Lease/Purchase Option Can be a Win for Both Parties
If negotiated fairly, a lease/purchase option can be a win for both parties. The option contract portion of the lease allows the renter to secure the right to buy the house in the future, while the landlord can typically make additional money on the deal. The basic elements of an option contract are (i) the option price, (ii) the option period, (iii) the purchase price, (iv) the monthly rent amount, and (v) the monthly rent premium.
The Elements of Lease/Purchase Option
The option price is the amount paid by the renter for the right to purchase the house by some future date. The landlord will typically keep the option price regardless of whether the renter buys the asset. The option period is the time during which the renter has the right to purchase the property, and the purchase price is the price at which the renter may so purchase the property. The rent amount is typically equal to the fair market rental value of the property, and the rent premium is an amount added to the monthly rent. The rent premium is typically applied as a benefit to the renter at the closing of the renter’s purchase of the property. However, the lease/purchase option contract might allow the landlord to keep the rent premium if the renter does not purchase the property within the option period. Each of these terms is negotiable and can differ significantly from one option contract to the next.
Lease/Purchase Option Contract Complexities
Each of these elements can also be simple or complex. The landlord, for example, might want the purchase price to increase at certain intervals in a long-term contract. The renter, on the other hand, might want the right to get out of the deal and recover some of the option price. An option contract containing these two features might for example include a purchase price of $100,000 in year one, of $105,000 in year two, and $110,000 in year three. The initial option price might be $10,000, but this value might decline by 50% in each of the three years, so that the renter can sell the option contract back to the landlord for $5,000 in year one, $2,500 in year two, and $1,250 in year three.
Before entering into a lease/purchase option contract, the renter should conduct all of the due diligence on the house as if the renter was going to buy the house rather than just rent it. For example, the renter should obtain a title report, inspection, and even perhaps appraisal. The renter might also ask the landlord for a disclosure statement, a roof certification, and various mechanical warranties that can be transferred to the renter at closing. A lease/purchase option contract should also state which party is obligated to pay the utilities and who is obligated to maintain and repair the property and to replace portions of the structure that become defective. (The risk of destruction will likely have to stay with the landlord until the renter closes on the purchase of the house.)
The lease/purchase option should also provide for whether the renter may make improvements to the property, whether the renter must obtain the consent of the landlord before making improvements, and whether the renter will forfeit the cost of the improvement if the renter does not close on the purchase of the house.