What Is A Lease Option?

A lease option is an agreement made up of two components. The option component allows a buyer to buy something within a stated period of time for an agreed upon price. The lease component allows the buyer the use of that thing while he is deciding whether or not to exercise the option.

So what is a lease option? A typical lease option contains the following components:

Lease – This is the agreement to lease or rent a property from an owner. This should be a separate document from the option. You want a lease term commensurate with the length of the option.

Option – The option agreement states that the buyer has the right to buy the property within a certain amount of time if he performs certain requirements. An option typically has an option consideration, which is the amount paid for the right to buy the property; an option term, how much time the buyer has to perform, and a strike price, how much the buyer will pay (in cash or kind) in order to exercise the option.

For example, I might option a property for $100,000. I put up $5,000 (option consideration) to seal the agreement. Under the terms of the option, in order to buy the property, I will have to pay the owner an additional $95,000 ($100,000 strike price minus the $5,000 option consideration) by a certain date. If the option termination date passes and I haven’t exercised my option, the option expires and the owner gets to keep my option consideration. I am liable for nothing more than that $5,000 I have already paid.

Lease options allow wiggle room on the buying side. The buyer has the right to buy, but does not have to buy. He can walk away from the deal. But, if he does so, he also walks away from his option consideration. You may hear an option called a unilateral agreement. That means that one side can make the deal go or not go. The seller cannot force the buyer to buy.

The benefit to the seller is that he has solved a problem, at least temporarily. He has a buyer lined up for something he wanted to sell. He has received some sort of compensation for granting the option. And, he now has lease payments coming in to give him cash flow. Additional benefits might include not having to maintain a property or answer late night calls from tenants. Depending on the terms of the deal, he may now have his costs covered for taxes, insurance, any principle and interest. Most of all, he has traded what he saw as a headache for cash.

The buyer is in a “try before you buy” situation. He can get a feel for a property and the neighborhood. For new investors, this is a great way to see if owning a home or being a sandwich leasing landlord is right for him. In addition, the buyer has managed to control a property with a smaller payment than he would have needed to buy the property. He has time to get his financing in place and maybe have money credited towards the down payment. In addition, if he makes his payments on time, he may find that the lease option could work into an owner financing situation or may lead to other properties that the owner has.

Lease options do not have to be long-term. Some fix and flip rehabbers like to buy on lease option, rehab the property and then put it on the market. When they find and qualify their buyer, they can exercise their option and sell the property. A better way is to assign the option to the new buyer at closing and be paid the spread between the original strike price with the owner and the new price the buyer is paying.

As with any real estate contract, nothing is written in stone and everything is negotiable. Just because something is “normally done this way” doesn’t mean that you have to do it that way. If most lease option investing agreements are three-year term and you want five years, negotiate for the five years. If your tenant prospect thinks that half of his rent should go to the down payment and you think only a quarter of it should be credited, then negotiate what you want and fall back to what you need. Remember: He who controls the paperwork controls the deal.

What is a lease option? More than you think.

Also don’t forget – lease options aren’t limited to real estate. Look for opportunities to use a lease option when you are buying or selling any high ticket item – cars, boats, airplanes or anything that catches your eye. So The next time someone asks you what a good deal is, you can smile and reply, “What is a lease option?”