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Addendum
Lease With Option To
Purchase (Rent to Own)
Since creation of the Buying &
Selling Income Property e-Course, RHOL has received a number of questions on
the member-only Support Forum regarding the Lease With Option To Buy or Rent
To Own way of buying and selling real estate. Accordingly, we are
providing a brief discussion in this lesson.
Definition
Option: A right
given a person to buy, sell, or lease property at a specific price within a
specified period of time. A valid option must name a valuable consideration.
Introduction
The lease option can be of
value to both buyers and sellers and the issues of importance can be different
depending on which seat one occupies. There are a number of important
issues to consider when an owner is giving an option to purchase the property to
a tenant who is occupying it. Failure to consider certain issues up front
can result in serious problems along the way.
Unless both the lease
agreement and the option agreement are properly written, serious problems can
result. While there are many possible problem scenarios, consider the following
question. What would happen if the seller must evict the tenant having a
lease option and the option to purchase survived the eviction? Can you now
rent the property to a new tenant?
From the point of view of an seller
Advantages can include the
following:
1)
The seller can
(at least theoretically) generate extra income because a lease option is usually
written with an above market monthly rent with the excess usually applied to the
option purchase price.
2)
Brokerage
commissions and other marketing costs related to the sale are usually avoided.
3)
Because the
tenant expects to end up owning the property, he will (in theory) take better
care of the property.
4)
If the market
declines, the seller may be able to sell at a higher-than-market price, if the
tenant still wants the property.
5)
In most cases,
the tenant will not exercise the option because they won't have saved the
necessary cash for closing the sale or won't qualify for the necessary mortgage
loan. So, if you obtained premium rent and had good tenants and it was not
important that you sell the property, you can be ahead of the game.
Disadvantages can include
the following:
1)
The Lease Option
is a unilateral contract unless and until the tenant elects to exercise his
option. That is, the seller must sell if the tenant decides to exercise
the option, but the tenant need not buy.
2)
Unless both the
lease agreement and the option agreement are properly written, serious problems
can result. While there are many possible problem scenarios, consider the
following question. What would happen if the seller must evict the tenant
having a lease option and the option to purchase survived the eviction?
Can you now rent the property to a new tenant?
3)
If the market
unexpectedly improves, the seller may end up locked into a lower-than-market
price.
From the point of view of a buyer
Advantages can include the
following:
1)
The Tenant can
try out the property before committing to owning it.
2)
The Lease Option
is a unilateral contract unless and until the tenant elects to exercise his
option. That is, the seller must sell if the tenant decides to exercise
the option, but the tenant need not buy.
3)
If the market
unexpectedly improves, the tenant/buyer will benefit from buying the property
for under-market price.
4)
Brokerage
commissions and other marketing costs related to the sale are usually avoided.
5)
Because the
tenant expects to end up owning the property, he will (in theory) take better
care of the property.
Disadvantages can include
the following:
- The
tenant/buyer will likely pay higher rent because a lease option is usually
written with an above market monthly rent with the excess usually applied to the
option purchase price. However, the higher rent is not a problem if the excess
is credited to the purchase price and the buyer.
- If
the market declines, the seller may end up buying at a higher-than-market price,
but the tenant needn't exercise the option.
- In
most cases, the tenant will not exercise the option because they won't have
saved the necessary cash for closing the sale or won't qualify for the necessary
mortgage loan. So, if you obtained premium rent and had good tenants and it was
not important that you sell the property, you can be ahead of the game.
Items of
Importance
There are a number of issues that
must be considered when writing a lease option contract. Included are the
following:
- Obligations regarding
inspection issues - Require that all inspections that are a contingency be
performed prior to move-in. However, since the tenant can fail to
exercise the option for no reason, this doesn't guarantee that a inspection
issue won't be the cause of no-sale, but it may reduce the probability.
- Maintenance obligations
should always be defined in any lease agreement, but it is much more important
that all details be covered when doing a lease option including who is
responsible for major repairs during the term of the lease. Be sure to
cover such items as replacement of heating/cooling equipment and
repair of major damage act-of-nature not covered by insurance.
- There are numerous issues
to consider in determining the option price as well as a number of related
issues including the rent premium, the portion of rent to be credited toward
purchase price, and the length of the option. It's a matter of negotiating
mutually acceptable terms.
A Purchase Option agreement should
also contain clauses that
cover at least the following issues:
- Time and Price: Tenant is granted the option to purchase the Premises for the
price of ____________ at any time during the period between execution of this
agreement and ___________.
-
Contingent on Performance: The option
agreement should state that the option is contingent on the tenant not being in
default under the lease and that the option terminates upon termination of
tenancy if before expiration of lease.
- Exercise of Option: Tenant must exercise option by written notice to Landlord
and shall designate a closing date not earlier than ____ days and not later than
____ days after the date of the notice. Said notice shall be personally delivered
to Landlord or mailed to Landlord by Certified Mail.
- Execution of Contract: Upon tenant's exercise or the purchase option, Landlord
and Tenant shall promptly enter into a contract of sale containing the
provisions of this agreement and the customary provisions regarding sale of real
estate in the County of ________________ and said contract shall be executed by
all parties within ______ days. Failure of Tenant to execute contract shall be
a material default of this agreement.
- Payment of Purchase Price: The purchase price shall be paid as follows:
___________________.
- At
closing Landlord will convey the Premises by _____________ deed, subject to
_________________.
- Closing Costs and Adjustments: transfer tax and/or other taxes payable for
conveyance, real estate taxes, water and sewer charges, fuel and other utility
charges, premium for any insurance policy being assumed, and any government
charges or assessments with respect to the premises will be apportioned.
- Condition of the Premises: Tenant acknowledges that he is familiar with the
condition of the Premises, has performed or caused to be performed all
inspection desired as to condition of the premises, and will accept the premises
"as is" at the time of closing.
The bottom line is that one
should seriously consider having a competent real estate attorney or a real
estate broker with experience in lease options review the transaction documents.
However, you must also consider all the issues yourself as they relate to your
particular property and other circumstances and utilize the professionals as a
check rather than depend on them to worry about every possible issue that might
become important.
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