Leasing options can be dangerous for a number of reasons, all of which are remedied with properly executed contracts or agreements. By definition, a lease option is a two-part agreement (contract) that provides the landlord with a lease agreement with a tenant. Additionally, an option contract may be an integral part of the lease or it may be a separate agreement.
The option agreement is a contractual agreement between two parties that allows the option holder the right to exercise the option to purchase the property at some point in the future. If the option holder is a lessee of the property, his lease will be part of the contract or a separate contract. Most importantly, if the terms of the lease are not met, the option agreement will be null and void.
Therefore, the usual case would be that an investor (optor) would lease a property that he owns to a lessee and give the lessee an option agreement at the same time. The lessee would then reside in the property until he was ready to exercise his option at the predetermined price (exercise price) within the predetermined time period (one year) and purchase the property from the investor.
A more creative strategy is for an investor to enter into a lease option agreement with the seller of the property and re-lease it to a potential buyer at higher terms than what they are paying. This is known as a “butterfly lease option” and can be very profitable if all goes to plan, as the investor will have little to no money or risk in the deal.
With all that said, what’s so dangerous about leasing options?
1. If you are giving a tenant a lease option, it is critical that they sign two separate documents: a lease and an option agreement. The reason is that if you have to evict the tenant, the eviction process is based on the tenant’s own lease and is not clouded by the option part of the lease.
2. Option consideration (NOT deposit) is non-refundable and should not be construed as a refundable lease deposit. Unfortunately, the courts have had this problem of “confusion” when there is one document (lease option) versus two documents (lease plus separate contract option).
3. If you are considering a butterfly lease option, make sure the seller uses a single agreement lease, while giving your tenant two separate leases. This protects you on both sides of the transaction if something goes wrong.
4. Make sure the tenant understands and signs that all repairs under a certain amount ($3,000) are theirs, since they will become the owner and cease to be the tenant. If you don’t make this ‘threshold’ high enough, you’ll be a typical tenant calling you in the middle of the night with their latest plumbing problem.
5. Do not make the terms of the “cure period” unreasonable to the tenant. For example, if the lessee is one day late, his option contract is null and void and his option consideration is forfeited. States have passed laws just to control this type of malicious behavior by the owner (opter).
6. A common problem is that investors charge too low a rent and when a tenant is ready to finance their purchase they realize that their “new rent” will be double what they are paying. His pride of ownership turns to lack of interest and he does not buy the property. Some investors like this because they can re-lease the property over and over again, constantly raising nonrefundable option considerations. The renter’s rent must be equal to what his mortgage payment including principal, interest, taxes and insurance (“PITI”) will be when he purchases the property.
7. To support a higher lease payment to get the tenant ready to move in, give the tenant a monthly credit to be deducted from the principal purchase price or as a seller’s credit at closing. If you are evicted or do not exercise your option, you lose your “credit.”
8. The renewal terms of the option agreement may not be the same as the lessee’s lease agreement. Renewing a lease does not cost the lessee another lease deposit, while the option holder (tenant) must pay a non-refundable renewal fee of $1,000 to $2,000 which will be a credit at closing, if any. a closure. The other possibility is that the exercise price of the option increases each year. Investors must give their option holder a maximum of two years and 3 months to exercise, while they must ask the seller for a minimum of five years and 6 months.
A lease option is a very powerful method of renting out properties, making deals with little or no money in them, contractually controlling the properties with no down payments other than what the ultimate buying tenant pays, and generally offers the owner the ability to find tenants who will take better care of your property because you intend to buy it in a year. As always, do your planning ahead of time before both parties sign anything, and verify that your documents will pass the scrutiny of a real estate attorney.
