Lease Option Agreement
A lease option agreement is a contract which gives the tenant an option purchase the property at the end of their rental period. The landlord will let the property to the tenant who as an option to purchase the property after an agreed time has passed. The option can be used with both residential and commercial lets. The tenant and landlord make a legal agreement, where the tenant has the option to purchase the property from the landlord.
A lease option agreement is different to a lease purchase contract, a lease purchase contract binds the tenant to the purchase of the property. Whereas a with a lease option, the tenant has the option to purchase the property but is not legally obligated to purchase the property. In both situations the landlord has agreed to sell the property, with the lease purchase the tenant is also legal obligated to purchase the property. But with an option, the tenant does not have the obligation to purchase the property but has the option to purchase.
To make simplify, a lease option agreement can be separated in to two parts, the lease and the option.
A lease: A tenant pays rent on a property to the landlord. The tenant can operate the property as defined in their agreement with the landlord. If the property is a commercial property, they can use that property for commercial purposes.
An option: A tenant has a right to purchase the agreed property at their discretion but is not under obligation to purchase the property. The tenant has the option to purchase the property at a date agreed on with the landlord.
An option is popular within the financial sector. With options being agreed on stocks, land and real estate. Allowing the holder to buy or sell something at an agreed price after an agreed period. It is normal for the holder to pay a premium for the option as this gives them a right but not an obligation.
The following main conditions are usually included within an option agreement.
Periodic payments, otherwise known as rent. This is typically required for the landlord to let the property.
The price of the purchase, this is usually included in the contract and should not changed unless included in terms.
The agreement duration. The landlord will usually require the tenant to rent the property for a minimum time before the purchase is made. The agreement will also include a time frame in which the tenant should make the purchase if the chose to purchase the property. If the tenant does not make the minimum amount of rental payments, or if the tenant does not decide to purchase the property within the agreed time frame then the agreement is void. The landlord will retain the property. The buyer should pay a consideration in advance.
For the agreement to become a legal contract at least one payment must be made, this can be any value, even £1.
Reasons to use a rental option
A lease option agreement may give the landlord an opportunity to sell a property that they may not be able to sell under other situations. For example, the landlord may give favourable terms to the tenant to increase the likelihood of obtaining the sale. The landlord may be able to generate a better yield from the agreement as rental payments are paid before the sale and the landlord could generate better yield through terms set in the agreement. If the tenant was already renting before the landlord and tenant formed a rental option, then the landlord may be able to avoid brokerage fees.
Other times the landlord may add a purchase option to attract a tenant, but, do not expect the tenant to be able to make the purchase. For example, putting a short rental period before the purchase must be made, thus not allowing the tenant enough time to save for the deposit, or give enough time to resolve other legal matters.
It is likely that the landlord or seller has no other options which is why they are offering a purchase option. They are tying themselves into a long-term transaction where the buyer has the option to withdraw. Whereas the seller does not have the option to withdraw. A typical scenario is that the owner is in negative equity, this means that the seller owes more than the house is worth, so they delay the sale until they can make up the payments.
Disadvantages when using rental options?
If the landlord is offering the agreement as they are in negative equity and the landlord can no longer afford the mortgage, the mortgage lender may repossess the property. Both parties should also ensure they have the correct insurance and terms in place with mortgage lender.