When should I consider a lease-option?

“Why do so many home buyers want to buy with a lease-option, but few home sellers want to sell on a lease-option?” That question was recently asked by a student in my college real estate law class.

“Because home buyers realize the lease-option benefits more than home sellers do,” was my quick reply.

Purchase Bob Bruss reports online.

Having bought and sold houses for more than 25 years with lease-options, I then shared some of the benefits for both buyers and sellers. I hastened to explain lease-options aren’t right for every situation, but they work beautifully for both buyer and seller in the proper circumstances.

WHAT IS A LEASE-OPTION? A lease with option to purchase is a combination rental, sales and finance technique. Car dealers understand the benefits very well. Reportedly, more than 50 percent of new cars are now leased, with the renter having an option to buy at the end of the lease term.

If lease-options work so well to increase car sales, why don’t they have wider use in house and condominium sales? The answer is most real estate agents have never learned the lease-option benefits for buyers, sellers, and realty agents.

A variation is called a lease-purchase where the tenant is obligated to buy at the end of the lease period, typically one to three years. But a lease-option gives the tenant the “opportunity” to buy during the lease period without the requirement to do so.

EXAMPLE OF A LEASE-OPTION. I bought my current home on a lease-option. Originally, I planned to buy a house. But, like many prospective home buyers, when I found a house I wanted to buy, I discovered I didn’t have enough cash.

So I offered the seller of the vacant house a 12-month lease-option, which would give me time to raise the necessary cash by selling my former residence. To sweeten the offer, I included my check for $10,000 non-refundable option consideration.

My offered option purchase price was nearly the seller’s full asking price. If I didn’t buy, the seller could keep my $10,000, plus the $1,500 per month rent.

After convincing the real estate agents involved that a lease-option was good for them by earning a sales commission on a house which had been unsold almost six months, they enthusiastically explained the lease-option benefits to the sellers. However, the sellers insisted on a six-month term rather than the year’s term I offered. I accepted. Three days later I moved into my new home.

WHEN IS A LEASE-OPTION APPROPRIATE? Although many local home sales markets are “hot” due to the current low mortgage interest rates, other local markets are slow. For example, an investor friend who recently visited Indiana said he had never seen so many homes offered for sale, many on lease-options.

When a home seller wants an immediate cash sale, and there are lots of cash buyers, few lease-options are offered by sellers. That’s when buyers who want to use lease-options need to become creative.

The best place to find lease-options is in the “Homes for Rent” newspaper classified ads. That might sound strange. But smart home buyers know that many house and condo landlords would be thrilled to receive a lease-option offer to get out of the landlording business.

To illustrate, suppose you see a house or condo advertised for $1,500 per month rent with a $1,000 security deposit. You like it, but you don’t yet have enough down payment cash to buy. Or maybe it is a “fixer upper,” which needs some work. So you offer the landlord $2,000 per month rent plus $5,000 non-refundable option money. You can be sure that landlord will give serious consideration to your lease-option offer.

Another way to find lease-option sellers is to run a newspaper classified ad under “Homes Wanted” and “Homes Wanted to Rent” for a week. Your ad might read “Executive needs 3 BR, 2 BA home on a five-year lease with option to buy. Excellent references. Call Jim 555-5555.”

PROS AND CONS OF LEASE-OPTIONS FOR HOME SELLERS. As the typical example above shows, a lease-option offers financial benefits for home sellers. Other advantages include (1) an over-supply of lease-option home buyers in most communities, (2) lease-option tenants usually treat the house or condo very well because someday they will own it, (3) lease-option tenants will pay higher than market rent (in return for a partial rent credit toward their down payment; it’s like a forced savings account for the buyer), (4) if the tenant doesn’t buy, the landlord gets to keep the forfeited option money and rent credit, (5) lease-option home buyers will pay top dollar option purchase prices, (6) during the lease term, the seller retains the income tax benefits, and (7) until the option either is exercised by the buyer or it expires unexercised, the seller gets full use of the option money without owing tax on it.

A possible disadvantage for the home seller is not receiving an immediate cash sale. If a real estate agent is involved in the lease-option, it is customary for the agent to receive part of the option money as a leasing commission, with the balance of the sales commission received when the tenant exercises the purchase option.

PROS AND CONS OF LEASE-OPTIONS FOR HOME BUYERS. Just like leasing a car, most lease-option buyers don’t need to be convinced of the benefits. Advantages include (1) smaller up-front cash requirement than for purchasing a comparable home (usually 1 to 5 percent of the option price), (2) locking in the option purchase price at today’s market value for the home, (3) the lack of home owner mortgage interest and property tax itemized income tax deductions is outweighed by the rent credit for part of the rent paid (typical rent credits are 10 to 100 percent of the rent paid), (4) the buyer can try out the home before buying it, and (5) the buyer can move in within a few days after signing the lease-option with the home seller.

Although lease-option disadvantages for buyers might seem to be the higher than market rent and the lack of immediate income tax deductions, the “forced savings account” rent credit benefit outweighs these perceived drawbacks.

That reminds me of a couple who bought one of my rental houses on a lease-option a few years ago. At the closing table, the wife told me how she viewed the situation. She said the $1,500 per month rent seemed high, but she and her husband considered it as $1,000 monthly rent plus a $500 forced savings account for their rent credit toward their down payment.

HOW TO SELL YOUR HOME ON A LEASE-OPTION. Even in today’s robust home sales market, every city has “pockets” of houses and condos which aren’t selling well. When a house or condo is unsold after 90 days, if the owner is motivated to sell, a lease-option could be ideal.

From the realty agent’s viewpoint, a lease-option delayed sale is better than no sale or losing the listing. Lease-options work especially well for luxury houses and condos, which have a limited number of prospective buyers who can afford to buy them.

One or two weeks of effective lease-option marketing is usually all it takes to sell a home that hasn’t sold “the regular way.”

My most effective newspaper classified ad to market a lease-option home is headlined “$10,000 MOVES YOU IN.” Of course, change the amount up or down depending on the home’s market value. Then briefly describe the home’s features and benefits, the monthly rent, and the key words “Rent to Own” or “Lease-Option.”

Lease-options can be effectively marketed by advertising a weekend open house on Saturday and Sunday. Be sure to have at least 100 information sheets describing the home, with an attached rental application form. I find it best to insist on at least a $500 or $1,000 deposit check with the completed application from a serious prospect.

Using this method, if you don’t get at least two or three applications during the weekend, you did something wrong. Then on Monday morning, check the credit reports and references of the prospects and quickly accept the best qualified.

CONCLUSION. Lease-options offer significant benefits for house and condo buyers, sellers, and their realty agents. More details are in my special report, “How to Profitably Use a Lease-Option to Buy or Sell Your Home or Investment Property,” available for $4 from Robert Bruss, 251 Park Road, Burlingame, CA 94010 or by credit card at 1-800-736-1736 or instant Internet download at www.bobbruss.com.