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PROS AND CONS OF USING LEASE-OPTIONS TO BUY REAL ESTATE
by Bob Bruss

Borrowers use newspaper classifieds to their advantage

A few weeks ago I sat next to a businessman on an airline flight who told me he was moving with his family to take a new job. After we exchanged a few pleasantries and answered the usual "What business are you in?" question, my new friend said he was having difficulty finding a home to buy in the neighborhood his wife likes.

My reply was: "Are there any houses for rent in that area?" He said there were several but he and his wife want to buy rather than rent.

Then I suggested they consider leasing a house with an option to buy. "What's that?" he replied.

Having used lease-options to buy and sell houses and condos for many years, including my current home, I felt qualified to explain the lease-option pros and cons. Perhaps you might also enjoy learning why lease-options are always in very strong demand from buyers, and how a lease-option can be used to "sell" virtually any home.

WHAT IS A LEASE-OPTION? Most people are familiar with automobile leases, as more than 50 percent of new car transactions are now leases rather than sales.

At the end of the automobile lease period, typically two or three years, the lessee has an option to buy the car. During the lease, the "tenant" gets to test the car and see if it meets the driver's needs. At the end of the lease, the lessee can either return the car to the "landlord"dealer or exercise the option to buy the car.

Real estate lease-options are very similar, except the dollar amounts are larger.

Such realty transactions are a combination rental, sales and finance for a fixed term, such as one year, three years, five years, or longer.

The longest lease-option I have negotiated, as the buyer, was for 15 years. But I have heard of commercial lease-options as long as 45 years. However, as a lease-option realty seller, I prefer one year lease-options so I can "adjust" the monthly rent and the option purchase price annually.

EXAMPLE OF A LEASE-OPTION. Although I've been involved in many lease-options, my best one was for 15 years. I was the tenant-buyer. You didn't expect me to tell you about my worst lease-option, did you?

Several years ago, a local residential real estate broker phoned to ask if I (1) was interested in a lease-option on a nice three-bedroom, two-bath house and (2) if I could act fast because his client was anxious to return home to Sri Lanka. We agreed to meet the next morning at a nearby coffee shop.

The broker suggested I prepare a lease-option offer, along the guidelines he outlined, so we could discuss it with the owner. As I filled in the blanks on the printed lease-option form, the only non-issue was the $125,000 fair market value option price the owner insisted on receiving.

My next issue was the lease-option term. Having been cut-down on my previous 10-year lease-option offers for other houses to five years or less, I was thinking big when I filled in 15 years.

Next, I decided to offer the owner $500 per month net rent. I agreed to pay his monthly mortgage payment, property taxes, insurance, and all necessary repairs. I also agreed to prepay one year's net rent of $6,000. Also, I needed the right to sub-lease to a tenant.

When I got to the line on the lease-option form for the rent percent to be credited to my purchase price when I exercise the option, I filled in 50 percent.

As for the realty broker's commission, I agreed to pay half up-front and the other half if and when I exercised my purchase option.

The meeting went smoothly. The only debate was about the rent credit. Neither the broker nor I recall how we agreed on the odd number of 17 percent. The owner and I signed the lease-option, the broker agreed to arrange title insurance (at my expense), and a few days later my lease-option was recorded.

Thirteen years later, I elected to exercise my $125,000 purchase option. By then the owner had died of a heart attack and I acquired the title from his heir in Hong Kong. But that's another story. Yes, the broker then received the remainder of his commission.

WHEN TO USE A LEASE-OPTION. There are always more lease-option buyers than sellers. Buyers understand the benefits. But most sellers don't understand their equal or greater benefits.

Prospective buyers, such as my airline friend, understand the "try before you buy" benefits, just as auto lease-option lessees have enjoyed for many years.

But lease-option property owners often don't comprehend what their benefits include: continued income tax deductions such as mortgage interest, property taxes, and rental depreciation. If the option purchase price terms annually "adjust" to reflect rising property values, the seller can benefit from increased market-value appreciation, too.

Additional lease-option benefits for sellers include an over-supply of eager lease-option buyers; lease-option tenants will pay higher-than-market rent in return for the rent credit toward the purchase price; tax-free, up-front option money until the option is exercised; lease-option tenants will pay top dollar; and the lease-option future owner tenant usually treats the house or condo extremely well.

HOW BUYERS VIEW LEASE-OPTIONS. At the closing table a few years ago, a couple who bought their rental house from me on a lease-option revealed how they viewed their five-year residency before I practically forced them to exercise their option.

The wife said their $1,500 per month rent seemed high, but she and her husband considered it as $1,000 very reasonable monthly rent, plus a $500 "forced savings account" for their rent credit toward the purchase price.

Lease-option buyer advantages include (1) up-front "option money" is smaller than a typical down payment, (2) lack of mortgage interest and property tax deductions are outweighed by the "forced savings" rent credit (typically 10 percent to 100 percent of rent paid), (3) the buyer can try out the home before buying, (4) the option purchase price is locked-in for the specified term, and (5) the buyer can move in within a few days after signing the lease-option.

HOW TO SELL HOMES ON LEASE-OPTIONS. Although most local home sales markets are currently quite strong, there are pockets of slow home sales. Whether you are a home seller, builder, or realty agent, a delayed lease-option sale is better than no sale. Lease-options work in all price ranges, especially when there is little cash buyer demand.

My most effective lease-option newspaper classified ad is headlined "$10,000 MOVES YOU IN." Of course, change that amount up or down for your situation. Then describe the house or condo benefits, the monthly rent, and key words "Rent to Own" or "Lease-Option."

Saturday and Sunday advertised open houses usually provide quick results. Be prepared with at least 100 information sheet flyers describing the home with an attached rental application form.

It's best to insist on a $500 or $1,000 deposit check from serious prospects. Owners should then run credit checks on all lease-option applicants before selecting the best qualified.

HOW BUYERS CAN CREATE LEASE-OPTIONS. But most cities have few or zero lease-options advertised. However, prospective lease-option buyers can create their own by (1) reading the "homes for rent" classified ads and offering a lease-option when you find a house or condo you want to eventually buy, or (2) running your classified ad under "homes wanted," such as "Executive needs 3 BR, 2 BA home on five-year lease with option to buy. Excellent references. Call Bob at 555-5555."

SUMMARY: Lease-options offer major benefits for home sellers, buyers and realty agents. More details are in my special report, "How to Profitably Use a Lease-Option to Buy or Sell Your Home or Investment Property," available for $4 from Robert Bruss, 251 Park Road, Burlingame, CA 94010 or by credit card at 1-800-736-1736 or instant Internet download at www.bobbruss.com.