Question on lease-option purchase

[mixxalot]

I know a lady in my church who is a real estate agent and trying to sell her condo. Would there be any benefit for me to do a lease-option purchase agreement on it? If so, how would I best cover my bases to ensure the best deal to avoid risk in current market?

[SD Realtor]

Just be careful mixxalot. Lease options in general are structured to be in favor of the seller. More often then not the tenant ends up not exercising the option, thus the option money ends up going to the landlord. I am not sure I would recommend a lease option in a declining market either. Why? Well think about it. First off you giving someone money that they will earn interest on. Second if there are circumstances that dictate a change in your life and you cannot exercise the option it will be lost money. Third, if the market is declining how will you base the final sales price? Will you price the home at the beginning of the lease term or at the end of it? If the market is really going to decline like we think it is, doesn’t it seem prudent to keep your options open in case something better comes along?

Anyways I am simply trying to give you some helpful words of advice. If you do choose to enter into a lease with an option to buy make sure you are well protected or set it up so you have as little exposure as possible. If this person is novice in real estate you may be able to dictate favorable terms for yourself. As a landlord I have had 2 lease options on properties I have owned. In both cases the tenants didn’t exercise and I did very well.

SD Realtor

[Anonymous]

Hello, SD Realtor, and mixxalot. I’ve just subscribed to this excellent and informative forum and I wanted to post my two-cents’ worth on this very interesting thread. I have always thought that lease-options were more favorable to the buyer, since (in appreciating markets, at least) the buyer is able to lock in a lower purchase price at the beginning of the lease-option period than the higher price at which the property likely would be listed at the end of the lease-option term (assuming that the sale price is agreed to at the beginning of the lease-option). The option price (which should always be subject to negotiation) is the consideration the buyer pays for locking in the sale price at the beginning of the lease-option period.

In a declining market, however, the above rationale is obviously lacking. Still, a lease-option could make sense in a declining market, I think, if the seller is truly “motivated” and wants to move the property, and if, as SD Realtor aptly notes, the buyer is able to dictate favorable terms. Such terms could include a provision that the purchase price will be determined at the end of the lease-option term, as mentioned by SD Realtor. However, the problem I see with this approach is that the declining market might have reversed by the end of the lease-option period, in which case the buyer could end up paying a higher price.

Alternatively, the purchase price could be tentatively set at the beginning of the lease-option term, with a provision that the final purchase price would be adjusted downward, based upon the Fair Market Value as determined by an independent appraisal at the end of the lease-option period. I think the buyer’s interests would be best protected with such a provision, since this will ensure that the buyer pays the lesser of the tentative purchase price and the FMV.

Sellers may be reluctant to such an arrangement for obvious reasons. But sellers need to understand that funding sources will require the appraisal to reflect FMV and to be in line with the purchase price. According to this rationale, it only makes sense to include a contractual provision that any reduction in FMV be reflected in the final purchase price. Of course, in all-cash transactions, this line of reasoning would not apply; but even in those situations, buyers should be protected from paying more than the FMV, as determined at the end of the lease-option period.

Lease-options, in my humble opinion, allow for much flexibility and creativity in structuring real estate deals. However, as SD Realtor also points out, if the buyer is unable or unwilling to go forward with the sale for whatever reasons, he or she could end up losing a substantial amount of money. Careful negotiation and clear contractual terms are therefore critical for a successful lease-option arrangement.

[Author]

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