These things go by many names in the industry, lease purchase, lease option, lease with option to buy, rent to own. They are all similar creatures. I want to try and explain these a little bit at least from my own experience with them in Central Florida. I am not a lawyer, nor do I play one on TV, but this is how I like to do these.
I like to call these arrangements a "lease purchase" and nothing else. A lease purchase basically means that a tenant is renting the property and ultimately will purchase the property by the end of the lease term.
I used to like to give tenants a "lease option" or a "lease with option to buy" which gives the tenant the option not to purchase the property if they don't want to, but the end result is either the tenant is going to be able to get financing or they aren't, so why give them an option? My goal is to sell them the property, not have them rent it and back out. Also, I don't like the term "rent to own." When I used this language in my advertising, people started thinking about how they rent a television set or furniture, no money down and make payments for years until it is finally paid off.
The first thing I do once I have an applicant that wants to lease purchase a property is to do a credit check. I have my mortgage broker pull their credit and see if maybe just maybe we can get this person in to a mortgage right now. If so, then we don't even have to bother with the lease purchase. We just do a regular sale & purchase right then and there. More often than not the applicant cannot get a mortgage right now, so we do have to go the lease purchase route.
If the property is one I have listed for a 3rd party seller, I have that seller provide me an application. Then I have the seller do whatever background checks they need to do. I help guide them, but it is ultimately their decision on whether or not to accept the applicant.
Now if the property is one in my own portfolio, I have a system in place for screening. I already have a lease purchase application posted on my company's website, and I have the applicant fill it out. My purpose with the background check is two-fold. (1) to verify if these people have any chance at all of ever buying the house, and (2) to make sure that I really want these people as a tenant for the next year. If they have acceptable credit and income with just a few dings, they pass #1. For #2 I screen just like I would a regular old tenant, I check for evictions, criminal, rental history, income history, and overall general character. Of course the more money they have to give me upfront the more likely I am to be lenient on both #1 and #2.
Typically the more money people have to give you upfront, the better chance they have of closing and not walking away at the end. However, I still have had people with fairly good sized deposits that ended up not closing. About 2 years ago at the height of the market boom, I had someone give me $20,000 upfront and a year later they walked away from the deal. (I did give them some of their money back because I just felt really bad for them - business failing, were not getting their visas renewed by the government.)
I have had an attorney draft up a generic document for me to use on my own deals. For a 3rd party seller and buyer, I have to send them to an attorney to draft up the paperwork for the transaction because the local Realtor association does not have a standard form for lease purchases and I cannot legally draw up forms for them.
As far as structuring the deal goes, I use a standard Realtor purchase & sale contract, a standard Realtor lease agreement, and a special addendum (drafted by my attorney) to change the contract to a lease purchase. Basically there are 2 separate agreements. 1 agreement is the purchase & sale contract with LP addendum, the other is the lease agreement. I want the applicant to have 2 distinct relationships with me. 1 relationship as a buyer and the other as a tenant. That way if for some reason I have to evict this person, I can do it under the lease and not be forced to do some sort of foreclosure or ejectment proceeding. Evictions can typically be done in a few weeks whereas foreclosures can take 6 months or a year. By keeping the 2 agreements separate, this gives the tenant the right to still buy the property even if they are being evicted - I give them 7 days after the eviction to close the transaction or else the purchase & sale contract terminates by its own terms.
I also split the deposit money they give me into 2 groups. The bigger chunk is an earnest money deposit under the contract. This money is non-refundable and I get to pocket it and do what I want with it right away. The second smaller amount is the security deposit under the lease. This money is placed in an account as required by the Florida landlord/tenant act. This way even if the person does not end up buying, at least they get something back if they move out in an orderly fashion.
Some people like to let the buyer have a portion of the monthly payment go towards the deposit. To sort of add up during the time of the agreement. Personally I prefer not to do this, but if the buyer insists I will allow it as long as they are paying above market rent and give me a good-sized upfront deposit.
How much do I ask for the upfront deposit? I learned years ago that it is best to be vague about this. Normally when people ask me, I tell them we standardly ask for 5% of the purchase price as a down payment, but if they do not have that much we are willing to work with anyone who is interested. You definitely need to be much more liberal right now when the market is slow, so if they try to nail me down on a bare minimum I will give them a minimum figure of a few thousand dollars.
Regarding the term of the agreement, I don't like to write these agreements for more than 12 months. As most people know from this latest roller coaster market we have had, prices and market conditions can change drastically in a short period of time. If at the end of a year, the people need an extension I am willing to sit down with them and reasonably re-evaluate the price and terms of the agreement. I did have one couple do this with me for 3 years by paying me a $500 extension fee each year.
The main thing with all this is to be flexible. In a buyer's market, anything you can advertise to make your property stand out above the others is a good thing. If anybody has specific questions on lease purchase, feel free to ask.
Copyright © 2007. Sand Dollar Realty Group, Inc. All rights reserved.
Rob Arnold, ABR, CPL, GRI, Full service and investor friendly Realtor, Managing real estate broker, Licensed mortgage broker, Notary Public