Lease Option / Rent to Own
07/17/2009 - By Brian Jarrett 
Lease Option
Lease Options can be a win/win transaction between buyer and seller. It can also be used as an effective low down investing method for Real Estate Investors.
Lease Options, or Rent to Own (RTO) have always been used for a variety of reasons for purchasing a property. In a Lease Option, the buyer pays an Option Fee to lock in their right to purchase the property at the end of the contract term. There are pros and cons to entering a Lease Option agreement for properties that should be considered prior to taking this route. In addition, the current economic conditions are changing some of the factors that should be considered when considering buying or selling using lease option. Lease Options are usually offered by Motivated Sellers in slow markets to help them sell the property. They can also be used to get top dollar for property in a slow market, provided the Lease Option is exercised at the end of the term.
Reasons Buyers use Lease Options:
They do not Qualify for Mortgage. The most common reason why buyers consider lease options is because their credit or time on the job is not sufficient to qualify for a mortgage. In today's market, there are more people every day who fall into this category. For some people, it is just a matter of time until they will qualify for the mortgage. Often, the buyer likes a particular property that they do not want to lose.
1) Insufficient Down Payment. With down payment requirements getting higher, sufficient cash on hand is a common hurdle for homebuyers. For the many people, the possiblity of coming up with a 20% down payment is out of reach. By using Lease Options to lock in their right to buy a house, they are also able to apply their monthly credits to apply towards a down payment. The rule of thumb is that the Option Fee is not credited, but anything is negotiable.
2) Smaller financial impact than Purchasing. This can apply to the front end as well as the back end of the transaction. It takes less money out of pocket to Lease Option a house than to purchase it outright. On the back end, if the buyer needs to walk away from the property for any reason such as flat or declining property values it is much cleaner and cheaper than selling a property. First of all, the Optionee can just walk away and only lose their option fee and whatever rent credits were above market rent. If the property was purchased, the buyer would be stuck with falling values, Realtor commissions to sell, and possibly not being able to sell the property at all.
3) Investor Strategy. Lease Options or RTO's can be effectively used as a very profitable investing strategy. This is particularly true in the current Real Estate market. Motivated sellers have more reason to agree to more favorable terms for the investor just to get out from under the property. Maybe it is a vacant rental that they're unable to fill and are about to fall behind in payments. Whatever the seller's motivation, investors can use it to their advantage when negotiating terms for a Lease Option. Investors can use the “Sandwich” method to control a property via Lease Option and then flip it as a Sub-Lease Option. The investor negotiates minimal option fee and then can profit immediately by collecting the Option Fee from the sub-lessee.
Things to Consider for Lease Options:
1) Know Your Market. If property values are declining, it is important to be very careful about doing a Lease Option. However, risk can still be minimized by negotiating down the Option Fee and monthly Lease. If the seller is desperate enough, they may just require an Option Fee of $1. In this case the buyer would want to negotiate a longer term to allow time for the market to recover. As a buyer, make sure your contract has an assignability clause in case you wish to assign the contract to somebody else. As a buyer, always try to eliminate a non-assignable clause – although most sellers will not.
2) Do Your Due Diligence. Treat a Lease Option transaction the same as a home purchase. As a seller, make all disclosures that you would normally do in a sale. As a buyer, make sure to perform all due diligence just like any other home purchase. This would include a professional home inspection, title research, appraisal, and pest inspections.
3) Buyer Considerations. If you choose to enter a Lease Option agreement, make sure to consult an attorney for advice. There are many changes from State to State that require careful wording in the Lease Option contract. A lease option buyer should protect their interests by having documents notarized and record the documents. The option should be recorded as a “Memorandum of Option”. Additionally, have the deed held in escrow to protect yourself if the owner dies. Your best protection is to record a Mortgage to ensure performance on Lease Options.
4) Seller Considerations. Theseller in a Lease Option transaction can best protect themselves by being very careful in the contract language to eliminate the appearance of an Equitable Mortgage. The appearance of an equitable mortgage can best be avoided by having the contract terms of a Landlord and Tenant, rather than a buyer and seller relationship. This helps avoid or minimize problems that can arise from a nonpaying optionee. If an optionee can show that they have an equitable interest in the property, some States will require the owner to foreclose instead of simply evicting. It is extremely important to consult professional legal advice to ensure your contracts are properly written for the State you are doing the Lease Option in!
Lease Options require careful legal review before entering into a contractual agreement. With that said, it can also create a win/win situation for all involved and can be a profitable Real Estate Investing strategy!
