Lease Option Sandwich

Training Report: A Strategic and Legally Defensible Approach to Buying on Lease Option & Lease Purchase

Prepared For: Real Estate Investors & Homebuyers
Executive Summary

This report provides a comprehensive framework for acquiring real estate using Lease Options and Lease Purchase agreements.

While these creative financing strategies offer a path to homeownership and investment without traditional financing, they are fraught with legal and financial peril if structured incorrectly.

This guide details the essential agreements, negotiation strategies, and—most critically—the legal safeguards necessary to protect the buyer/investor and ensure the transaction is not recharacterized by a court as a disguised installment sale.

Adherence to the principles herein will maximize control, minimize risk, and create a defensible position for all parties involved.

1. Understanding the Core Agreements

The foundation of a successful transaction is the correct use of legally precise documents.

1.1. Primary Agreement: The Lease Option Agreement (Form 3.27)

• Purpose: This is the central contract granting the Buyer the right, but not the obligation, to purchase the property. It is distinct from agreements used when selling, as it is drafted to prioritize the Buyer’s control and protection.
• Key Advantage: It preserves the Buyer’s right to walk away, a crucial distinction that helps avoid judicial recharacterization as a mandatory purchase contract.

1.2. Securing Your Interest: Memorandum of Agreement (Form 3.2)

• Purpose: To record a “cloud on the title” at the county recorder’s office, providing public notice of your equitable interest in the property.
• Critical Function: This prevents the Seller from selling the property to a third party or obtaining further financing against it without your knowledge. It is a non-negotiable protective measure.

1.3. Ensuring Payment Control: Collection Account Agreement (Form 3.28)

• Purpose: To appoint a third-party service to collect your lease payment, pay the Seller’s underlying mortgage, and disburse any remaining funds to the Seller.
• Risk Mitigation: This is the most effective way to ensure the Seller’s mortgage is paid, protecting your interest from foreclosure due to the Seller’s negligence or malfeasance.

1.4. Additional Essential Documents:

• Lease Option Deposit Receipt (3.29): Documents the initial deposit, with a provision for installment payments.
• Add Additionally Insured Letter (3.30): Requires the Seller to add you to the property’s hazard insurance policy, protecting your financial interest.
• Notice to Renew (3.31) & Notice to Exercise (3.32): Formal letters to execute key contractual rights.

2. Structuring the Deal: Terms & Negotiation

2.1. The Purchase Price (Paragraph 8)
Three primary structures are available:

• Flat Price: A fixed amount, potentially reduced by rent credits. Simple and predictable.
• Loan Balance: The purchase price is the outstanding mortgage balance at the time of closing. This can be highly advantageous as your payments reduce the price you’ll pay.
• Pitfall Alert: A loan balance structure does not build a separate down payment for you, which may impact future bank financing.

2.2. Rent & Rent Credits (Paragraph 4)

• Rent: Aim for the lowest possible payment, ideally matching the Seller’s mortgage payment.
• Rent Credits: A portion of the rent is credited toward your down payment upon exercise of the option. This is essential for building a down payment.
• Legal Safeguard: To avoid the “badge of a sale,” ensure the agreement states that rent credits are forfeited if the option is not exercised. This reinforces the “option” nature of the contract.

2.3. The Deposit (Paragraph 2)

• Negotiate for the smallest possible deposit. Consider offering repairs or upgrades in lieu of a cash deposit, as this increases property value.
• Use the Lease Option Deposit Receipt (3.29) to pay the deposit in installments if needed.

2.4. The Term & Renewals

• Secure a term long enough to qualify for financing (1-5 years minimum).
• Critical Legal Strategy for Due-on-Sale Clauses: Instead of a single long-term lease, use a one-year lease with multiple, pre-negotiated renewal options. This structure (e.g., 1 year + nineteen 1-year renewals) is less likely to trigger the bank’s “due-on-sale” clause than a single 20-year leasehold interest. Control of renewals should rest with the Buyer.

3. Advanced Strategy: The Sandwich Lease Option

This involves becoming the “middleman” by leasing the property from the Seller and then sub-leasing it to your own Tenant-Buyer.

3.1. Securing the Right to Assign/Sublet (Paragraph 12)

• It is imperative to check the box granting the “unqualified right” to sublet or assign the agreement. This allows you to execute the sandwich strategy.
• Assignment vs. Sublet: An assignment transfers your entire interest to your end-buyer, releasing you. A sublet keeps you in the chain as the master tenant.

3.2. Payment Timing

• Structure your payment to the Seller to be due on the 10th or 15th of the month, giving you a buffer to collect rent from your sub-tenant.

4. Critical Legal Safeguards & Risk Mitigation

This section addresses the legal doctrines discussed in the Sacramento Law Library research.

4.1. Title & Lien Protection

• Conduct a Title Search: Never assume the Seller owns the property free and clear. Discover all existing liens and judgments.
• File the Memorandum of Agreement: This is your primary tool to prevent the Seller from placing new liens on the property. It ensures any new lender will discover your interest and contact you.

4.2. Ensuring Mortgage Payments & Insurance

• Never Trust the Seller with Payments: Use the Collection Account Agreement (3.28) to make payments directly to the lender. This is non-negotiable for risk-averse investors.
• Get on the Insurance Policy: Use the Add Additionally Insured Letter (3.30). In the event of a loss, this ensures you have a legal claim to insurance proceeds to repair the property in which you have an equitable interest.

4.3. Protecting Against Seller Disappearance or Litigation

• Land Trusts: The optimal solution is to have the Seller place the property into a land trust with a neutral trustee. The trustee holds the title and is contractually obligated to transfer it to you upon exercise of your option. This:
  • Protects the property from the Seller’s personal judgments.
  • Ensures a party (the trustee) will be available to sign the deed at closing, even if the Seller disappears.
• Escrow of the Deed: As an alternative, the Seller can sign a deed now and place it in escrow with a title company, to be recorded only when you exercise your option.

5. Legal Red Flags: Avoiding Recharacterization

Based on legal research, the following practices will help ensure a court upholds your transaction as a true Lease Option, not a disguised installment sale.

• ✅ DO:
  • Use two separate documents (Lease + Option Agreement).
  • Make the Option Fee a reasonable, non-refundable payment for the right to purchase.
  • Make rent credits contingent on the exercise of the option.
  • Maintain the Seller’s landlord responsibilities for major repairs and insurance.
• ❌ DO NOT:
  • Automatically apply the Option Fee to the purchase price.
  • Structure payments so they are clearly amortizing the loan balance.
  • Have the Buyer (you) pay property taxes and insurance directly.
  • Use language like “equity,” “principal,” or “loan balance.”

6. Conclusion

Buying on a lease option or lease purchase is a powerful strategy that requires a disciplined, legally-informed approach.

By utilizing the specific agreements outlined, negotiating favorable terms, and—most importantly—implementing the robust legal safeguards against payment default, title issues, and judicial recharacterization, investors and homebuyers can leverage these tools to build wealth and acquire property with significantly reduced risk.

Always consult with a qualified real estate attorney to ensure all documents and strategies are compliant with local and state law.