Original Source: Struggling Home Sellers Should Consider Lease Options
Before I get into why you might want to consider a lease option, let me give you a little background on market statistics.
The other day, the National Association of Realtors (NAR) released a troubling statistic. In July, home sales across the nation dipped 27% year over year from July 2009. This was due to many buyers purchasing before the home buyer tax credit expired, but it's still an ugly statistic for home sellers.
Obviously, the tax credit had a major impact on home sales. Everyone who would have bought a home in July or August this year, that qualified for the credit, moved up their purchasing dates to get the credit.
The credit didn't increase sales, rather it made buyers move up their purchase to qualify for it. Waste of tax payers money? Most likely, but that's a story for another day. Back to my post:
What Is A Lease Option?
As home sales slow moving into the fall selling season, a lease option might be something that could work for you, especially if your home is vacant. What is a lease option you say?
A lease option allows someone to lease your home with the option to purchase it. It's like a glorified rental, in that the renter of your home has the option to purchase the home at the end of their lease agreement; usually 12 months. Here are some basic principles to a lease option:
The lease option binds the seller to sell and not the buyer to buy. The option gives the buyer discretion to buy or not. This is why lease options usually come with a larger deposit than a months rent. This deposit usually ranges from 2-5% of the home price. Of course this is negotiable between buyer and seller.
How do you determine price? Price can be dealt with in two ways. The buyer and seller can agree to a price when the contract is signed, or they can agree to price by when the date the option is exercised. Either way, it's usually still based on an appraisal. The monthly payment is determined by buyer and seller, and it can be applied to the cost of the home or not.
It all depends on the terms of the agreement. If the payments are applied to the purchase price of the home, if the buyer decides not to purchase the home, the seller will not have to pay that back. Basically, a lease option is the same as a lease, with the option at a determined time period for the buyer to purchase the property.
Advantages Of A Lease Option For Home Sellers
A lease option opens you up to more buyers. A lease option allows you to sell your home where you otherwise wouldn't have been able to sell it.
For example, there are many people right now that don't qualify for financing with the increased regulations in the lending industry.
Many of these potential buyers have been taken out of the market, and a lot of times all they need is more time to qualify. They may need to pay off some debt, raise their credit scores, or save up a larger down payment. Many of these buyers are very close to purchasing, but can't quite get over the hump.
For you the seller, this gives you an advantage in an otherwise strong buyers market. When I deal with sellers looking for lease options, I like to tell the buyers they get price or terms, pick one. Meaning, they can either get a better price with terms that are more strict, or they can pay more and get more lenient terms. As a seller, both will work in your favor. You either get a better price on your home, or you will get some great terms with a nice non-refundable down payment.
If the buyer doesn't exercise the option to buy your home at the end of the agreement, they forfeit all rent paid, and usually forfeit their down payment. And once this happens, you go into landlord-tenant relations, giving you the right to evict and retain your home. You may also work out another agreement, either way the ball is in your court.
Another advantage is; if you have to move fast or your home is sitting vacant, you get someone to pay your mortgage payment for you. They may also do some upgrades that could add value to the home, and you get people living in your home to maintain it.
Disadvantages Of Lease Options For Home Sellers
A lease option has it's disadvantages. One of them being having someone in your home that may not take care of it. They may trash it and leave you holding the bill, just like any renter.
Also, the buyer may not exercise the option to purchase your home and you're left with another mortgage payment when the lease runs out.
If you are unable to make payments on two homes, if that is your situation, you might not be able to find another renter. And if you try to sell the home again, you may not be able to sell it either.
The real estate market is still declining here in Logan. If you sign a lease option today, in 12 months from now when it's time for the buyer to purchase, your home may be worth less. If you take if off the market today, you won't have the chance to sell it for today's prices. You're locked into the agreement unless the buyer defaults.
Interest rates may go up. If interest rates go up, the buyer who could afford your home today may not be able to afford it tomorrow. Even if interest rates go up only a point, it could disqualify many buyers from purchasing your home.
Why Should Struggling Home Sellers Do A Lease Option?
If you're home is sitting vacant, there are many renters right now in the Logan UT real estate market. These people are calling my brokerage everyday asking for lease options or rentals. I can't speak for other markets around the country, so I would talk to a local Realtor about markets where you live.
If you're tired of showing your home, a lease option could help you get out of the market, out of your home, and get someone who will pay part of your mortgage for you.
If your not getting any showings and you can't reduce your price, a lease option is a great way to wait out the market. Even if the buyer doesn't buy your home at the end of the option period, you still have someone paying you rent, and you can negotiate keeping a nice down payment. Plus, you could always try to sell when there is less inventory and get a better price.
All in all, if your a home seller, I truly understand how difficult it is right now. A lease option may be something you could try if your home isn't selling and you're struggling to make ends meet. If you do a lease option, be sure to consult with an attorney about terms of a contract, or talk to a Realtor about the options we can provide.
Lisa Udy
Platinum Real Estate Group
View My Other Blog @ Homes For Sale Logan UT
Search --> Logan Homes And Logan Real Estate
Lisa - This is one of the best summaries I've seen regarding this option - Thanks for sharing it!
You are on a roll this summer! I love how you spelled out the option advantages and disadvantages! More useful material for your Logan UT buyers and sellers!
Lisa,
Yes it is an option for the seller in the cases of buyers just beware. Alot of fraud going on where they get in the home only to find out 6 months later that the home is being foreclosed on because the seller stopped making payments.
Great advice Lisa! I see no upside to a vacant home!
I like lease purchase rather than lease with option. Under current market, I wanted to do a land/sales contract where payments are made with a balloon 5/10/15 years down the road and ownership doesn't transfer until house is paid for but my attorney says in our area judges look at those contracts as owner financing and you still have to go through foreclosure. What worked in the past just doesn't seem to work today!
Lisa: For the states that still legally allow them, lease options are a wonderful way to handle an unsold home. They are illegal in Texas (and I think in Oklahoma, too). Here we have "owner financed" properties to fill the void.
Hi Lisa -- Great framework to help put things into context. Understanding a local market intimately is key to helping a seller truly evaluate their options, etc.
Lisa- Here most of our sellers who have tried this option got the " trashed your home and did not make a payment" ones. We just don't even feel comfortable doing this option . In fact- we just got an offer on a short sale listing we have where the tenants just filed bankruptcy and now sellers can not give clear title without paying an attorney an arm and a leg... they have not paid their rental payments in over 6 months. Katerina
Hi, Lisa.
Lease Options / Lease Purchase (in states where legal) can be good for both parties, if due diligence is performed.
First, a Real Estate Attorney should be involved. The Lawyer should draft two (2) separate agreements: A Contract to Purchase, Contingent, and a Lease/Rental Agreement.
Second, Deposits and any Monies that may be applied toward an Ultimate Purchase should be held in 3rd party Escrow. Rent/Lease Payments should go through 3rd party to the Lender.
Third and Finally, the scenario suggested by Larry in #3: Is the Owner current on the mortgage(s), and will they make the payments?
*** I recently encountered a friend in (April 2010) who was paying $2600/month on a "$500,000" house. Something did not seem right. His lawyer found that the Owner was in default, lis pendens had been filed, foreclosure was eminent. Owner was pocketing the $2600. When confronted, the owner disappeared. After a month or so of "free rent", my friend had to move out. So much for the "Lease Option or Lease Purchase".
Proceed with caution!
Kudos for suggesting this alternative. It can, indeed, be a solution for some. I would disagree with Fred Griffin Real Estate about the need for an attorney being involved in every transaction IF the agents are members of a REALTOR Association with good standard forms that have been vetted by the Association attorney - although it's always a good idea to advise clients of their right to take that form to an attorney for legal advice.
Lisa:
This is most definitely a sign of the times - sellers becoming so desperate that they decide to do a lease option. I know that it may seem better than letting the property be vacant but Katerina's horror stories are a bit scary. Tenants are not known for taking care of a home. This could be a difficult choice to have to make.
Lisa the biggest hurdle to the lease with option to purchase is on the part of the lease option buyer. Many view it as if they are giving up far more than the seller they don't exercise the option. They view that their down payment is worth more than the value of delaying the sale for the seller.
Lease option buyers also only look at one side of the coin and this is what if we can't close? They completely forget to consider: what if we can?
To the buyer and the seller if the buyer does not exercise the option, each party feels as if they are the only one who has lost.
Yes it's a viable option, but people parties must realize that in order for it to be work from the beginning, they both have to sacrifice something of value and as you pointed out, the value lies in either the price or terms.
Great post about both the positives and negatives of lease options. This allows your consumers to make informed decisions.
Lisa, Lease Options are used in commercial real estate deals all the time. A good alternative for sellers and buyers who know the advantages and disadvantages, as you pointed out. Good Post!
We don't participate in lease options in our market but have noticed that leases are moving very quickly. We have recommended leasing their home to several sellers having trouble moving their house.
Lisa,
When my husband and I were Realtors in Las Vegas, we specialized in seller financing. We used the land contract/contract for sale/contract for deed more than the lease option. We also bought and sold investment properties using the same vehicles and it worked out very well.
As far as getting trashed properties back ... this never happened to us. If the buyers could no longer make the payments, they would call us and send us the keys. In 10 years we never received a trashed property. And if we did this seller financing for our seller clients, they all had positive outcomes as well - never had a problem.
There is a KEY to seller financing ... although there may be no BANK qualifying, it is up to you (the Realtor or seller or investor) to "qualify" the buyer. We always got full information from them - including their employment, why they couldn't qualify with a bank, etc. Based on that information (and doing some of our own checking) we would decide whether or not they met our standards for buying the home.
Another reason we didn't get trashed properties is because under the contract the buyer gets equitable (not fee) title and that makes them feel as though they really own the home. They didn't look at themselves as "tenants."
In this current market I believe agents have to explore ALL possibilities to help their seller and buyers. If buyers can't qualify, the banks won't give loans. If banks don't give loans, houses aren't sold. This is where OWC (owner will carry) financing comes in. Real estate is cyclical - owner financing is making a come back.
Hi Everyone! Thank you for all the detailed comments, I will be responding to them later today. Excellent input!
Overall, good post. A few comments on the post and on some of the other comments:
POSTING: "The option gives the buyer discretion to buy or not. This is why lease options usually come with a larger deposit than a months rent. This deposit usually ranges from 2-5% of the home price. Of course this is negotiable between buyer and seller."
COMMENT: Generally correct, except . . . the deposit itself should be as small as possible. Deposits are refundable. From the seller's standpoint, take as much of the money as possible and have it go toward the option fee--it's NOT a deposit or down payment. The option fee generally is not refundable under any conditions. As for the 2%-5%--yes, that's probably the range. Still, I've optioned properties with no option fee whatsoever. It's all negotiable.
POSTING: "Price can be dealt with in two ways. The buyer and seller can agree to a price when the contract is signed, or they can agree to price by when the date the option is exercised. Either way, it's usually still based on an appraisal. The monthly payment is determined by buyer and seller, and it can be applied to the cost of the home or not."
COMMENT: True, except that when it's determined when the contract is signed, an appraisal often isn't done. However, the price is usually determined up front. Both buyer and seller tend to want to lock in a price. As for applying the payment to the cost of the home--it's not usually an "either/or" situation. Generally, a portion of the rent--frequently in the range of 20%-30%--is credited toward the purchase price if the tenant-buyer purchases.
POSTING: "If the buyer doesn't exercise the option to buy your home at the end of the agreement, they forfeit all rent paid, and usually forfeit their down payment."
COMMENT: Wrong. They forfeit all rent paid. They usually forfeit their up-front option fee and any rent credits. At no point have they made a down payment.
POSTING: "A lease option has it's disadvantages. One of them being having someone in your home that may not take care of it. They may trash it and leave you holding the bill, just like any renter."
COMMENT: Far less likely than "any renter" because you're not looking for a tenant. You're looking for a tenant-buyer. Screen them on that basis. Look for someone who wants to buy, who'll treat the home as their future home. If you take any warm body--whether in a straight rental or in a lease-option--you're asking for trouble.
POSTING: "the buyer may not exercise the option to purchase your home and you're left with another mortgage payment when the lease runs out."
COMMENT: True. So why is this a problem? You've collected an up-front option fee. You've probably collected above-market rent. And now you can collect another up-front option fee (another 2%-5%, perhaps), and more above-market rent. Some investors see this as an advantage, not a disadvantage.
LARRY: "Alot of fraud going on where they get in the home only to find out 6 months later that the home is being foreclosed on because the seller stopped making payments."
COMMENT: True. But there are plenty of ways for a tenant-buyer to protect him/herself. Have the owner sign an "Authorization to Release" information so the tenant-buyer can determine whether payments are being made and are current. Or make rent payments to a third party which will, in turn, forward the appropriate sum to the lender. Or put the property into a land trust, and have the trustee make the payments (from the money paid by the tenant-buyer). Or have the tenant-buyer make payments directly to the lender. There are advantages and disadvantages to each, but there's no reason for a tenant-buyer to be caught in that situation.
LINDA: "Under current market, I wanted to do a land/sales contract where payments are made with a balloon 5/10/15 years down the road and ownership doesn't transfer until house is paid for but my attorney says in our area judges look at those contracts as owner financing and you still have to go through foreclosure."
COMMENT: That can be a problem. Has to do with equitable interest--and, really, even lease-options represent a transfer of equitable interest. One way around that--legally and ethically--is to have the owner put the property into a land trust. The tenant-buyer is a beneficiary of the land trust, but is also renting the property from the trust. It's a dual role. It's not owner financing; no purchase is made until the property is brought out of the trust and the tenant-buyer (in this case called a resident beneficiary) purchases. See http://www.landtrust.net for more information.
FRED: "First, a Real Estate Attorney should be involved." MARGARET: "I would disagree with Fred Griffin Real Estate about the need for an attorney being involved in every transaction IF the agents are members of a REALTOR Association with good standard forms that have been vetted by the Association attorney - although it's always a good idea to advise clients of their right to take that form to an attorney for legal advice."
COMMENT: I come down somewhere in the middle. An attorney should review all the documents. However, because each lease-option is different I'm not sure that "good standard forms" can be used without--in some cases--substantial modification. And, as we've had pounded into our heads, "We're not lawyers!" And there are plenty of modifications that an owner or a tenant-buyer might want that could affect other parts of the agreement. Just the references we've seen here to "down payments" raises red flags . . . among investors and certainly if a dispute ever made it to court. Also not discussed here is: What happens if the property doesn't appraise for the agreed-upon purchase price? There are plenty of ways to deal with this that are fair to both seller and tenant-buyer, but they should be incorporated into the original option.
Donald - I appreciate your comments, but you obviously put to much into this. This is an educational post based on my own experience, and I am not the be all end all to lease options. You clearly took this post way to seriously. If a home seller and buyer decide to do a lease option, they should consult with an attorney if they feel necessary. Realtors do have forms approved by our state association attorneys, and they seem to work just fine.
You stating that I am wrong about a down payment is correct to a point. In our market the upfront option-fee is credited to the buyer when they close, which applies to their down payment. So, I could have explained it better, but come on. This is a general post for people to think about lease options. If they want all the legal language they should talk to a lawyer, which I clearly state in my post.
I also don't agree with you calling out people in my comments. Your contracts, your market, and your state laws may not coincide with others.
Your comment about the disadvantage of a home buyer not exercising the option is not what I was getting at. For a normal home seller, who is not an investor, they may not want to deal with the property. If the option isn't exercised, they will have to deal with the house again. This could be a disadvantage to a home seller who just wants to be done with the property.
You clearly have a different point of view as an investor than many home sellers. This post is guided towards basic information. If they want more detailed information, it would be in their best interests to contact a local Realtor and/or a lawyer.
Lisal
I have recommended to my clients that they should do a lease especially when their
home has been sitting on the market for several months and we are not getting any activity.
I really enjoy reading your posts and the way you present your point of view.
Great Post!!
Thanks
Bill