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Lease options are like standard lease agreements, except they allow tenants the option to buy a rented property after a specified period, typically at the lease’s end.
Depending on the landlord, the lease option can also be called a lease with the option to buy, a rent-to-own agreement, or a lease-to-own agreement. They all generally work the same way: lease options allow a tenant the right to purchase a property they previously leased.
Like a standard lease, a lease option lays the groundwork for how both parties will operate to fulfill their end of the bargain. The difference between a standard lease and a lease option is that once a standard lease agreement is up, the tenant can renew or leave the property.
For lease options, once the lease expires, tenants are granted an additional option — they can buy the property, but they aren’t contractually obligated to. Tenants should know that they’ll typically lose the option fee if they choose to walk away, though.
Understanding a lease option’s essential terms and components will help you better understand how they work. Let’s explore their key elements.
Typical terms found within lease agreements include lease duration, monthly rent amount, and the future purchase price of the property.
The tenant usually pays an upfront fee known as an option fee or consideration. The option fee grants the tenant the exclusive right to purchase the property and is typically non-refundable.
The tenant lease period is typically much longer than that of standard leases. Whereas standard leases normally span six months to a year, options generally stretch several years.
The tenant pays the predetermined rent payment as specified in the agreement. Some lease options set aside a portion of the rent payments and put them toward the property’s purchase price.
The agreement outlines responsibilities for property maintenance and repairs. Some lease options stipulate that tenants must maintain and repair the property as needed.
Lease options include a clause granting the tenant the exclusive right to purchase a property.
The agreed-upon future price might be based on the current market value or a predetermined amount. Because the agreement is made before the sale of the property, tenants may gain potential equity if the property appreciates.
If the tenant exercises the option and proceeds with the purchase, they must notify the landlord, and the sale is executed according to the agreed-upon terms.
If the tenant doesn’t have the capital to buy the property outright, they’ll have to obtain a mortgage or another form of financing.
Finally, the property is officially transferred to the former renter, and they become the new property owner.
Landlords and tenants both benefit from opting to enter into a lease agreement. Let’s examine the advantages for both parties.
As with any real estate investment arrangement, risks persist. Let’s explore possible risks for landlords and tenants.
With all the terms, advantages, and risks known, a couple of example scenarios help to put it all together.
Scenario 1: A tenant is eager to become a homeowner but lacks the financial means to secure a mortgage.
Lease Option Structure: The landlord and tenant agree on a rent-to-own arrangement with a three-year lease term. A portion of the monthly rent, say $200, is designated as a “rent credit,” accumulating over the lease period. The tenant has the option to purchase the property at a fixed price within the three-year timeframe, and the accumulated rent credits can apply towards the down payment.
Scenario 2: A landlord wants to encourage the tenant to secure financing sooner rather than later.
Lease Option Structure: The lease option includes a balloon payment provision, specifying that a significant portion of the purchase price becomes due after a certain period — two years, for example. The balloon payment provision motivates the tenant to secure mortgage financing and complete the purchase to avoid the balloon payment.
TurboTenant’s state-specific lease agreements provide landlords with rock-solid pre-built leases to make lease creation more effortless.
When you start with the general terms of a lease agreement ironed out beforehand, you only need to account for the critical components of your lease option, including the option fee, rent payment amount, and maintenance responsibilities.
Sign up for a free account today and see how TurboTenant can help you quickly transition from a potential applicant to an approved tenant in no time.
When structuring a lease option to buy, define lease terms, set a fixed purchase price, and establish an upfront option fee. Specify rent credits and responsibilities for maintenance and improvements and consider optional provisions like market value adjustment, right of first refusal, and balloon payment.
A lease-back option, or a sale and leaseback, occurs when a property owner sells their property and immediately leases it back from the new owner. In this arrangement, the original owner becomes a tenant, allowing them to continue using the property while no longer holding ownership.
Businesses or individuals looking to unlock capital tied to real estate while retaining the property’s operational use often employ this strategy.
Lease options can be a good idea for landlords seeking potential buyers among their tenants and for tenants looking for flexibility and the opportunity to become homeowners. However, both parties should carefully assess the risks and benefits.
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