As I deal with a lot of investors, I often run into deals with Options, Lease Options, and Lease Purchase agreements. The problem is that these terms are often used interchangeably because many investors have received bad information on what they actually are. “Lease Options” are often pitched to investors in a “sexy” manner but nine times out of ten, they person pitching them is using the terms incorrectly. This brings us to a question that was recently asked (and recently misunderstood by another):
What is the difference between an Option, Lease Option, and Lease Purchase?
An Option is easiest defined in the manner in which it is stated. The buyer has the “option” to buy it. He also has the option not to. An option by itself has no lease attached and typically no other tie-in agreements. There may be an option fee associated with purchasing an option (or there may not be). Options are used primarily by investors, but also may be used by buyers who are nervous about certain external aspects of a property. For example, an option may be used to give a buyer the ability to buy a property at a pre-negotiated contract value/terms at some point in the future. A personal experience where this was used was when one of my buyers put an option on a piece of land where he wanted to build a gas station. There was a new road getting ready to come through and he did not want to buy the property if the road was going to dissect the property. He put the option on the property until the department of transportation finalized the plans for the road. Options typically:
- Have a predetermined/pre-negotiated contract in place and the buyer has the “option” to purchase at some point in the future
- Have a fee associated with obtaining the fee. This can range from $1 to several thousand dollars and is usually determined by the motive of the option (someone just wanting an option to pre-negotiate deal while waiting on an external source such as department of transportation is called an “innocent option” and is usually not costly where an investor trying to tie up a property to resell or assign the option may have a higher fee associated with it). Option costs are also determined by the length of the option. An option for a few months may be next to nothing where an option for a few years would be substantially more
- Owner of the property cannot sell to anyone else while the option is in place
- Are typically easily assigned or transferred by buyer without consent by seller unless specifically noted otherwise in option
- Have an expiration. If a buyer does not exercise his option within the time period – it expires and he loses option and typically any fees associated with obtaining the option (the option fee which could have been as little as $1 or quite substantial).
- Come without obligation. The buyer has an “option” to buy property but he is not obligated to.
Now, this brings us to a Lease Option. The only real difference between an Option and a Lease Option is that a Lease Option also has a lease attached. Think of this like renting a place (the lease) and having the ability to buy it at any time during the lease period. In a lease option, the option may be easily assigned but often times, the lease is not. A perfect example of a lease option is the a buyer really likes a home but he has to sell his first before he will qualify for a loan or there may be other issues associated with obtaining financing. He may negotiate the terms of the purchase agreement up front using the option, and then you attach a lease so he can move in now and the seller can cover the note. Lease options are very popular among investors and vacant properties because it gives the seller the ability to have money coming in on the property during the interim while buyer is getting their financing together. A lease option is nothing more than a lease [with an] option to purchase.
Now, this brings us to a Lease Purchase. This is probably the most under-used term for what it is. Often, investors and real estate professionals alike, substitute the term lease option for lease purchase. In fact, there are entire books written by real estate agents who improperly use this – no wonder the investors are confused! A Lease Purchase is pretty easily understood once you have full understanding of options and lease options.
- A Lease Purchase agreement still includes the lease and an option, HOWEVER, the buyer (or tenant) is responsible for things such as insurance, taxes, HOA dues, and other basic maintenance items as well as mechanical issues, and any other expenses
- The “option” in Not Really an option – it is more of a convenience fee
- Buyer is typically obligated to purchase under a lease purchase
- A Lease Purchase is also typically classified as “Rent to Own” and some portion of the money from the lease may (or may not) be applied toward a future downpayment for the purposes of a bank loan
- May be called a “Land Contract”, “Land Trust”, “Deed Contract”, “Contract for Deed” or other terms which are more in the legal realm than the investor/real estate realm.
Options and Lease Options are typically used when a buyer is not 100% sure if they want to buy a property or if they just need a small amount of time to determine their ability. Lease purchase agreements became really popular in the 80’s when bank rates were very high and sellers were willing to finance to buyers under long term loans (seller financing). They have since become an instrument for investors to sell to people who may not otherwise qualify for a loan or need a long-term solution to get prepared. A lease purchase agreement could last from 1 year to 10 years. An average is 3-5 years with the ability to renew if necessary.
If you are considering any of this as a viable solution for your properties or as a buyer, I urge you to contact me, quite frankly because there simply are not that many people in our area that fully understand this and you run the risk of serious issues if you do not know what you are doing – or have someone that does!
