To Lease or Not to Lease, That is the OPTION.
We have all seen the listing for sale with "lease option available" on it. Most of us probably look past that unless we happen to have a client that is indeed looking to rent for a while before purchasing. There may be for any number of reasons that this person wants to rent or do a lease option. On the surface, a lease option seems like a great way to get into home ownership. However there are pros and cons to the transaction.
We are talking about lease options, NOT lease purchases.
The difference can be simple, but significant. The lease purchase is usually a straight purchase contract with an extended time frame to close and a lease agreement written into the contract. A lease option is NOT a purchase contract. It is a lease with an addendum that gives the renter the first right of refusal to purchase the home with an agreed upon price and timeframe.
Why would someone want or have to rent?
Many reasons come to mind, but the main two that I have come across are either because they do not have necessary means to get a loan today or they just know they love, love, love the house and do not want to risk losing it. The key to a lease option is really the option itself. There is usually a hefty, non refundable option fee that the renter must pay upfront to the seller to have this option. If the renter leases the property for the specified time, they have the "option" to purchase the property at the predetermined price. If they do not purchase, they lose the option fee and the seller keeps it. Another reason the renter may not purchase is that after living in the home a while, they may start to see imperfections and other reasons they do not want to live there permanently.
Opt In Versus Opt Out
In an appreciating market like we had before the bust, lease options were very advantageous for the renter. As the property appreciates in value, it makes the option price more attractive because it was set below what the current market value will be at the end of the lease term, say in 1-3 years. Sometimes the option fee can be applied to the purchase price as well as a small stipend added to the monthly rent to further help the renter save more towards the down payment. So the buyer/renter is now able to get a loan because the home has equity in it. The seller gets to sell the property, pocket some rent money, and possibly keep the option fee if the renter decides not to purchase or defaults on the lease. The seller does typically have the same risks associated with being a landlord and property manager, but that usually is well worth it.
However, in a flat or declining market like we are in now, there really is very little benefit to the renter. Because there is no foreseeable appreciation, the option purchase price would not be below market value. In fact, it would probably be at or above market, making no sense to exercise the option. When this is the case, what is the most likely outcome for the renter? That's right. They would rent it and in the end, not purchase the home and lose the option fee. The seller would get to keep the option fee, and either re-rent the property or do another lease option. Option fees add up quickly, so in this situation, I think the advantage goes to the owner.
Save The Option Fee and Just Rent!
I would rather see the renter just do a standard lease because more than likely the seller will not have sold the house during the lease and chances are the seller will still be interested in selling it to the renter at the end of a normal lease.
BONUS: If the value did drop, the renter could get an even better sales price than had they locked it in a year or two before.
We have seen an increase number of buyers in our market asking about these possibilities, especially in Louisville homes for sale priced between 300,000 and 600,000. Louisville, KY is a historically stable market which did not get the huge upswings that the larger and coastal markets saw, so it did not have the catastrophic drops that followed. If I have a client that is interested in doing a lease option, I review their needs and their love of the house. Nine times out of 10, it usually ends up with them just renting for a while and buying a home afterward. And they save the option fee to put down on a home when they are really ready to buy.
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