There are 2 sides to this story- one for Sellers & one for Buyers. There are pros and a whole lot of cons. Let's take a look...
Sellers:
Frequently, frustrated sellers with homes to sell find themselves with a willing tenant throwing the "lease-option" or "lease-to-own" plan into their lap. There are still lots of sellers in Phoenix & Scottsdale, who bought homes between 2006-2008 when the luxury market peaked, who are still unwilling to sell their homes at current market value, likely below what they paid when they bought. In '08 I watched a seller decline a clean, but lower-priced purchase offer for a shinier lease-option... Let's just say, I don't believe that property has sold since.
If you've ever asked me about doing along the lines of "lease purchase", "lease-option", "lease with the option to buy", etc., this, I may have said something slightly warmer than "Hell no!"- but not much. Aside from the fact that I've never seen one actually close (not even if I've personally been party to it), legally it can have negative implication for sellers. My broker, Realty Executives', & our attorneys frown heavily upon these agreements. Finally, I once heard that the statistical probability of completing the agreement to a closed sale is ~22%, but I don't have any concrete numbers to back that.
If you ever wanted an additional opinion about it, the AZ Association of Realtors (AAR) weighed in with their thoughts. Here's what they had to say (note: that's their title, not mine):
"Recording a Lease Option Is Not Advisable for the Property Owner"
You may not be familiar with "recording" a lease. We record (make public record) real estate sales & loans with the county recorder, but leases are usually drafted and executed without recording. Options are a little different because they give an irrevocable right to the tenant to purchase the property within some pre-determined amount of time. The landlord/seller doesn't have too many ways out if the tenant/buyer can't perform. They are subject to the whim & follow through of the tenant/buyer. Even when you have hefty, non-refundable earnest & security deposits, if you decide you need to sell, you may not be able to do so quickly...
Note: One of the most important lines of this discussion is the very last one:
"Please note also that unless the lease and option to purchase contain cross-default provisions, a breach of the lease by the buyer and subsequent eviction by the seller may not prevent the buyer from exercising the option to purchase."
Then there are the other risks to Sellers:
- Tenant/buyer fails to qualify for a new loan (lacking the down payment, credit, job history, etc.)
- Landlord/Seller suddenly needs the money from a sale now, but the option is still good for another... (X amount of time).
- Even if the Tenant/Buyer assumes all maintenance, they don't actually have the ability to make a critical repair that arises
- Tenant/Buyer, tries before they buy and change their mind...
Buyers:
Sure, it looks pretty grim for Sellers, but if you're a buyer considering a lease option, there's a lot you need to know too! Chances are you want to lock in today's price for tomorrow. Maybe your credit history isn't good and/or you don't have the down payment or income you need to buy a home today, but you will... soon!
Most landlord/sellers want a sizable sum for the option"- maybe a few % of the price of the home, which could be several thousand dollars up front. They may want an inflated (from market) rent price, from which a portion gets set aside for your down payment down the road.
There are risks to Buyers too:
- Will the Seller keep the existing mortgage(s) paid & in good standing?
- Are there any "latent defects" (AKA the roof/plumbing/electrical/HVAC unit on its last legs) the Seller hasn't disclosed because they're not really a problem, yet?
- At the end of the lease option period, are you sure you'll have all your ducks in a row to buy? If not, what will you lose?
- What if the money you pay for your option and/or monthly rent premium vanishes, when you have a valid reason to cancel?
- What if you don't record your option (most aren't) and the seller sells the house out from under you?
It's a 2-way Street- what's good for one is probably bad for the other
Aside from all the risks to Sellers & Buyers I mentioned above, there also the unknowns:
- The value goes up, but the price is fixed lower- Buyer is glad, Seller is MAD!
- The value goes down, but the price is fixed higher- Seller is glad, but buyer is MAD. BUT... buyer now can't qualify because the house won't appraise...
- Buyer never had any intention to buy, but has a good lease in place...
- Seller demands contract terms that the buyer is unlikely to ever meet...
The Devil is in the Details:
How you draft the contract is important. This is not a simple, everyday transaction. Everything from, the purchase price, lease length, deposit amounts, clauses for default (either side)... must be pre-determined. The terms need to factor all of these details and MORE! The final document WILL be complicated- these transactions usually are. If both Tenant/Buyer & Landlord/Seller are not savvy, knowledgable participants, one or both have much to lose.
Sure, you can hire an attorney to do the legwork or a lender with strong knowledge of qualifying a Buyer for a lease-option agreement, but unless they're familiar with both the lease & sale markets, trends & even buyer financing, they may not be the best ones to advise either party from start to end. Both parties really need to know who you're dealing with and plan for just about everything. If Buyer & Seller don't have a vested interest in a win-win outcome, a lot can go wrong.
All this said, Buyers & Sellers DO benefit from these types of agreements. There are also other ways to accomplish the same thing without it being a "lease option". Participants who pull this off are usually sophisticated with this type of deal and have lots of stop-gap measures to avoid the pitfalls. If you have any hesitation you fit that description, this may not before you... We've scratched the tip of the iceberg, but consider yourself "informed".
If you're still not sure how to avoid all the pitfalls above or completely understand what they are, we need to talk... There are other options outside of *this* one and I can tell you all about them!
Happy New Year!
Related Pages:
Up in 2017 Real Estate: Buyer Purchase Power & Mortgage Rates