If you find yourself sitting on an unsold property and weeks, even months go by, one alternative may be the lease-option. This technique is as old as the real estate business in this country and for many, can get you out of your old house and into a new one. (Alternatively, it can get rid of a rental problem, if you’re an investor.)

What Is The Lease-Option?

Here a seller essentially converts a tenant to a buyer, although that tenant usually has aspirations of purchasing all along. The would-be tenant/buyer (lessee/optionee) is given an option to purchase. This is the right to buy, usually for a fixed price, up to some point in the future. For example, the option might be for $400,000 to be exercised up to 3 years from now. At any point before that time the lessee/optionee can come up with down payment and financing and make the purchase. For the option, a lessee/optionee can give some money to the seller, but it’s not necessary.

The seller also rents the property to the lessee/optionee under a lease, which in our example would presumably also run for 3 years.

As an inducement to the lessee/optionee, the seller typically applies a portion of each month’s rent as a future purchase credit. For example, if the rent is $2,000 a month, $1,000 each month ($36,000 over three years) might go toward the purchase price, IF the lessee/optionee does eventually exercise the option and make the purchase. As an inducement to the seller, the rent might be higher than market, for example, instead of $2,000 a month, it might be $2,500 a month.

Thus, as a seller you (hopefully) get a solid tenant paying above market rent and (hopefully) a sale three years down the road. In the meantime, you’re out from under the property.

Possible Problems

But, what if you need cash from the property in order to buy a new home? Easy, you refinance before you give the lease-option. Today owner-occupant refis for up to 90% of LTV (loan-to-value) and even higher with cash out are often arranged through a good mortgage broker. That way you’ve got your cash from the property, yet still own it.

What if the lessee/optionee finds that he or she can’t afford to make the purchase a couple of years into the lease-option? A bigger problem. However, you can mitigate it by requiring a credit report and credit score high enough to indicate the lessee/optionee should qualify for needed purchase financing.

What if prices go much higher after three years - won’t you be losing money by fixing a price today? Of course, but savvy sellers can tie the ultimate selling price to an index, just the way ARMs (adjustable mortgages) are tied.

What if the lessee/optionee bails out of the property? The lessee/optionee could decide not to keep making those above market payments and simply leave. That’s always a risk with any tenancy. But, then you get to keep the money already paid... and you can either sell, or lease-option the property again!

How Do I Do A Lease-Option?

Make sense? Any good real estate attorney can fill in the details and draw up the paperwork for you.