Are you having difficulty selling your home or other real estate? Or would you like to buy a home or an investment property but you don't have enough cash for a down payment? If you answered "yes" to either question, a lease with option to purchase may solve your problem. But it's important to understand the pros and cons of lease-options to maximize your benefits.
What is a Lease-Option?
A lease-option is a combination real estate rental, sales and finance technique. It is a property lease for a fixed time period, such as 12 or 24 months, with an option for the tenant to buy the property at an agreed option price during the lease term. Buyers like lease-options because little up-front cash is required. Sellers also like lease-options because they provide necessary cash flow to pay the mortgage and property taxes from a tenant who has a vested interest in treating the property well and who is likely to buy it.
What is a Lease-Purchase?
A lease-purchase is different from a lease-option because it obligates the tenant to purchase the property at the end of the lease. With a lease-option the tenant has the right, but not the obligation, to purchase the property.
With both, however, the tenant usually pays an above-market rent and receives a monthly rent credit toward the down payment. Of course, both a lease-option and a lease-purchase obligate the seller to sell the property on the agreed terms.
Advantages For Sellers
Unless your property is located where there is very strong demand from buyers, lease-options can be especially advantageous for home sellers.
Primary property seller advantages are:
- Strong Demand From Prospective Buyers
No matter how slow the local real estate market might be, there is almost always a strong demand from lease-option buyers. Many prospective home buyers can usually afford the monthly payments but they have often have insufficient cash for a down payment. The lease-option solves this problem by giving the tenant-buyer a rent credit toward the down payment. It's like a "forced savings account." In addition, the tenant-buyer usually pays up-front nonrefundable consideration for the option, typically several thousand dollars.
- Top Dollar Option Price
Because of strong buyer demand for lease-options, when done correctly, home sellers can demand and get top dollar for their properties. Usually, the option price is set at the market value when signing the lease-option. If the home's market value goes up during the lease-option term, the buyer benefits. Should the property drop in value, then the tenant usually doesn't complete the purchase.
- Top Quality Tenants
During the lease-option, the tenant-buyer usually take good care of the property as if they own it.
- Above-Market Rent
Another seller advantage is earning above-market rent. Landlords can charge tenants 10 to 20 percent above market rent.
- Seller Keeps the Tax Deductions
During the lease-option period, the seller retains all the property income tax deductions. If a tenant complains about not receiving any tax benefits, a reminder about the rent credit toward the down payment usually ends the discussion.
Advantages For Buyers
Lease-option benefits are not one-sided. Advantages for buyers include:
- Small Amount of Up-Front Cash Required
The amount of up-front cash required to acquire a home or other property on a lease-option is usually small, often just a few thousand dollars for the first month's rent plus non-refundable option consideration. This option money is in lieu of a security deposit.
- Monthly Rent Credit Builds a Down Payment
The unique characteristic of a lease-option is the rent credit toward the buyer's down payment. Typically, the rent credit is 10 to 100 percent of the monthly rent, depending on how motivated the seller is to sell. The higher the rent credit percentage, the greater the probability the tenant will buy.
- Try Out the Property Before Buying
Another special lease-option benefit for the tenant is the ability to try out the property before buying. If it is undesirable, the tenant hasn't tied up a large amount of cash in a home that might be difficult to resell.
- Control Property With Very Little Cash
The ability to control a property and profit from its market value appreciation with very little cash is called leverage. Lease-option buyers have this unique advantage.
- Longer Terms Mean Greater Profitability
Although most residence lease-options are for short terms, such as one or two years, smart investors seek lease-options with the longest possible term. They reason the property is likely to appreciate in market value over the long term.