By Robert Irwin
As inventories rise in many parts of the country and the torrid housing market gradually slows, some sellers are reporting difficulty in getting their high prices. While this may--or may not--herald a "bursting of the bubble" in real estate, it poses a problem for sellers - how to get a quick sale, today?
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.
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.
Robert Irwin is the most prolific real estate writer in America having produced over 100 published books in the field. His TIPS & TRAPS McGraw-Hill series has sold well over a million copies and his FOR SALE BY OWNER KIT and FIND IT, BUY IT, FIX IT and other books have been strong sellers for Dearborn. In addition Irwin writes a regular real estate column for The Wall Street Journal online and is introducing a new weekly column forOwners.com.
Irwin has sold his own property "by owner" and during over 30 years in the business has been a broker and consultant to lenders, agents, buyers and sellers.