In real estate investing, as complicated as it can seem, there are mostly two options: Buy and sell or buy and hold.
It can be argued that those are the same two options for any sort of investment. Stocks, for example, can be bought low and sold for a higher dollar amount. Or they can be held for long-term appreciation and for dividends collected along the way.
But there might be an avenue for residential real estate investors to kind of combine the best of both worlds — to reap the advantages of buying and selling, plus gain the advantages of holding real estate in a portfolio.
And that avenue might be the lease option.
“Lease option” is the legal term for what is commonly known as “rent-to-own,” which sometimes has a negative connotation because the rent-to-own industries outside of real estate have been viewed by some as exploitative.
But in real estate, a lease-option is just what it sounds like: a lease with the option to buy.
In real estate, the lease-option is a legal instrument between the investor/seller and a tenant/buyer. It involves a lease with a monthly rental amount due, but it also includes an option to buy — for a predetermined price — at any time during the agreement.
Typically, lease-options include a rental credit that goes toward the purchase of the home. If the tenant-buyer pays the rental amount due each month, a portion of that rental payment is credited back should the tenant-buyer exercise his or her option to purchase the property.
This arrangement has plenty of advantages for the owner of the property under the lease-option agreement. Those advantages, in a nutshell, include:
Higher monthly rents: Because a portion of the rent paid is to be credited to the buyer at the time of purchase, the owner of the property can typically demand monthly rent higher than the market norm.
Greater tenant responsibility: If a rental is structured as a lease-option, the tenant (buyer) is operating under the assumption that he or she will eventually own the property, which means he or she might be more willing to take good care of it.
On-time rental payments: If structured properly, a lease-option arrangement can include the provision that the amount of rent credited toward purchase is only applicable if the rent is paid by a certain date each month. The tenant has a big incentive to pay on time.
Prearranged sales price: The owner of the property can build in expected appreciation and be guaranteed a bottom-line sales price years in advance.
A typical lease-option period is one to three years. The tenant signs a lease, including the higher-than-market-average rental amount and agrees to a purchase price set in advance. An investor might write the lease-option on a home worth $100,000 to be sold to the tenant-buyer in three years for, say, $115,000, thereby guaranteeing the sale of the property for more than its original purchase price.
In the meantime, during the three years, the tenant will be paying above-market rent each month. Even if the monthly credit is achieved every month, reducing the sales price or contributing to the buyer’s down payment, the investor is likely to get more out of the property than it cost. That’s a version of the “buy-and-sell strategy” that many real estate investors aim for.
The buy and hold advantages are realized in regular rent payments each month. But instead of collecting positive cash flow and having to manage the property indefinitely, the investor has an
Lease options, blending the buy-and-hold and buy-and-sell strategies of real estate, might be the best of both worlds for the real estate investor who plays his or her cards right.