In a challenging real estate market, there’s been a growing interest in lease/purchase options, which can benefit sellers and make it easier for prospective purchasers to buy. A common problem today is that, due to new lending restrictions, many potential buyers can’t qualify for a loan even though they have saved toward a down payment and are generally a good credit risk.
The solution for both sides might be a lease/purchase option. Basically, the prospective purchasers agree to rent the property for a year (or more), after which they have the option to purchase it at a given price. Each month a portion of their rental payment is credited toward the purchase price, which will reduce the amount they have to pay if they decide to buy. In effect, it’s a “rent-to-own” arrangement for real estate.
Why it’s good for prospective purchasers: Suppose you’ve found a dream home or office but you’re just a little short of meeting the requirements for a loan. This arrangement lets you occupy the property right away, while giving you time to get your finances in shape and close on a mortgage. (In addition, it might be easier to get a mortgage later because the purchase price will be reduced by a portion of the rental payments.)
Why it’s good for sellers: If you can’t sell a property and you decide to rent it while looking for a buyer, you’re way ahead of the game if you can rent it to someone who is likely to turn into that buyer down the road.
Plus, the biggest problem most landlords have is that tenants don’t take care of the property (or actually damage the property) because it doesn’t belong to them and they’re only using it for a short time. Tenants who plan to become owners are much more likely to carefully look after a property during the lease term.
What to consider
There are a number of things to be negotiated in a lease/purchase arrangement. First and foremost (after the amount of rent) are what the purchase price will be and what percentage of the rental payments will be credited toward that price.
Some sellers charge a non-refundable upfront fee for the option, which gives them a cushion in case the deal falls through at the end of the term. They might also insist that only on-time rental payments will be applied toward the purchase price; this creates an extra incentive to pay the rent on time.
Another question is the length of the lease term. Most commonly, the term is one to three years. But you could also have a one-year term that is renewable at the end of the year, so if the prospective purchasers still aren’t ready to buy, they can lease for another year. In some cases the buyer can decide whether or not to renew; in others the seller has the right to say no. If the buyers want an absolute right to renew, the seller might compensate for this by asking for higher rental payments in the second year, and/or a higher purchase price at the end of the second year.
Since the tenants are thinking of the property as one they will eventually own, they are often willing to agree to perform routine repairs and maintenance on the property. Landlords usually appreciate this (especially if they really want to sell the property and are only reluctantly acting as a landlord), so they might be willing to compensate the tenants by charging lower rent payments or applying a higher percentage of the rent to the purchase price.
There are other variations. For instance, rather than agreeing on an ultimate purchase price, the parties can agree to have the market value of the property appraised at the end of the lease term by an independent appraiser, and use the appraisal value as the purchase price.
Another possibility is to allow the prospective purchasers the right to sell the option to a third party. For instance, suppose a lease/purchase contract allows a purchaser to buy a property in a year for $250,000. After a year, the purchaser has a job transfer to another city and can’t go through with the purchase. Meanwhile, the market recovers and the property is now worth $275,000. The purchaser could find another buyer and sell the option for, say, $15,000. The purchaser would make $15,000, and the new buyer would have an incentive to purchase the property since he or she would still save $10,000 over its market value.
