© Copyright 2000-2011 Landlord.com
By Bob Cain
www.rentalprop.com
Copyright 2000 Cain Publications, Inc.,
used by permission
The lease option offers a
way for you to control property for little or no money and for you to
rent out or sell a property you might not otherwise be able to rent or
sell.
First, what is
an option? An option is an option to buy. A buyer makes an agreement
with the owner of a property to buy a piece of property within a
specified length of time for a specified amount of money at specified
terms in return for which he pays the seller of the property an option
fee. The option fee is compensation for the seller for keeping the
property off the market for the period of time of the option agreement.
Here is sample
option agreement language:
In consideration of the
payment by the undersigned optionee in the amount of $__________,
receipt of which is hereby acknowledged , optionor grants the optionee
an option to purchase the real property described in the Agreement of
Sale (attached) upon all the terms and conditions set forth therein. If
not exercised, this option shall expire on _____________ at midnight.
This option shall be exercised by mailing or delivering written notice
to the optionor prior to the expiration of this option. Notice, if
mailed, shall be by certified mail, postage prepaid, to the optionor at
the address set forth below, and shall be deemed to have been given upon
the day following the day shown on the postmark of the envelope in which
such notice is mailed.
In the event the option is
exercised, the said sum of $___________ shall (shall not) be credited
toward the purchase price.
In the event the option is
exercised, the Agreement of Sale (attached) shall be effective as if the
offer and acceptance thereof had both been made upon the date the option
is exercised.
Dated:__________
_____________________
________________
Optionor
Optionee
_____________________ ________________
Address
Address
As you can see the steps in an
creating an option are as follows:
1. Buyer and seller agree
on the price and terms under which the buyer will buy the property in
the Agreement of Sale. Write it up just as if you were buying the
property now, but leave the sale and closing dates either blank or write
in the words "upon exercise of the attached option" in place of a date.
2. Buyer and seller attach
an option agreement to the Agreement of Sale saying that the buyer has
the right to go ahead with the purchase under the terms of the Agreement
of Sale until the specified date.
3. If the buyer decides not
to buy the property on or before the date the option expires, he usually
forfeits his earnest money and the option fee.
4. If the buyer decides to
go ahead with the purchase, he can buy the property under the terms and
conditions set forth in the Agreement of Sale. It is negotiable whether
or not the option fee is applied to the sale price.
Things you might want to add to
an option agreement:
1. A provision that permits
the extension of the option for an agreed-upon amount of money.
2. A provision that allows
the buyer to pay the option fee in monthly payments. You would then have
to specify what happens if the monthly payment does not arrive on time.
Note:
Nowhere in the option agreement does it allow the buyer to live in the
property, only to buy it at the terms and conditions agreed upon.
Options are used every day by companies wanting to tie up properties to
buy in case they meet their expansion or building plans. They might buy
an option on anything from bare land to 100-story skyscrapers. They
don't want to do anything with the property just yet, just have it under
their control until they decide if they really need and want it.
When you write
an option on a piece of property both the buyer and seller take a
chance: the market price of the property could drop below the option
price, or it could rise far above the option price. If it drops far
enough, the buyer could decide to forfeit his option money and not
exercise his option, since buying the property at the option price would
be a bad investment.
The seller, on
the other hand, cannot decide not to sell at the option price no matter
how high the market price of the property goes. He can be forced to
abide by the contract in the courts.
Lease options
are actually two separate agreements, the lease and the option. They do
not have to both be present. Obviously you can lease a property without
having an option to buy it, you do that all the time with your rental
property.
So when you go
about buying a property with an option, and want to take control of it
to rent it out, you have to write both an option agreement and a lease
agreement. It is important that you write them both separately. If you
are the seller it is also important that in the option agreement you
place a clause such as: "nothing in this agreement permits the optionee
the right to occupy the property." If you don't put that provision
in the option agreement and you try to evict someone with an option from
the property for nonpayment of rent or some other offense, a judge could
allow the optionee to stay because they have "equitable title" to the
property and so as much right to occupy it as the seller.
By the same
token the lease should not mention the fact that there is an option on
the property. It should be a straight lease agreement that coincides
with the beginning and ending dates of the option.
A use for the
lease-option arrangement for buying or selling property is to allow you
to sell or buy essentially on contract or using owner financing without
triggering the "due on sale" clause in the mortgage. Since you
have not actually "sold" or "bought" the property most mortgagees don't
consider the use of an option to buy as something that means the lender
has to call the loan. Rather it is an agreement that gives someone the
right to buy the property at a future date.
Here's how it works
Suppose you
want to sell your four-plex for $360,000 and a Mr. Jones has agreed in
principle to buy it for $90,000 down. The problem is the current
$270,000 loan you have on the property has a clause that says that if
you sell the property the entire balance is due on sale. There are 17
years left on the loan. Mr. Jones can't do the deal because his debt
load is too high to make a lender want to do business. So either you'll
have to lower your price or find another buyer.
You and Jones
consider several different alternatives, but finally solve the problem
with a lease-option arrangement.
Jones has
$90,000 cash available. You will take $76,500 of that as a security
deposit for a 20-year lease on the four-plex. Under the lease he'll make
monthly rental payments to you equal to or slightly larger than the
payments on your $270,000 loan. (One reason for making them larger is
that you would be compensated for your trouble in the matter. It would
still work if Jones just made lease payments to you equal to your debt
service.)
At the same
time you give Jones an option to buy the property at any time during the
20-year period of the lease. Under the terms of the option he can buy it
for $13,500 cash plus whatever amount is then required to pay off your
loan, with the understanding that he also forfeits his $76,500 "security
deposit." These two amounts total the $90,000 he has already
agreed to pay you for the down payment.
Jones, per
your agreement, also has to pay all property taxes and other expenses.
The entire agreement is filed with the county recorder. You're free of
all expenses connected with the property and essentially in the same
position as if you had sold it. In fact, you're better off in one way.
You can still take the tax deductions for depreciation because you still
legally own the property.
After Jones'
payments to you reduce the balance on the 17-year loan to zero, the
due-on-sale clause is a moot question. At that point Jones pays you the
$13,500 option price, forfeits his security deposit and takes title.
The
lease-option sale process can be a complicated procedure, filled with
traps for the unwary and inexperienced. Have an experienced real estate
attorney draw up the documents and be ready to give advice if you have
any questions, regardless how trivial. The most seemingly trivial
incongruity can turn into the biggest headache.
Robert Cain is a
nationally-recognized speaker and writer on property management and real
estate issues. For a free sample copy of the Rental Property Reporter
call 800-654-5456 or visit their web site at
www.rentalprop.com.
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