All Your Questions On Lease Options Answered Here
Lease options are a recent heated topic of discussion in the property circles. While some buyers are still skeptical about the benefits of lease options, others are raving about it. So, what is this new trending topic that has divided the opinions of property dealers? Let’s determine if the lease option is the right tool for landlords and buyers to gain profits from the property.
What is a Lease Option?
A lease option is a legal contract that lets a buyer control a property, gain income from it in the form of rent, with the right to buy the property at a later stage. With this explanation, you would’ve come to understand that two separate agreements go into making the lease option.
You agree to pay the property owner a fixed amount of money every month. You can rent out the property to tenants and manage the property as if it’s your own.
You come to an agreement with the owner to an amount at which you have the option (and not obligation) to buy the property at a later stage.
Points to Consider while Drawing up a Lease Agreement
The 4 critical points you need to agree on before getting into lease options are:
You have to agree to pay the owner a monthly payment that usually covers their mortgage and any other costs.
Length of the Agreement:
You’ll have to agree to a period after which you are obligated to return the property if you haven’t used the buy option.
You’ll have to agree to a price at which you would be willing to buy the property in the future.
Termed as consideration, according to the laws of contract, you’ll have to pay an upfront amount for considering the option. If the lease agreement has to be legally binding, there should be some upfront payment. It can be as low as £1 as well.
The lease option has two separate parts – the lease agreement and the options agreement.
The Lease Agreement
The agreement will specify the exact amount you’ll pay the property owner every month and other conditions..
The Options Agreement
The options agreement will stipulate the length of the contract, the amount you’ve agreed to pay upfront, the future purchasing price, and more.
In addition to this, you might also want to consider getting yourself another agreement. The restriction on the title agreement which will provide the buyer some legal protection from the property owner offering the property to others.
Key Points to Note while Negotiating the Terms of the Agreement
First, it is always better to get a solicitor’s help in drafting the lease options documents. It’s unlike a rent-to-rent agreement where it’s generally enough to have a solid agreement, and much legal advice is not needed. In a lease options agreement, legal representation must be available for both sides.
You’ll have to engage the services of a good solicitor who can draw up an air-tight agreement legally binding on both parties. It is also a good idea to ensure that the property owner also has a solicitor present while signing the agreement. So that they can’t later claim coercion or that they didn’t understand the legal jargon. This is to make sure that in case the owner backs down from his contract or is unable to honor his terms of the agreement because of financial issues, you don’t end up paying the legal expenses for both parties.
Before agreeing to the agreement, you’ll have to make sure that both parties are on the same page in terms of:
The Option Period:
When you are negotiating the option period, make sure you allow yourself a longer timeline for the property to gain capital. Option period doesn’t necessarily mean having the choice to buy the property only at the end of the period. You can buy the property at any time within the option period.
The Monthly Payment:
Also, negotiate a monthly payment that is easy for you to pay (even if you have gaps in tenancies), and that is enough for the owner to cover his expenses.
The Upfront Payment:
Otherwise known as consideration, the upfront payment is a legal requirement. So it is better to make sure you pay as little as possible so that you don’t end up at a loss.
The Option Price:
It is better to negotiate a lower option price to earn profits earlier.
Lease Option Explained
If the lease option is structured correctly, it can be a win-win situation for both parties involved:
- The initial payment can be very nominal – can be as little as £1 – instead of a 25% deposit for purchasing.
- You’ll still be able to make money out of the property in the form of rent – just like you would if you owned the house.
- You’ll not be required to take a mortgage.
- If you don’t see much capital appreciation of the property, you’ll still have the option of handing over the property back (after making rent money from it!).
- If the property value shoots up to more than the agreed price, you can still buy it.
For example, let’s assume I have agreed to a lease on a property worth about £100,000 with an option to buy the same for £110,000. The agreed options period is 5 years, and the agreed consideration is £1. And I have also agreed to pay the property owner £300 per month.
Now, I take control over the property, put it out for tenants, and earn a monthly rental of £700. Monthly maintenance comes to about £100. So, I gain a profit of £300 every month. In the next five years, the profit gained totals £18000.
There are two possible scenarios now:
- Either the property value is still £100,000 even after 5 years. But I have agreed to buy the property at £110,000. I wouldn’t want to buy it at this price now. So, I allow the option to expire and hand over the property. Yet, I have made £18000 profit (well, £17999 to be exact, if you deduct the money paid upfront!).
- If the value of the property increases to £120,000. I take a mortgage out and buy the property for the agreed £110,000. Essentially, I have purchased a house at a discount of £10,000. And I have also made a profit of £18000 in the form of rent in these 5 years.
- There is another option here – I can resell the option to those interested in buying the property for £10,000. They would have to pay me £10,000 and the balance £110,000 to the property owner. This way, I can walk away with a profit of £10,000 from selling the option and £18,000 from the rent.
The Drawbacks of Lease Options
For a property owner, the lease option wouldn’t have been their first choice. They would’ve chosen this option only because of their unstable financial condition.
Your success in implementing this strategy depends largely on their co-operation.
- You will be in trouble if the owner misses paying their mortgage (despite you paying rent every month) and the lender repossesses the house.
- You’ll also incur losses if you had to do a lot of maintenance work for up-keep of the house, dipping into your profits, and still cannot buy the property.
- If your owner doesn’t allow you to use the buy option, you’ll be forced to take legal action which might not be entirely beneficial to you.
Finally, if you are interested in lease options on property, I suggest you have a solicitor draw up a solid agreement. It is not advisable to spend too much money on upfront payment. And, always enter into such contracts only when you can identify potential and willing sellers or buyers.