do want to buy it. During that period, if I find a good buyer, most of our deals, we already have the buyers in mind who want it.
I’ve always said that in wholesaling, it’s much easier to shop for what your buyers want than to sell them what you have. Get some good buyers, find out what they’re looking for and get it. Find that inventory. When we’re looking at a property, we already have two or three buyers in mind and we know what they’ll pay for this and we can sell it pretty quickly. A lot of times, we don’t even advertise the properties or the contracts. We just make a few phone calls and send a few texts. In my opinion, there’s very little risk in that. Anybody can be sued for anything. If they think you’re ugly, they could sue you. You got to be careful with making sure you’re doing the right thing. You do what you say and you say what you do and that is important. If you’re just nice and you’re not a jerk, that will nine times out of ten help you avoid stupid lawsuits.
A lot of people reading this episode are either involved in active real estate investment strategies and doing stuff along those lines. They’re just getting started in that area or thinking about it. Maybe they’re contemplating it, but they’re all over the place. We have a diverse audience. For those people who are doing it or thinking about doing it, how would they transition from being an active real estate investor to becoming a passive real estate investor? Just paint the bridge between those two because you are doing it.
That’s important. I don’t own enough rental properties as I should. I’m still actively doing the business. For various reasons, we can talk about that offline like some of my personal goals. I think people, as soon as they can, should take the active income that they’re doing and start putting it into passive income assets like single-family homes. I’m a big fan of single-family homes. There’s a place for apartments and multi-families. For me, I like single-family homes. People are always going to want a roof over their heads. They’re predicting the population of the United States to double in the next 50 years. Those people need a place to live. Usually, the rent is the first bill that they pay. Maybe their car payment is the first payment, but their house is the first. It’s a very safe investment. I love real estate. I think people, if they’re doing active real estate investing, they need to start setting aside a certain percentage of those profits. Setting those aside for buying passive income.
If they can, they should be putting as much money down as they can and not over leveraging, in my opinion. They shouldn’t be getting into too much debt. They should be paying off these rental properties as quickly as possible. That’s my opinion. There are so many advantages to owning single family homes from the write-offs, the depreciation and the cashflow. To bridge that gap and this is why I like wholesaling because you learn the market, you learn what are the good areas and the bad areas. You learn how to evaluate properties. Sometimes you may find a deal that’s so good, instead of selling it, you should keep it. You may find a deal that you can wholesale it and make $10,000 to $20,000, but if you keep this thing and put $5,000, $10,000 into it to fix it up and get a tenant in there, you should hold those properties for 30, 40, 50 years.
That’s called cherry picking.
I’d rather cherry pick my own deals than pick deals that have already been cherry-picked by ten other people.
Joe, thank you very much. This has been incredibly enlightening and helpful and the contrast has been great. Tell our audience how they can find you and find more information about you or what you do.
I appreciate you letting me be on the show, Marco. You’re the passive guy and I’m maybe more of the active guy, but I think there is a place for both. I have a podcast called the Real Estate Investing Mastery Podcast. I’m doing it since 2011. I don’t have as many reviews as you do. I need to get on my game. We need to talk offline to get some of your tricks for getting more reviews. Let me say this to everybody out there. If you’re listening to this show, you need to give us some reviews. You need to give Marco some reviews. It’s a lot of work putting these shows together. It’s like going to the restaurant or the coffee shop and you see the tip jar right there. Put in a dollar, give those guys a tip. The reviews are awesome and they’re so helpful.
We appreciate them because we get to hear from you guys what you like and what you don’t like about the shows. Marco has way more reviews than I do by 100 or 200, but you should still give him some more. My podcast is Real Estate Investing Mastery. You can check that out. Just go to iTunes or Google Play or Stitcher, any of those and it’s on there. That’s one way. The second way is I do have a book. It’s a free book that you all can buy. It’s free. You just pay a couple of bucks for shipping and handling. It’s called Wholesaling Lease Options, and I put a lot of effort into this. There’s no fluff in it. It’s solid content and stuff. People can get it at WLOBook.com if they want. I’ll send it out to you. It’s a good primer on this whole topic and that there’s enough in here. It’s not like I’m upselling you other stuff. It’s a really good book in my humble opinion. Those are the two good ways.
Joe, thank you so much for your time. This has been great and I appreciate you coming on.
I’m going to have you on my show. Some of the audience may have been listening to Marco for a long time, I’m going to ask him a lot of questions on how he got started in the business. Hopefully, I can ask him some questions that he might not have told his audience on his podcast. Maybe you’ll get some insider and you can read into his mind a little bit a little better and hopefully ask him some questions about why he does what he does. Come and listen to that.
Joe, thank you so much. I appreciate your time.
Thanks, Marco. Take care.
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I hope you enjoyed this two-part episode on active real estate investing with Joe McCall. It’s interesting stuff and I hope it gives you some perspective on the strategies involved with active real estate investing and where you can make some quick money or chunks of cash. Ultimately, you want to turn those chunks of cash into streams of cash. You want cashflow. That’s why I wanted to do this episode a comparison and contrast. I hope you enjoyed it. Download our free report, The Ultimate Guide to Passive Real Estate Investing. If you haven’t subscribed, hit that subscribe button. We love the reviews, they’re great. Thank you. Keep them coming in. Just head on over to iTunes. You probably need to do it on your laptop or desktop. Doing it on an iPhone is hard. We greatly appreciate all the positive feedback and the great review. Thanks for that. Thanks for tuning in and we’re going to see you again on our next episode.
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