Post by Chuck Braxton, REALTOR® GRI, Roche Realty Group, Inc.
We are entering a real estate market where buyers and sellers of residential property may be more likely to consider offers structured as a lease-purchase. This article provides an overview of the lease-purchase transaction, the possible benefits for buyers and sellers, and the role of the real estate professional in it.
A lease-purchase or more formally a “lease with option to purchase” is a lease combined with an option to purchase the property at an agreed sales price within a specified period, typically two years or less.
Contract Features of a Lease-Purchase: A lease-purchase has six major provisions.
• Sales Price
• Option Period
• Monthly Rent
• Option Fee
• Security Deposit
• Option Premium
The sales price of the home and the monthly rent are market-determined yet are subject to negotiation just as in a typical purchase or rental transaction. The basis for the sales price may be a comparative market analysis (CMA) or an appraisal. The monthly rent typically has some relationship to what the loan payment would be on the sales price or to the seller’s carrying costs for the property. In general, when the option fee is higher, the rent can be lower. Rent excludes utilities and services such as lawn care and removal of snow and trash that would be the buyer’s responsibility.
The buyer pays the seller an option fee, 2% to 5% of the purchase price, which is credited to the purchase when the agreement is signed. The buyer also pays an option premium along with each monthly rent payment that is also credited to the purchase. If the purchase option is not exercised, the seller keeps the option fee and the option premium.
As with any kind of financial contract, lease-purchase transactions can be structured so that all of the benefits flow to the seller or to the buyer. However, since a lease-purchase has a solid economic rationale, it can be a win-win situation for both parties.
Under New Hampshire law, the security deposit cannot be more than one month’s rent and does not necessarily have to be in an interest bearing account. The lease-purchase contract might provide that the security deposit would be refunded unless the buyer elects to credit it to the purchase price at closing.
The option period, option fee, and option premium are balanced to meet the needs of both parties. Let’s examine the reasons why buyers and sellers might consider a lease-purchase transaction.
Buyer Motivations to Consider a Lease-Purchase
Buyers enter a lease-purchase transaction for several reasons. Here are some typical buyer profiles. Professional employees who are relocating and who do not have generous relocation benefits may find the lease-purchase is a way to buy a home while absorbing the added one-time costs of relocating, and, once settled, the buyer will be in a better financial position with lenders. In these cases, buyers also save the cost and hassle of moving twice.
Many buyers have property to sell outside the Lakes & Mountain Region of New Hampshire in order to buy here. Or, buyers may have timing issues regarding the sale of a property that affect their ability to purchase now. These buyers are typically interested in properties here priced in the range of $350,000 to $800,000 or more. Since buyers know that seller’s are unlikely to accept an offer contingent upon sale of the buyer’s property. Thus, a lease-purchase transaction can create a way for both parties to move ahead.
Another group is buyers, typically making a job-related move to the Region, who had been considering rental properties. Using a lease-purchase can provide an inventory of properties in better locations and with more features than what may be available in the long-term rental pool in the area. Looking at properties priced at $300,000 or less, these buyers might have settled for an expensive but unsatisfactory rental unit. Thus, a seller willing to consider a lease-purchase can access this pool of potential buyers.
All buyers considering a lease-purchase should consult with a mortgage lender at the outset to obtain detailed guidance. The lender may have suggestions on structuring the lease-purchase agreement so that fits the buyer’s situation and the lender’s underwriting criteria. This information should be fed back to the real estate professional preparing the offer or, better yet, have the agent and lender talk directly.
Even though the option fee is non-refundable, the right not to exercise the option may also have value to some buyers. If there are changing professional demands on the buyer or something wrong with the house, the neighborhood, or the neighbors, the money left behind on a lease-purchase is smaller than the costs of an outright purchase followed by a sale within two or three years.
Seller Motivations to Consider a Lease-Purchase
While most home sellers want a cash sale, for those who are prepared to hold onto their property for a while longer, the benefits can be compelling.
For example, consider a seller who has a property that is appealing in many respects but may be underdeveloped compared to the value of the underlying lot. In such a case, the seller may face difficulty in having the property appraise for the asking price. When the property fails to appraise, the buyer in a conventional purchase contract can exit the transaction unless the seller agrees to accept a lower purchase price that is in line with the appraisal. The lease-purchase provides a way to realize a higher price while buyers to get the property they want and build equity. The change in the buyer’s position benefits the seller so a longer option term can be an advantage to both parties.
A changing market can be another reason for sellers to consider a lease-purchase. Whenever the market shifts from a sellers’ market towards a buyers’ market, there are more homes for sale, time on the market increases, and perhaps the cost of home mortgages goes up reducing the purchasing power of buyers and, thus, the number of buyers in the market. The lease-purchase can broaden the market and reach buyers who are on the sidelines while being less risky than a straight rental because of the option fee and rental premium.
The Role of the Real Estate Professional in a Lease-Purchase
Buyers and sellers should seek a real estate agent equipped with the tools and the team to evaluate, negotiate and structure a lease purchase transaction. Tools include (i) financial spreadsheets that illustrate the affects of various terms over the life of the transaction on the buyer, the seller and the real estate agencies involved and (ii) a term sheet to communicate and negotiate the essential provisions of the transaction. The tools work hand-in-hand with real estate legal counsel available to the seller that is experienced with lease-purchase transactions and the needs of mortgage lenders for such transactions.
From the seller’s viewpoint, most listing agreements do not adequately cover a lease-purchase transactions, so it is likely that the listing agreement will need to be amended to ensure that the services and compensation under a lease-purchase are thoroughly covered and to parallel the specific terms of the lease-purchase including an extension of the listing agreement through the end of the option period.
When sellers want the listing agent to proactively promote lease-purchase of their property in the marketplace, the listing agreement can be amended broadly to cover terms such as seller’s constructive receipt of the option fee, extension of the listing agreement through the end of the option period, and other model terms. In addition, a rental listing agreement should be executed to incorporate terms regarding the definition of the monthly rental rate, property rules, and security deposits.
Once a lease-purchase agreement is in place, the major services that the real estate professional and agency provide will include escrow, collection, and accounting services to monitor the lease-purchase agreement. Since the listing agency is deferring its compensation until the option is exercised, part of the commission earned may be paid out of the option fee and rent premium or a sizable portion of the option fee may be held in escrow by the agency.
About the Author: Chuck Braxton is a REALTOR® with the Meredith office of Roche Realty Group, Inc. He has applied his 25+ years of experience as a business executive to the challenges facing sellers and buyers of real estate in the Lakes & Mountains Region. His website is www.ChuckBraxton.com . Mr. Braxton may be reached at 603/677-2154 or toll-free at 800/926-5253 ext. 342 any time of day or evening, or by email at email@example.com.