Lease with option to buy, who benefits more?

[shiphead]

saltonre, There is someway to have yourself registered as a realtor on this forum. You get a little house next to your name or whatever.

[stephpan]

Hi,
My family and are are looking to move to the bedminster area on up to basking Ridge. We will be looking for lease with option to buy. If there are any sellers out there looking to do that please let me know. We are looking to move in Aug.

[andrzejn]

Originally Posted by stephpan

Hi,
My family and are are looking to move to the bedminster area on up to basking Ridge. We will be looking for lease with option to buy. If there are any sellers out there looking to do that please let me know. We are looking to move in Aug.

Just be careful and make sure the initial deposit is not too large. From buyers perspective you have no idea if the seller is paying his mortgage and bank may foreclose on the property and you loose your money.
In current market if your credit is good enough to qualify for FHA loan I would strongly suggest in buying instead of lease to own.
On top of that first time home buyers get $8000 tax credit and if you purchase a foreclose home in Phoenix city will give you $15000 interest free loan.

[Captain Bill]

Both buyers and sellers need to go into a lease option with open eyes.

In AZ, they should have a Lease Agreement, and in that agreement there should not be any mention of the Purchase Agreement.

The reason is to avoid giving any false indication that the lessee has an equity position in the property. The standard deposits that apply to all leases will be in this agreement, along with whatever rental rate is agreed on.

The Purchase Agreement, in Additional Conditions, will state (among other things) that the buyer is leasing the property under separate Lease Agreement dated xx,xx,,xxxx, and buyer shall have no equity position until Close of Escrow.

The problem for the seller is that they agree on a purchase price using today's current market value. If in one year, when the purchase is to be consumated, the prices has fallen by 15%, then the property will not appraise for the selling price, so the buyer will not be able to finance it, and will be able to cancel the contract.

Any Purchase Agreement like this should carry a non-refundable earnest money deposit for the purpose of compensating the seller for the delayed sale, and the risk of it not closing escrow. This money goes straight to the seller and is his to uses as desired as soon as the contract is signed.

Example:

Purchase Price agreed on: $500,000
Non-refundable earnest money: $10,000
Market value decline in the 12 month lease/option + 15% =$75,000

House appraises for $425,000
Buyer cannot finance for $500,000
Buyer is also aware that he agreed to pay $500k a year ago, but the value is less now, so decides that even though he could pay cash, he does not want the house at $500k.

So the buyer does one of two things:

1. Declines the property on the basis of not passing his inspection during the due diligence time frame of 30 days prior to COE.

2. Declines the property based on the financing contingency because the property will not appraise for $500k.

The seller has lost a lot of equity by taking his house off the market for that year, and now it's fallen out of escrow. It probably needs about 10k of work for carpet paint, minor repair to get it in marketing condition now.

The buyer paid an extra 10k (non-refundable deposit) for the privelege of delaying the escrow. However, he has had a place to live for a year, and did not have to buy the house at last years price.

In this case the seller loses a lot of money.

The buyer has made out ok. The 10k was the cost of the risk he assumed. Now he can buy the same type house for 75k less.

What happens if the market increases by 15%?

The buyer closes escrow and gets a house for $500k that is now valued at $575, so he makes out. He paid rent for a year, which could be around 20k, plus the 10k non-refundable earnest money, and still comes out 45k ahead.

The seller has pocketed a 10k earnest money, but lost the 75k potential profit. He also got rent money, but had to pay his mortgage and other expenses.

Of course the seller could elect to return the earnest money and refuse to sell. The buyer would have the option of accepting that, or go to court and sue for specific performance. That is a risk for both seller and buyer.

Advice: Prior to entering into a Lease/Purchase Agreement as a seller or a buyer, give careful consideration to all of the potential problems.

As a seller, make sure that your realtor understands how to protect against the buyer acquiring an imputed equitable position. Or that you have an attorney draft the language in the Purchase Contract that prevents the buyer/lessee from having equitable interest.

If that isn't done, then at the end of the lease, the lessee may not move and may not buy, and may stop paying rent. It will be extremely difficult to evict them because the court may rule that they have equitable interest and cannot be evicted.

[andrzejn]

Originally Posted by Captain Bill

Both buyers and sellers need to go into a lease option with open eyes.

In AZ, they should have a Lease Agreement, and in that agreement there should not be any mention of the Purchase Agreement.

The reason is to avoid giving any false indication that the lessee has an equity position in the property. The standard deposits that apply to all leases will be in this agreement, along with whatever rental rate is agreed on.

The Purchase Agreement, in Additional Conditions, will state (among other things) that the buyer is leasing the property under separate Lease Agreement dated xx,xx,,xxxx, and buyer shall have no equity position until Close of Escrow.

The problem for the seller is that they agree on a purchase price using today's current market value. If in one year, when the purchase is to be consumated, the prices has fallen by 15%, then the property will not appraise for the selling price, so the buyer will not be able to finance it, and will be able to cancel the contract.

Any Purchase Agreement like this should carry a non-refundable earnest money deposit for the purpose of compensating the seller for the delayed sale, and the risk of it not closing escrow. This money goes straight to the seller and is his to uses as desired as soon as the contract is signed.

Example:

Purchase Price agreed on: $500,000
Non-refundable earnest money: $10,000
Market value decline in the 12 month lease/option + 15% =$75,000

House appraises for $425,000
Buyer cannot finance for $500,000
Buyer is also aware that he agreed to pay $500k a year ago, but the value is less now, so decides that even though he could pay cash, he does not want the house at $500k.

So the buyer does one of two things:

1. Declines the property on the basis of not passing his inspection during the due diligence time frame of 30 days prior to COE.

2. Declines the property based on the financing contingency because the property will not appraise for $500k.

The seller has lost a lot of equity by taking his house off the market for that year, and now it's fallen out of escrow. It probably needs about 10k of work for carpet paint, minor repair to get it in marketing condition now.

The buyer paid an extra 10k (non-refundable deposit) for the privelege of delaying the escrow. However, he has had a place to live for a year, and did not have to buy the house at last years price.

In this case the seller loses a lot of money.

The buyer has made out ok. The 10k was the cost of the risk he assumed. Now he can buy the same type house for 75k less.

What happens if the market increases by 15%?

The buyer closes escrow and gets a house for $500k that is now valued at $575, so he makes out. He paid rent for a year, which could be around 20k, plus the 10k non-refundable earnest money, and still comes out 45k ahead.

The seller has pocketed a 10k earnest money, but lost the 75k potential profit. He also got rent money, but had to pay his mortgage and other expenses.

Of course the seller could elect to return the earnest money and refuse to sell. The buyer would have the option of accepting that, or go to court and sue for specific performance. That is a risk for both seller and buyer.

Advice: Prior to entering into a Lease/Purchase Agreement as a seller or a buyer, give careful consideration to all of the potential problems.

As a seller, make sure that your realtor understands how to protect against the buyer acquiring an imputed equitable position. Or that you have an attorney draft the language in the Purchase Contract that prevents the buyer/lessee from having equitable interest.

If that isn't done, then at the end of the lease, the lessee may not move and may not buy, and may stop paying rent. It will be extremely difficult to evict them because the court may rule that they have equitable interest and cannot be evicted.

Great post Bill but that doesnt address the problem where non-refundable earnest deposit which in most cases is higher than regular security deposit with "regular" rental and seller stops making his mortgage payments right after he/she signs the contract and lender forecloses on the property.

[Captain Bill]

Originally Posted by andrzejn

Great post Bill but that doesnt address the problem where non-refundable earnest deposit which in most cases is higher than regular security deposit with "regular" rental and seller stops making his mortgage payments right after he/she signs the contract and lender forecloses on the property.

Right, I was only discussing the issues of doing a lease/purchase.

When a property owner accepts rent money from a tenant, (whether in a regular lease, or a lease/purchase) and stops making the mortgage payments, that is fraud, and one can and should go to jail.

It's unfortunate that not much can be done in advance to stop that practice.

[johnnyb1]

Great- so if you enter into a lease with option to purchase, and the market goes up a year from now, the option gives you the right to purchase at the strike, just like a stock option. What happens if the market goes down, (which here in SoCal, it most certainly will) if it does not appraise at the pre-determined price, does it mean you lose you option fee, or does it give you the right to renegotiate?