An Option You Shouldn’t Pass Up

by Cari Silverman September 20 2009, 15:22

          The nationwide credit crisis has made the “American Dream” unattainable to most citizens. As lenders instituting rigorous requirements making qualifying for mortgages nearly impossible. The record breaking foreclosures and unemployment have added fuel to the fire, putting pressure on homeowners to reduce their asking prices. Many owners have been forced to sell at far below market value, accepting a large loss on properties that when purchased had high potential for profitability. However, the resurgence of lease-option agreements, especially in areas where foreclosure rates are high, has sparked hope for many sellers and buyers. [1]

          A lease-option agreement, also called a rent-to-buy option, combines a traditional lease between a landlord and tenant with the option or right to purchase the leased home. [2] The agreement stipulates that “the buyer take possession of the goods with the first payment and takes ownership with the final payment.”[3] With a lease-option, the prospective buyer is afforded an exclusive option, but not obligation, to procure the home after a specified period of time. [4]

          Lease-option agreements are an effective tool designed to assist buyers who are struggling with obtaining financing due to credit issues or financial circumstances. [5] The lease-option provides ample time for the buyer’s down payments to aggregate, improving or repairing their credit profiles which in turn make securing a mortgage more probable. [6] Rent is typically set above competitive market value, with the excess rent being credited towards the purchase price, therby creating a forced savings plan that is beneficial to the buyer. [7]

            Furthermore, the option has been used as a means of establishing a credit history in this country for immigrants who are unable to obtain money from lenders since a positive credit history in a foreign country has no bearing in the United States. [8] The lease-option is not only limited to providing financial benefits. Buyers are given the chance to test out a neighborhood or home, before being saddled with a long term responsibility. [9][10] Moreover, lease-option tenants are afforded more flexibility and discretion in fixing up the property and changing it to please them aesthetically. [11]

          In addition, a lease-option offers a very viable option for both residential and commercial sellers. This option opens the door to a new market of potential buyers and offers an opportunity for sellers to obtain higher rental income with the possibility of a future sale. Owners are able to collect higher-than-market-rate rent, since renters are willing to pay the extra amount in return for the chance to buy when financing becomes available. For commercial sellers, a lease-option has proven to be an attractive alternative since it brings in cash flow to properties that would otherwise be stagnant.  [12] Both residential and commercial sellers can avoid sales commissions since there is no need for a real-estate agent to conduct the sale in a lease-option agreement. [13]

          The rent-to-buy option is most utilized by sellers, who have purchased new homes and have had difficulty unloading their previous home. [14] This method presents a chance for sellers to decrease the financial burden of two mortgages by offsetting some of the costs. [15] The lease-option, unlike a traditional rental lease, shifts the responsibility of minor property upkeep, such as lawn care and snow removal, to the tenant alleviating both time and monetary burdens. [16] Moreover, the option fee is tax free money that the seller can use. [17]

          The lease-option has also found recent success with a new area of buyers, at the high end of the market, who in the past have barely utilized the myriad benefits of the lease-option agreement. [18] Affluent buyers are utilizing this option to stake “their claim on recently foreclosed-on luxury homes at a time when jumbo mortgage loans are expensive and nearly impossible to get.” [19] Additionally, this option has proven attractive to buyers that are able to pay cash for affordable housing. These buyers have chosen to utilize the lease-option, since luxury home owners are willing to negotiate very attractive terms to prevent the affects of the harsh decline in pricing of luxury homes.[20] Supporters believe that that the “lease-option could help ease the looming problem of investment homes flooding the market when today’s investors decide to sell.” [21] The lease-option has already begun to help absorb the 7.9 months of surplus real estate inventory wreaking havoc on New York City’s market prices. [22]

            Critics of the lease-option agreement argue that the option affords little protection for buyers who fall behind in payments. [23] Buyers who cannot satisfy the payment schedule are evicted from the property and lose any up-front fees and rent premiums that served as down payments towards the purchase price. [24] Additionally, there is no guarantee that the extra time given by the lease-option will be enough for the buyer to secure financing. [25] Furthermore, since the purchase price is agreed upon at the drafting of the lease-option the purchase price at the time the option is called could not reflect current market values. However, with proper due diligence and a well-drafted agreement all of these concerns are nullified leaving little credence to opponents’ arguments.

          The current market is optimal for buyers, which affords the opportunity for lease-option tenants to draft beneficial contingency clauses in their contracts. [26] Buyers are able to specify that any rent premiums and up-front fees be returned if they do not qualify for a loan or default on the rent. [27] The optionee should also protect their investment by recording the option, putting the public on notice of their interest in the property. This will ensure the optionee’s interest in the property and provide protection from the seller reneging when market prices recover.  Furthermore, buyers can protect themselves by speaking with a loan officer or credit counselor to determine whether they will qualify for financing by the time the option expires. [28]

            Despite the risks associated with the lease-option agreement, this alternative to standard purchasing methods has proven to be very practicable for both sellers and buyers during these harsh economic times. It has afforded sellers current income, potential for future sales and the opportunity to avoid sales commissions. Buyers are able to aggregate their payments, while repairing their credit portfolios making it easier to obtain financing in the future. With lenders implementing and enforcing vigorous lending requirements, both sellers and buyers need relief and it appears to be coming in the form of a lease-option agreement.

 

End Notes

 

1.    Vivian Marino, Rent Now, Buy Later, N.Y. TIMES, Dec. 7, 2008, *at 1.

2.      J. Craig Anderson, Rent-to-own home deals gaining in popularity, ARIZ. REP., July 29, 2009. 

3.      Black’s Law Dictionary (8th ed. 2004).

4.      ASK A LAWYER: Lease-option has benefits and drawbacks, ATL. J. CONST., Jan. 27, 2008 .

5.      Les Christie, Rent-to-own your home: Pro and con, CNN, June 4, 2009,

http://money.cnn.com/2009/06/02/real_estate/rent_to_own/index.htm?postversion=2009060416 .

6.      Id.

7.      Vivian Marino, The Maybe Option, N.Y TIMES, Dec. 7, 2008, *at 8.

8.      Marino, supra note 1.

9.      Don Levy, You Can Buy a Home Now-use a Lease Option, ARTICLEBASE, Oct. 7, 2008,

http://www.articlesbase.com/real-estate-articles/you-can-buy-a-home-nowuse-a-lease-option-593739.html .

10.  Tom Kelly, SECOND HOMES; Consider 'tryout' option,  L.A. TIMES, Oct. 14, 2007.

11.  Levy, supra note 9.

12.  Marino, supra note 1.

13.  Ray A. Smith, Building Value: Rent Now, With the Option to Buy Years Later, WALL ST. J., Nov. 17, 2004.

14.  Christie, supra note 5.

15.  Id.

16.  Smith, supra note 13.

17.  Levy, supra note 9.

18.  Anderson, supra note 2.

19.  Id.

20.  Id.

21.  Id.

22.  Marino, supra note 1.

23.  Christie, supra note 5.

24.  Id.

25.  Id.  

26.  Id.

27. Id.

28. Anderson, supra note 2.

 

 

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