Property owners who’ve had trouble locking down sales are offering potential buyers a gradual approach to purchasing their property — lease options. Although a lease option may not be the ideal structure for a sales transaction, it offers some attractive benefits, especially in today’s down market. This article explains how lease options work and their potential benefits and drawbacks.
How can lease options help me in this slow economy?
Property owners who’ve had trouble locking down sales are offering potential buyers a gradual approach to purchasing their property — lease options. Although a lease option may not be the ideal structure for a sales transaction, it offers some attractive benefits, especially in today’s down market.
How does it work?
Lease options — more commonly known as lease-to-own arrangements — combine a traditional lease and a purchase option. Under the option, the seller/landlord gives the buyer/tenant the exclusive right to buy the property. There’s usually a fixed price at the beginning of the lease. But the price could also be the market value on the exercise date or the amount offered by another interested buyer. The buyer can exercise the option at any time during the option period, which typically runs concurrent with the lease term.
The buyer generally pays an above-market monthly rent, receiving a nonrefundable credit of 10% to 100% of the rent toward the eventual down payment. The buyer also pays some nonrefundable consideration upfront for the purchase option.
What are the potential benefits?
This leasing tool lets you benefit from market appreciation (if the exercise price equals market value on the exercise date). Monthly rent payments provide a cash flow that you can use to pay monthly mortgage payments and property tax bills. And, because you’re still technically the owner, you can also deduct the interest payments and property taxes.
A lease option also gives the buyer/tenant a vested interest in and an incentive to care for the property. The greater the upfront option consideration, the greater that incentive. Plus, some lease option contracts require buyer/tenants, not landlords, to pay for routine maintenance on the property.
Are there drawbacks?
With a lease option, you’ll likely receive a smaller down payment if you sell the property to the buyer/tenant (because of the rent credit) than you would otherwise. Plus, monthly rental payments might not cover your mortgage obligations. An option could also keep you from offering the property for sale to other prospective buyers who might be ready to buy before the buyer/tenant.
Worth considering
If you have property that’s been lingering on the market for some time, a lease option might be just what you need to grease the wheels on your sale and improve your cash flow. Your real estate and financial professional can show you the way.
Warmest regards,
Douglas Rutherford, CPA, CGMA
© 2012 Douglas Rutherford, CPA, CGMA. All Rights Reserved. Douglas Rutherford is a nationally recognized CPA practicing in the real estate industry. He is the founder of Rutherford, CPA & Associates, and the President and CEO of RentalSoftware.com. He is also the developer of the national leading real estate investment analysis software, the Cash Flow Analyzer ® & Flipper’s ® software products. Doug earned his Masters of Taxation degree from Georgia State University, Atlanta, GA.
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