I have done lease options for over 40 years and that’s a long time. I learned about options in general from the book “Nothing Down” with Robert G Allen.
It was the mid-80s and interest rates were high and I learned a lot about seller financing and wraparound mortgages because the interest rates were so high.
No one really taught me what a option was and how valuable they were until I learned it from Jack Miller. His Advanced Options Course is amazing. Jack Shea and Jack Miller really had opened up my eyes as far as what is truly possible using Options in Real Estate Investing.
This article is going to lightly touch on what I’ve learned from an attorney Mark Ward and Jack Shea. They always look for solutions for Real Estate Investor. They’re always careful about the law and careful about the taxation.
So let’s keep it simple and talk a little bit about what an option to purchase is.
I spent a lot of years in financial services so we had to understand basic contracts.
An option contract is a one-way contract or unilateral contract. It’s one way. Gets something from the other the other person doesn’t get anything.
So if somebody gives me an option to purchase a property at a price of $100,000, and I have 12 months. They can’t sell it to anybody else. And if I’m smart, I will cloud the title so that he can’t sell or re-mortgage the house for that year.
So let’s talk about options.
An option is a way to secure an uncertain financial position in the future for a payment of a fixed sum in the beginning today. The payments not refundable and it’s not taxable to the seller until the due date. The legal term for money down is consideration,
Required for a valid option, it can be a lump sum or an installment payment or actually performance on a lease not money. So just remember consideration being some valuable consideration.
An option can take a lot of the risk out of investing in real estate. Many things can go wrong, the market value of the property can decrease or new zoning can come in . So you’re betting on the future by putting a small amount of money in during the present, versus buying the entire property.
I remember learning about options by being in financial services, helping people with their retirement planning. And that experience helps me a lot with private lending and joint venture partners. In the stock market I’d put in a call. Call Option of stock is , traded on the stock exchanges currency options or commodity hedging power futures, and many exotic derivatives have been advised by the market to control the product at a minimum cost for maximum reward, so just think of an option as a small amount of money to control something.
So options have been around for hundreds and hundreds of years and they’re in the tax law and the tax code.
Quoting Jack Shea, “options can be private, portable, invisible, silent, salable, exchangeable, option, assignable, mortgageable, and many other features not found and other types of real estate investments. “
I think Real Estate options presents some wonderful benefits for very little money and high leverage.
So what if you lose a few dollars with what you paid for the option and some time and effort.
There’s no cheaper way to
- control real estate and
- it’s appreciation and i
- it’s cash flow and
- it’s mortgage buy down and
- it’s tax benefits and
- it’s use and occupancy when you combine it with the lease.
When you give an option, you don’t have a lot of risk to yourself and option could be canceled or just ignored.
The use of a purchase option can capture all the ownership rights and with fully executed and escrow documents. The seller of the property that you have an option on, cannot cancel the agreement. It’s locked up.
Foreclosure would be required to eliminate the option is rights.
To protect yourself though, use a memorandum to move option and record it against the title of the property so this is seller cannot sell and cannot remortgage the property without your permission.
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Now everybody heard of “rent to own” where you lease with an option to a tenant.
There are right ways and wrong ways to do this.
I have heard a lot of people talk about “Leasing To Buy” and have the tenant(s) do maintenance. That’s not a good thing to do.
You have to obey the landlord tenant law.
And once you have a tenant do something that’s outside the scope of landlord tenant law, like making improvements on property, you are creating perhaps a “disguised sale”. This could be a disguise sale on just a tag spaces, where the IRS Court would say it’s not a legal lease option. So you have to be careful.
There is a legal issue when you hand somebody an option. They have a legal interest in that property. It’s not the same as having an interest in a lease.
It’s about having equitable interest in the property. And if you go to court, and the judge says “well, you gave this person equitable interest in the property.”
They may require or foreclosure to get the tenant out of there.
Because now they have an option to purchase. I know that sounds confusing, but I worry that a landlord has a legal problem with the person that’s in the property.
For 20 years, I never to give an outright option.
I give a different kind of contract.
It’s called a “contract for option”, which does not convey any property rights, until the agreement is complete.
This contract position does not have to be foreclosed.
I can regain the property with an eviction if the lease is not followed.
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Now, there’s another tool that we use called Land Trust where we can “assign beneficial interest” of a land trust.
Similar to a contract for option, we use a contract for beneficial interest of a land trust.
And it does not require a foreclosure to regain possession of the property if it’s done properly.
Again, my thanks to Mark Warda and Jack Shea for teaching me how to do these transactions and how it protects me as the Real Estate Investor.
Mark Warda and Jack Shea call these “virtual options”.
They are more or less standard contracts, but they’re all fully described and fully disclosed to all parties.
So I like the term “Virtual”, it means existing in essence or effect, though not an actual factor form.
Virtual contract options aren’t any scheme or trick.
They are exactly what is written in the document and it is fully disclosed to all parties.
Let’s look at how the virtual lease purchase option works.
Lease purchase option contracts is what it says, and that is the lease and a contract to purchase the property.
The terms of the lease and the purchase contract are clear and thorough and exact.
The lease purchase can convey the burdens and benefits of ownership if desired, or can leave some of these hallmarks to the seller if desired.
There are different levels of ownership; purchase can be on one side of the equitable title dividing line as the parties can choose. By including all of the tests of ownership, the document can deliver equitable title to the option and with the benefits and advantages of ownership, which also carry some of the burdens of ownership .
Always benefits and burdens.
Next look at a contract option.
This is where it can be any or many kinds of leases and a separate contract for option. This is not an option, as it does not convey equitable interest, and it states that it’s not an option in the beginning of a contract, but “a contract to deliver an option” at the end of a fixed number of payments or the lease term or a time set by the parties.
The purpose of this “virtual option” is to protect the party with the greatest equity in the contract and that is the lessor. This is to avoid passing equitable title to the tenant.
