To Lease or Not to Lease, That is the OPTION!

By
Real Estate Agent with The Gatti Group at Keller Williams Realty
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. Declining market graph on isle with presenter standing with pointer protected by armour helmet and sheild

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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As Always, Please contact Larry Gatti with any questions or comments about the Louisville KY Real Estate Market.  If you know of anyone that has real estate needs, contact me directly.  We will take excellent care of your referrals.


Larry Gatti

Keller Williams Realty

Office: (502) 554-9445

Larry Gatti, The Gatti Group

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Comments (10)

Anonymous
Justin Thomas

Well said, man.  I like the explanation of what happens in different markets. Rock.

Mar 23, 2012 06:18 AM
#1
Chris Thomas
Keller Williams Realty Louisville East - Saint Matthews, KY

Larry, I think it's best to just rent without the option unless it's clear the buyer really is interested in the property to purchase.  It's rare that these things end up working.

Mar 23, 2012 07:25 AM
Lynda White
Bluegrass Homes & Farms Realty, Agent Know How - Louisville, KY
Admin. Mgr., Keller Williams Realty

Welcome to Active Rain, Larry! I always get those two terms mixed up but it's quite easy really..lease purchase is a purchase contract, option is not. Thanks for clearing that up. I have so much to learn...and learn lots of new things every day. 

Mar 23, 2012 09:00 AM
Anonymous
Anonymous

We did a lease option a year ago and I thought it was a win-win.  The tenant started paying the rent slowly and eventually quit paying.  They had to be evicted and the house ended up in disrepair.  Steve took a lot of heat over this.

I do my best to discourage lease options and lease purchases.

Mar 23, 2012 10:49 PM
#4
The Hollinden Team
EXP Realty - Louisville, KY
Serving the Greater Louisville area

I should have logged in before posting the last comment.  I must still be asleep!

Mar 23, 2012 10:50 PM
Larry Gatti
The Gatti Group at Keller Williams Realty - Louisville, KY

Chris, Thanks for the thoughts.  I couldnt agree with you more.  It's rare that these really work out good for everyone.

Mar 24, 2012 01:14 PM
Larry Gatti
The Gatti Group at Keller Williams Realty - Louisville, KY

Thanks Lynda.  I'm just getting started in blogging.  This is a topic that seems to come up in client questions recently so I thought I would touch on it.

Mar 24, 2012 01:16 PM
Larry Gatti
The Gatti Group at Keller Williams Realty - Louisville, KY

Steve, I wonder if we could get some stories of these working out for people recently.

 

Mar 24, 2012 01:19 PM
Larry Gatti
The Gatti Group at Keller Williams Realty - Louisville, KY

Thanks Justin.

Mar 24, 2012 01:20 PM
Adam Borders
Keller Williams Realty Louisville EAST - Simpsonville, KY
Kentucky REALTOR

Even with all the leasing I have been doing lately, most renters with any sort of good credit are looking to just rent.  I do get lots of cals to rent to own, which is a very bad scam that doesn't involve a licensed agent normally. 

The difference between lease-purchase and leaase-option can be hazardous to your seller if not drafted properly

 

Mar 25, 2012 06:19 PM