Lease Options When Selling – Warda & Shea

Lease Option – Author Mark Warda – Jack Shea – Sell on CFO – Rent-to-Own Real Estate Investing

Audio – 15 min

https://notebooklm.google.com/notebook/2617eeac-1a16-420b-ab88-b061272b6587/audio

This education piece offers guidance on selling property through lease options, emphasizing benefits for both landlords and tenants.

It outlines a system designed to avoid granting tenants vested property rights early in the agreement, focusing instead on a contract to deliver an option in the future.

It details how to find and screen suitable tenants, negotiate lease option terms, manage the tenant/optionee relationship, and handle potential defaults.

Crucially, it explains the process of closing the sale when the tenant exercises their option.

The information covers legal considerations, specifically highlighting landlord-tenant laws and providing state-specific resources.

It emphasizes the importance of maintaining a clear landlord-tenant relationship throughout the lease period to avoid complications.

This briefing document summarizing the provided text on lease options, focusing on the key themes and important ideas:

Briefing Document:

Lease Option Strategies for Selling Property

Introduction:

This document reviews key concepts and strategies related to selling property using lease option agreements, as presented in the provided text. The text advocates a specific approach that aims to maximize profits while minimizing risks associated with traditional rental properties and lease options. The central theme is using a contract for option separate from the lease, designed to maintain a landlord-tenant relationship until the purchase option is earned.

 

Key Themes and Ideas:

Problems with Traditional Rentals & Lease Option Motivation:

Traditional rentals come with challenges such as vacancies, maintenance issues, and delinquent tenants.

Lease options are presented as a solution to these problems, offering above-market rents and reduced management effort.

However, the text emphasizes the risk of traditional lease options granting tenants “vested rights” in the property, requiring a lengthy foreclosure process for eviction.

The text promotes the use of a carefully structured contract for option to avoid this issue, instead establishing a contract to deliver an option after the tenant fulfills certain obligations. The author states “Under this system, the tenant can be evicted in the same manner as if he did not have an option.”

The “Contract for Option” Approach:

The core of the suggested method is a separate contract for option, which is distinct from the lease agreement.

This approach aims to create a landlord-tenant relationship where the tenant does not gain a vested interest in the property until the terms of both the lease and the contract for option are fully met.

The text emphasizes “no rights vest in lessee until all of the terms of this agreement have been fully complied with.”

The contract for option specifies a series of payments, events, or time periods that must be completed before the actual option is granted.

It emphasizes that an actual option to purchase the property is delivered in the future upon the performance of the lease and contract.

“The contract for option states and restates that an option will be delivered in the future, after the specific performance on the lease and that no right title or interest is passed at the execution of the contract.”

Targeting a Specific Tenant Demographic:

The text highlights a large pool of prospective tenant-buyers who desire home-ownership but face financial obstacles.

These include people who may not qualify for traditional mortgages due to debt, credit problems, or lack of a down payment.

“For the first time since the depression (1932) the public spent more in 2005 than it earned…

The staggering debt load has helped the economy…

Debt has grown faster than income and that can’t continue forever.”

The “Rent-to-Own” approach appeals to this demographic by offering the security and stability of home-ownership, alongside credit counseling and a path toward building a down payment.

 

“There is a vast unmet demand for Rent To Own housing. Apartment and house renters desire the security, stability, prestige and equity build-up that a Buy While Renting program offers.”

 

Benefits for the Tenant/Optionee:

The system offers potential tenants several benefits:

– A clean, functional home often with improvements.

– Fixed monthly payments with modest increases for a set period.

– “Fixed credits” towards a down payment.

– Credit counseling to help qualify for a mortgage.

– A fixed sales price for a specific time.

“They get the benefit of fixed payments with modest increases and a fixed sales price for a period of time.”

Tenants are given responsibility for management and maintenance.

Benefits for the Landlord/Seller:

The advantages for the landlord/seller are numerous and include:

– Above-market rental income (about 10% higher).

– Reduced repair expense (approximately 30% less).

– Tax deferral on the option deposit until exercised or abandoned.

– Low turnover, with an average tenancy of 4-5 years.

– Minimal management effort, stating you can manage 35% more option properties than rentals with the same effort.

– Full retail sales price for the property, without Realtor commissions.

– Property improvements made by the tenants, sometimes without compensation to the tenants if they don’t buy.

-“The tenants sometimes add improvements for their own use and enjoyment… Some of these did not buy the property, and left the improvements without compensation.”

– Pre-set rent increases are included in the lease agreement.

Finding and Screening Tenants:

Advertisements should focus on “Rent-to-Own” opportunities.

Target tenants who have the desire to own a home and who need assistance in accumulating a down payment. The text states that “Prospective tenants from the homes-for-sale ads are not im pressed with lease option terms if they are qualified to buy.”

Screen applicants using provided forms (application, approval criteria, question list, etc.)

Negotiating the Lease Option:

Emphasize the importance of a perfect payment history for the option and obtaining a mortgage.

Explain the higher level of responsibility required from tenant/optionee.

Review the lease and contract, ensuring all parties initial terms related to nonrefundable option money and other key clauses.

Key Contractual Elements:

The “Contract for Option” clearly states that the tenant does not receive an option until they meet all the terms.

The contract states the conditions that need to be met, for instance it states how much the initial payment is and how much the credit will be each month.

The document should clearly state that the initial payment is not a security deposit.

The contract should state how much the purchase price is, and how any repairs or credits will be determined.

If the tenant fails to exercise their option, payments are declared rent.

Dealing with Tenant/Optionees:

Maintain a professional, business-like relationship.

Be firm and insist on contract compliance.

Address issues promptly and explain the legal provisions of the contract, and encourage tenants to make improvements to the property.

Strictly enforce payment deadlines, as late payments result in a loss of credit toward the purchase price.

Use the provided forms for late payments, bad checks, and insurance reminders.

Handling Defaults:

Because the tenant has no vested legal rights (with the correct contract for option), use standard landlord-tenant procedures for defaults.

Consider offering a buyout to encourage a peaceful departure and mitigate the expense of an eviction.

Issue a claim letter for any portion of the option deposit you intend to keep, detailing reasons such as damages, cleaning, and option consideration.

Closing the Sale:

Initiate the closing process several months before the end of the lease.

Provide tenants with their payment history and final credit calculations.

Direct tenants to mortgage brokers who specialize in first-time buyers with credit challenges.

Ensure all required inspections (termite, home) are completed.

Work closely with tenants to help them complete any repairs or clean up work that may affect the property appraisal.

“The culmination of this long and involved process is to attend a closing and receive a check for the net proceeds without major repairs, vacancy or Realtor’s fees. It will be worthwhile.”

Landlord-Tenant Legal Issues:

The core principle is to maintain a landlord-tenant relationship and avoid giving the tenant a vested right in the property before the option is earned.

Strictly adhere to your state’s landlord-tenant laws regarding security deposits, late notices, and breach of lease.

Consult state-specific resources and statutes for guidance on landlord-tenant law.

The author recommends the following,

“If there is one available specifically for your state, this is much better to use than a generic national book.”

Key Quotes:

“Simply put, lease option agreements can help you make more profits from your rental properties with less work and less stress.”

“The one big disadvantage to most lease option agreements is that the tenant receives a vested right in the property.”

“A simple contract was devised to deliver an option after a series of payments, events or time periods have passed. It works.”

“There is a vast unmet demand for Rent To Own housing…They get the benefit of fixed payments with modest increases and a fixed sales price for a period of time.”

“A Rent To Own Agreement is a people management, not property management, system since it attracts future buyers who need and desire help in accumulating a down payment.”

“No rights vest in lessee until all of the terms of this agreement have been fully complied with.”

“The contract for option states and restates that an option will be delivered in the future, after the specific performance on the lease and that no right title or interest is passed at the execution of the contract.”

“If a property right was established, then a foreclosure would be the procedure required to extinguish this right.”

“The option deposit is not taxable until it is exercised, or abandoned.”

“The tenants sometimes add improvements for their own use and enjoyment… Some of these did not buy the property, and left the improvements without compensation.”

“Upon removal, the normal notices and charges are documented. The option deposit will become the last month’s rent, and provide the funds for required repairs.”

“The most important aspect of a lease with contract for option arrangement is making sure it is a landlord tenant relationship.”

“With the system explained in this book a tenant gets no vested rights, only a contract right which does not vest until it has been fulfilled.”

Conclusion:

This instruction presents a structured approach to lease options using a contract for option that allows landlords to avoid the pitfalls of traditional lease options, while tapping into a market of potential home-buyers who need assistance.

The process emphasizes careful contract structuring, tenant selection, and a focus on maintaining a strict landlord-tenant relationship until a purchase is complete.

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Lease Option Study Guide

Quiz

What is the primary benefit of a lease option agreement for the seller, according to the source?

Why might a potential buyer be attracted to a “rent-to-own” arrangement?

According to the text, what is the key difference between an option that vests immediately, and the contract for option detailed in the text?

What are some examples of property improvements a tenant might make that could qualify for a letter of credit?

Why is it important that the initial payment for a lease option is not considered a security deposit, according to the text?

What happens to the option deposit if the lessee defaults or chooses not to exercise the option?

What steps should be taken when dealing with a tenant who makes a late payment?

Why does the text recommend that the landlord assist the tenant in connecting with a mortgage broker?

What is the most important consideration for a landlord/seller to maintain throughout a lease option arrangement?

What should a seller do to ensure the option deposit is viewed as a legitimate down payment by lenders?

Answer Key

The primary benefit is the ability to make more profit with less work and stress by reducing vacancies, maintenance problems, and issues with delinquent tenants, while also potentially collecting above-market rents.

Potential buyers are attracted to a “rent-to-own” arrangement for the security, stability, and ability to build equity, all while having fixed payments and a set purchase price over a period of time, particularly if they are unable to qualify for a traditional mortgage.

The key difference is that an option that vests immediately gives the tenant a “valuable right” requiring foreclosure to evict, while the contract for option detailed in the text ensures that no rights vest until all conditions are met, allowing for a standard eviction process in case of default.

Examples of property improvements that could qualify for a letter of credit include a new roof, central air conditioning, room additions, landscaping, and other enhancements that increase the property value.

It is important because if not designated as separate from the security deposit, it can cause disputes about what payments will go towards rent and what is refundable. The initial option payment should be acknowledged as nonrefundable.

If the lessee does not exercise the option, the total monthly credit is considered rent, and the initial payment is typically kept by the lessor, although the text recommends possibly refunding some of it, contingent on the condition of the property, as a means to encourage the tenant to leave the property in good order.

When a payment is late, the landlord should point out the loss of credit and enforce late payment fees and also the loss of monthly credit for that particular month.

The text recommends assisting the tenant by providing credit counseling, reviewing their credit report, advising on removing negative items, and connecting them with a mortgage broker to increase the likelihood of the tenant closing on the purchase.

The most important consideration for a landlord/seller is to maintain a landlord-tenant relationship to ensure the tenant does not have a vested legal interest in the property, to avoid foreclosure procedures, and to be able to use the state’s normal landlord-tenant legal processes.

To ensure the option deposit is viewed as a legitimate down payment, the seller should make sure the initial check for the option deposit is annotated as such on the memo line of the check, and retain a copy of the check along with documentation of the monthly credits.

Essay Questions

Discuss the benefits and potential drawbacks of using lease options as a real estate investment strategy, for both the seller/landlord and tenant/buyer.

Compare and contrast the “contract for option” model described in the text with a traditional lease option agreement, focusing on the key differences and advantages of the “contract for option” model.

How does the text suggest managing potential issues, such as late payments, defaults, and property maintenance, within the context of a lease option agreement?

Analyze the importance of communication and documentation throughout the lease option process for both the landlord/seller and the tenant/optionee.

Considering the market conditions described in the text, discuss the viability of lease option strategies in contemporary real estate scenarios.

Glossary of Key Terms

Lease Option: An agreement that gives a tenant the right to purchase a property at a specific price within a certain timeframe, but does not obligate them to do so.

Contract for Option: A contract that does not convey any present right, title, or interest in the property to the tenant. Instead it is a contract for the future delivery of an option, after a specified series of events have occurred.

Vested Right: A legal right in a property that is secured and cannot be taken away without due process, usually requiring a foreclosure procedure for termination.

Optionee/Lessee: The tenant who has entered into a lease option agreement and has the option to purchase the property.

Optionor/Lessor: The landlord/seller who grants the lease option on the property to the tenant.

Option Deposit: An initial payment made by the tenant to the landlord/seller for the right to be granted the option to purchase in the future. This is not intended to be used as a security deposit.

Monthly Credit: A portion of the monthly payment, over and above the fair market rent, that is credited towards the future purchase price of the property.

Letter of Credit: A written guarantee provided by the landlord to the tenant that acknowledges and values improvements made to the property that will be applied as a credit if the tenant buys the property.

Default: A failure by the tenant/optionee to meet the terms of the lease or contract for option, potentially leading to eviction and loss of rights.

Foreclosure: A legal process by which a lender or seller takes back ownership of a property when the borrower or buyer fails to make payments. It is generally necessary when a tenant holds a vested right to the property.

FHA Loan: A mortgage insured by the Federal Housing Administration, often preferred by first-time home buyers due to the lower down payment requirements.