What is a Lease Option and How Does it Work?
A Lease-Option is more formally known as a “Lease, with Option to Purchase.”
With a Traditional Lease Option, you arrange to sell a property at some pre-determined time in the future at some pre-determined price. This is typically structured by letting the person live in the property as a lease tenant for some period of time, typically 12 to 24 months.
The Lease Agreement is linked to a Purchase Option Agreement, which defines the price, terms and conditions upon which the lease-option buyer shall have the right to exercise their option and close on the sale of the house. Those conditions are typically that the lease-option buyer successfully completes the lease without defaulting. When the Option is exercised, the Lease-Option buyer will have the right to purchase the property win a traditional sale transaction at a pre-determined price (fixed when the purchase option agreement was executed).
MATRIX RATING: Low to Moderate Risk & Moderate Complexity.
INVESTOR LEVEL: You can be new to real estate investing and do lease options. They are relatively simple requiring only 2 documents to execute.
WHAT'S REQUIRED: Familiarity with real estate contracts and other legal agreements.
WHAT'S OPTIONAL: Although not required, we recommend getting a lawyer to assist with the documentation on a Lease Option (At least for your first). This is important because improperly executed documentation could cause problems in the event the lease-option buyer defaults and you have to evict them.
WHAT'S ADVISABLE: The problem some Lease-Option Sellers run into when their lease-option buyer defaults and they have to be evicted, is that there have been cases where judges have ruled specific lease option agreements as a form of financing. The Lease must remain distinctly separate from the Purchase Option, and the wording must be just right to avoid this interpretation. When the two agreements are bundled together, it can happen that your transaction might fall under mortgage foreclosure laws instead of tenant eviction laws. While both bodies of law vary from state to state, in most municipalities, evictions tend to happen a lot faster than foreclosures. To be safe get a good attorney to develop or look over your paperwork and assure it complies with the appropriate tenant eviction laws in your state.
ASSESSMENT: Lease Option Agreements are by far the preferable way to sell property and generate cash flow when bank financing is hard to come by. Granted, if you want to emotionally detach from a property by getting it out of your life completely, a lease option will not bring the satisfaction you seek. However, if you are holding a property that you cannot sell outright, your next objective must be to minimize the losses and costs associated with holding the property until you can get rid of it. Lease Options allow you to achieve two objectives with a bonus:
- The Lease Option allows you to offer your home for sale to a wider audience of buyers since bank financing will not be required.
- You will generate cash flow from rental income without the typical hassles of rental tenants. Lease-Option buyers far and away take better care of your property since they consider it their own, even while they are renting
- You get to jump start your cash flow by collecting lease-option fees, which are like rental deposits on steroids. Unlike rental agreements, you can charge whatever up front fee you want, since this fee is typically unregulated and it is formally credited to their down payment.
BENEFITS: When bank financing is hard to come by, it affects you as both buyer and seller. When selling in a market where bank financing is hard to come by, Lease Options provide an all around solution with good cash flow, live in “caretakers” of your property, substantial cash down payments, and you maintain full control of the property and the lease-option buyer.
The other “hidden” benefit is the statistical fact that most lease option buyers will change their minds about keeping the property or will default and move out before the lease is completed. Now, your first reaction might be that this is bad news but it is not…just think about it. You collected a substantial down payment, and had good cash flow by structuring the deal right. If your lease-option buyer decides not to exercise the option and purchase, you get to keep the non-refundable option fee, and then get to do it all over again. Your property will be in decent condition because buyers tend to treat the property as their own homes. You will have received a down payment, and will soon be in receipt of another when you execute the agreements with a new lease option buyer.
CHALLENGES: The biggest concern you may have with a Lease Option is easily mitigated up front by getting a good attorney. Lease Option agreements are relatively well known and you can get good contracts from a number of on-line sources. No matter where you get them, make sure you get a good attorney to bless them. Once he does, you can use the same paperwork over and over again. |
