Is a lease option really worth it for buyer or seller?
Basically, a lease option works like this: The buyer and seller agree on a price for the property a year or two years out (along with the terms, inspections, who will pay for repairs and yard work during the lease term, etc). They then agree on a rent, of which a portion goes towards down payment on the sale. The rent is usually high for the property because it also includes the down.
For example: The buyer and seller agree on purchase price for a home of $160,000 two years out. The buyer agrees to pay rent on the property of $1500 a month for two years (normally this house would rent for $1000 a month). $500 of the rent will go towards the down payment if the renter decides to buy, so at the end of two years there will already $12,000 down towards the $160,000 purchase price.
There may also be an upfront, non-refundable deposit/down payment of several thousand dollars in addition to rent.
So if the buyer decides to exercise his option and buy the home in two years, great. If the buyer decides not to buy he loses his $12,000 to the seller, plus any additional upfront down payment, and any money he spent on repairs and maintenance.
The seller does not typically have the right to walk away from the deal except in the case of eviction/foreclosure. You’ll need to have an attorney to draw up the paperwork on this one to cover all the variables.
Pros and cons to a lease option?
In our current market single family home prices are appreciating, but modestly. If a seller agrees to a lease option at today’s prices, he might lose 6% in appreciation over two years, but he’ll have cash flow. For the buyer they lock in today’s price and will get equity when they purchase, but will pay an over-market rent for the right to do it.
A lease option may be a great solution for so many of our beach condos (above $250,000) that are still stuck in a buyers market, with buyers scarce. In this case the seller can lock in a buyer at a favorable price, as this type of property is still expected to experience some declines in value. The benefit to the buyer is that they can cherry pick which unit they want, and if the price they agree on is unfavorable at the end of the lease, they can walk away. And at least for the seller an otherwise empty unit has cash flow.
The cons are typically on the seller side of a lease option.
“If the seller can only get a future contract price based on a current appraisal value,” asked Realtor John Walin in a recent online post, “why not just price the house at a fee for appraisal value now and not deal with [the buyer as] a tenant and sell it straight up as a traditional sale?”
Another con for the seller is that if he wants the whole chunk of money to invest now in another, more profitable investment, he won’t be able to while the equity in the property is sidelined. And if the buyer does walk away from the option, the seller has to go through the process of selling it all over again.