What is an OPTION in Real Estate and When do you want to use an Option?
First, let's clear up some "slang" terms often used with these that create confusion: Rent to Own, Lease Option, Lease with Option to Purchase all mean the same thing in general usage. A lease is simply a rental agreement that is established for a set period of time (e.g. twelve months required rental period); rent is often used to refer to month to month situations.
An option is a grant of the right to purchase property, at set price and terms, from the owner of the property. The person who receives the option can (but is not required to) purchase the property during a set period of time agreed to by both parties when they enter the option.
An option is different from an agreement to sell (Purchase Agreement). Under an option, the seller agrees to sell, but the buyer does not agree to buy; the buyer simply has the option of buying during the option period. A Purchase Agreement provides that the buyer agrees to buy and the seller agrees to sell.
NOTE: In an Option, the Seller is the Optionor (The one who gives the Option) and the Buyer is known as the Optionee (The one who receives the Option).
What is needed to SET UP a Lease with Option to Buy?
To set up a Lease with Option to Purchase with a tenant, you will need all of the documents you would normally use to set up a simple rental/lease:
· Option Agreement*/Purchase Agreement
· Rental Agreement
· Check-in/check-out list
· Lead Base Paint Disclosure and pamphlet
· Smoke Detector Agreement
· Any other agreements you would normally use).
*Be sure that Option Agreement you're using protects you as the Optionor, as many option forms available favor the Optionee. Attached to the Option Agreement will be a Purchase Agreement, which will spell out the terms of the sale under which the tenant may purchase.
NOTE: It is important that both parties initial the Purchase Agreement on the top or bottom corner to acknowledge that the terms have been agreed to but it is not yet a binding Purchase Agreement. Also, be sure to use an Option form that is not recordable, on the public records so that the tenant doesn't unnecessarily cloud the title to your property.
BENEFITS of doing Lease Options
Let's look as some things that you can expect when you offer your property on a Lease with Option to Buy:
1. If you place an ad for your property offering a lease with Option to Buy, you can generally expect five times the number of responses than a regular "For Rent" ad. There are a lot of people looking for an opportunity to own their own home rather than just continue to rent.
2. The tenants who call will be inherently more responsible and serious about owning their next home.
3. Traditionally, in addition to the monthly rent, you will receive a monthly payment towards the option fee (the fee you are being paid to grant the option) thereby increasing your monthly cash flow.
4. Since you are working with people who often aren't immediately able to purchase a home outright for various reasons (usually credit or time on the job), you are providing them the opportunity to own when they otherwise couldn't, and are therefore generally willing to pay a slightly higher sales price, often as much as15%.
How to STRUCTURE a Lease Option
Through our experience, we have found the following to be a good guideline for structuring Lease Options:
Charge market rent. Don't give discounts on rent just because the tenants are also paying you a monthly option fee or they are planning on buying the house; the option is separate from the rental.
Get as much option fee as you can up front, the more the perspective tenants pay up front, the greater their risk will be if they don't follow through. Credit the option fee towards the sale price if they close.
In Michigan, you can only collect equal to 1-1/2times the amount of the rental rent as security deposit up front when renting, plus you may have to give it back if the tenants move. When doing an option, don't charge a security deposit; apply the funds the tenant would have paid to the option fee, which is non refundable.
Make your option cancelable by you if the tenants default in any of the terms of the rental/lease. (We have this incorporated into all of our agreements)
Work with a mortgage loan officer to qualify your perspective tenants. Have the loan officer advise you on how long it will take to have the tenant "mortgage ready", then set your lease option term accordingly.
When pricing your property, you will be able to get more than market price, but remember the property will have to appraise for the purchase price when they qualify for the mortgage. 15% or higher is a good range, figuring their option fee being deducted and appreciation. An excellent explanation of "why pay more" is the example of car insurance, you get some accidents and tickets, and then you end up paying more. Just the same, your credit scores affect the cost of financing and the availability of sellers who will work with you.
Make the tenant responsible for repairs and maintenance to the property; make sure your rental agreement states they are responsible for the cost of such repairs and renovations. (Keep in mind under Michigan law, you are still ultimately responsible to perform repairs when you rent property, but often tenants will perform or arrange needed repairs and even if they don't, you can charge the tenants for the repairs.)
No matter what your investment plan or strategy, options can be used to produce better profits and less "management intense" rental situations, as well as one of the best solutions to sell your rental property at top dollar. It can truly work as one of the best "win/win" situations in real estate investment.
To learn more about options, visit our website at
Disclaimer: Real estate investing by nature is risky. You can win, lose or break even. Mark Maupin cannot guarantee a profit or loss. We do not provide legal, accounting or contracting advice. Please contact an attorney and/or financial professional whenever making a real estate investment.
Part One Rent to Own Video – Click here:
Part Two Rent to Own Video – Click here:
Part Three Rent to Own Video – Click here:
Ralph Mark Maupin has purchased and sold in excess of 3,500 single-family homes and many multi family properties. Mark teaches real estate investing seminars, and has real estate mentoring program. Mark co-founded company Donate Real Estate, https://activerain.com/blogs/markmaupin
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