LEGAL NOTES

Recent events in the financial and Real Estate markets have caused many hopeful buyers to experience difficulty in obtaining loans and many desperate sellers to settle for less because they need to get out of their homes. The lease-to-buy option can help alleviate these issues.

The Bush administration recently proposed a plan for a $700 billion bailout of financial markets, causing a backlash from lawmakers on Capitol Hill, who were concerned about the potential costs to taxpayers. The ensuing bailout controversy is a painful reminder that our Real Estate market continues to be hampered by today’s foreclosure crisis. Because so many banks were burned after large numbers of subprime loans turned into foreclosures, they are reluctant to issue loans—even to qualified borrowers. As a result, many people want to buy and sell homes, but find it hard to do so because they cannot get a loan or find a buyer who can get a loan. Fortunately, there are creative options that can help during this trying time. One growing trend is the lease-to-buy option, which is a type of contract that allows potential buyers to lease the property and, at the end of the lease, they are given the option to purchase it.

The lease-to-buy option can be beneficial for buyers and sellers alike. Potential buyers who are turned down for loans use the rent-to-own option as an opportunity to boost their credit and to give them time to save more money for a down payment while preparing for homeownership. Other buyers embrace this option because they are unsure if now is a good time to buy, and do not want to enter a risky housing market. The lease-purchase contract gives buyers the opportunity to take a step toward homeownership without fully committing on the timing.

When the Real Estate market is hot, lease options are few and far between because sellers do not need them. However, in slower markets, lease to buy options are attractive to sellers who are highly motivated to sell. It is critical, especially to sellers, that an actual written lease with terms and conditions be executed and agreed upon. Moreover, the rules, a security deposit, and the length of the lease should be spelled out and agreed upon in a written lease. I have seen terrible results when this was not done, or where the transaction did not involve a lease (sometimes these alternatives are called a “contract for sale”; other times an “all inclusive trust deed”). In my opinion, the best way to structure future ownership to protect both buyer and seller is via the lease option. Every step the participants take away from this type of arrangement is a step closer to a problem that can impact title and possibly result in a lawsuit.

In a lease-to-buy option, there are three main deal points: price, option details (time and manner to exercise the option), and down payment/credit toward closing. There is no absolutely “right” way to do such a deal. Many parts of it are open to negotiation. And, of course, the elements of a traditional sales contract apply and need to be dealt with after the buying option is exercised. In this market, the most important detail is whether the sale is contingent upon the buyer obtaining financing, and/or whether the property appraises.

There are several options when dealing with price. At the beginning of the lease, the seller and potential buyer can agree to a set price at which the property will be sold during the option period. Alternatively, they can agree that, upon the exercise of the option, a sales price will be based on an appraisal. Thirdly, a floor and ceiling price can be set, and the parties negotiate within that range when the option is exercised.

It is in the best interests of both the buyer and seller to contact an expert to determine and outline the sales price. For example, if a buyer agrees to purchase a home for $300,000 and during the lease period home prices drop to $250,000, the buyer may be stuck in a situation where a lender will not lend the full amount. On the other hand, if the property prices increase in value, the buyer earns instant home equity. Some of this requires a crystal ball and can be problematic if one side thinks it “won” and the other thinks it “lost.”

We had almost a dozen specific performance litigations that we reviewed, and half of them were taken to court during the crazy run-up in home prices in the first quarter of 2004. Sellers who had agreed to a lease-option price that was much lower than the property was then worth took wild steps to try to get the option deal not to close. Some of those folks crossed the line, or even flatly refused to close the option deal—at least until we had a court order them to do so.

The second consideration is the period in which the buyer must make an offer with a nonrefundable option payment from the buyer. From the seller’s perspective, it is very important that this money NOT be characterized as “earnest money” to be applied to the sale of the property. Usually, the buyer will have the right to buy at any time during the lease period. To allot for a reasonable escrow period, most often I require the option to be exercised in writing at least 60 days before the end of the lease.

Perhaps the most creative area for negotiation of these deals is the down payment/earnest money once the option is exercised. Some buyers want some or all of their rent or the option payment to be put toward the agreed-upon price. There is some risk to the seller to do this as a tenant can be magically changed into an unhappy person with an equitable claim to title in the property pretty easily if this is not handled right. Also, there are possibly tax consequences to the seller, depending on how things are characterized (these are beyond the scope of this article).

One potential trap I’ve seen in Nevada for sellers is the Seller’s Real Property Disclosure Statement (SRPDS). If the property has been a rental, does the seller really know its condition well enough to sign off on the SRPDS? In most cases, probably not, which means the seller should insist that the requirement be waived, as allowed by the statute. After all, the buyer who is living in the house is in the best position to know its condition. Still, just as in any purchase, during the due diligence period it is important for the buyer to conduct a home inspection in order to document the condition of the property, and to discover any defects or problems that were latent during the rental period.

As with any Real Estate deal, it is always a good idea to enlist the help of qualified Real Estate professionals to help ensure that the process is seamless and that all concerns are identified and understood. Specifically in a lease-option, both buyer and seller should also be represented by competent Real Estate counsel.

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Disclaimer: The above is not intended to be, nor is it legal advice, and should not be relied upon for any reason. Even though this article maybe disseminated throughout the U.S., the material covers only Nevada law, and no other. E RealEstateExec and Exec MediaGroup, LLC expresses no opinion on any other state's law, nor about the handling of any particular legal situation. You should consult your attorney, accountant or business advisor before undertaking any action. No attorney-client relationship is created between E RealEstateExec, Exec MediaGroup, LLC and the reader.