for a fixed period of time, but are not required to purchase the property. With a Lease Purchase, you have a Purchase Agreement declaring that on a given date you will purchase the property for the price and terms set forth in the contract. With a Lease Purchase contract, you have to buy.
With a Lease Purchase, there are two documents involved; a lease or rental agreement, and a purchase contract to buy the property at a later date. Extra bonuses are that you do not have to pay closing costs, and there is not a traditional down payment or other fees normally found in purchases funded by conventional mortgages.
“A Lease Purchase is different from a Lease Option because it obligates the tenant to purchase the property at the end of the lease,” confirms real estate attorney and nationally syndicated columnist Bob Bruss. “With a Lease Option the tenant has the right, but not the obligation, to purchase the property. With both, however, the tenant usually pays an above-market rent and receives a monthly rent credit toward the down payment.”
A Lease Option is a hybrid between a real estate rental and a sales finance method. The property is leased for a fixed time period – one or more years - with an option for the tenant to buy the property at preset price during the lease term. The tenant is not obligated to buy the property, but the premium option price they paid is usually non-refundable.
“Usually there is an up-front payment of some amount to purchase the option,” explains real estate author Ilyce Glink. “The amount can vary. Sometimes the monthly payment is larger than normal and the excess is used to purchase the option. Lease Options are usually done during a slow real estate market. During a hot market, the seller can simply sell the property in the regular manner.”
If the option is picked up, you need to do is schedule the closing date, hire an escrow or title company, and provide any state-mandated disclosure.
Buyers like Lease Options because little up-front cash is required. Sellers
benefit from Lease Options because they provide cash flow from a tenant
who has a vested interest in treating the property well.
According to Bruss, the primary property seller advantages are:
1. Strong Demand From Prospective Buyers –There is consistently a strong demand from Lease Option buyers. Oftentimes, buyers can afford the monthly payments but have insufficient cash for a down payment. The Lease Option allows the tenant-buyer to accumulate a rent credit toward the down payment. It's like a "forced savings account." In addition, the tenant-buyer usually pays up-front nonrefundable consideration for the option.
2. The Best Option Price – As there is a strong buyer demand for Lease Options, sellers receive top dollar for their properties. Most times, the option price is set at the market value when signing the Lease Option. If the market value on the property rises during the Lease Option term, the buyer benefits. Should the property drop in value, then the tenant will most likely not complete the purchase.
3. Great Tenants - During the Lease Option, the tenant-buyer tends to take good care of the property - as if they own it – hahaha.
4. Strong Rents – Landlords doing Lease Option contracts can charge tenants 10 to 20% above market rent – with those monies being applied toward the down payment.
5. Seller Keeps the Tax Deductions - During the Lease Option period, the seller maintains the property income tax deductions.
A Lease Options allows a seller to sell “during a slow market,”
1. Minimal Down Payment - The amount of up-front cash required to acquire a property on a Lease Option tends to be a minimal amount + the first month's rent + non-refundable option consideration. The option money may be in lieu of a security deposit. Buyers with credit problems benefit from this purchase method, as the seller may finance you. It gives a buyer time to repair less-than-stellar FICO scores prior to obtaining a mortgage.
2. Monthly Rent Credit Builds a Down Payment – Bruss notes that “typically, the rent credit is 10 to 100% of the monthly rent,” toward the down payment of the property. The higher the rent credit percentage, the greater the probability the tenant will buy.
3. Try Before You Buy – A nice Lease Option benefit.
4. Control Property With A Minimal Cash Investment – A Lease Option gives the buyer leverage – they get to control a property and profit from its market value appreciation with very little cash.
5. Greater Profitability – Seasoned tenant-investors seek Lease Options with the longest possible term, as the property is likely to appreciate in market value over time.
“Individuals who attempt to buy on a Lease Option rarely end up
buying the property,” concludes Glink. “This often has to
do with the reason they try to buy on a Lease Option. They usually cannot
qualify for a loan and expect that they will be able to qualify after
a period of time. Later, they find they still cannot qualify… whether
it is because of poor credit, lack of income (documentable income), or
lack of savings…“
For more on Southern California commercial properties there is a great
information blog at www.socalindustrialrealestateblog.com.