Lease Options, Lease Purchase Agreements & Installment Land: Fill & Download for Free

You may be referring to a lease that contains a "guaranteed" option to purchase, usually at a specified price, as opposed to a "right of refusal" or other purchase option structures contained in some leases.

The correct and more specific term is “lease-option.” Many people say “rent-to-own,” but that’s not as precise and could mean several different things.A “lease-option” gives the tenant-buyer the right—but not the obligation—to purchase the unit within a specific time frame for a specific amount of money. It also generally specifies the amount of rent, if any, that will be credited to the purchase price.“Rent-to-own” can be either a “lease-option” or a “lease-purchase.” A lease-purchase is what’s called a bilateral agreement: The owner must sell the property and the tenant buyer must buy it. There’s no option. It’s basically a delayed purchase.There’s nothing really wrong with a lease-purchase. Sometimes that’s the best choice. Sometimes (more often, in my opinion) a lease-option is the best choice. But, returning to your question, the term “rent-to-own” doesn’t make clear what the arrangement is.

I’ll assume you’re talking about residential properties. In that case, it’s equally applicable to single-family homes, townhouses, and condos.First, though, there’s a difference in lease-purchases if you’re going to live there (presumably, then, the goal is not as an investment but rather as a residence) or if your primary strategy is as an investor. I’ll first describe the mechanics for someone who’s going to live there . . . then add on the additional information if you’re an investor.Note that there’s a difference between lease-options and lease-purchases. In a lease-option, you lease the property and you have the option (but not the obligation) to purchase the property. In a lease-purchase, you are leasing the property and have committed (often with a completed purchase agreement) to purchase the property. That’s a big difference.In a lease-option, there’s typically an up-front option fee. It’s not a down payment; the fee is paying for your right to buy the property. In a lease-purchase, there may be an up-front down payment on the purchase. All the elements are negotiable, but the option fee often is 2%-4% of the agreed-upon purchase price of the property. The down payment in a lease-purchase usually is higher, just as a regular down payment on a property would be.The option will specify how long it runs (2–5 years, typically) and the purchase price if the tenant-buyer exercises the option. The purchase agreement in a lease-purchase obviously includes the purchase price; it also specifies how long the agreement is good for—when the property must be purchased.The lease in the two cases are similar. It’s a lease that runs (usually) the same amount of time as the option or purchase agreement. In the case of a lease, though, it may be shorter; for example, you might have a 1-year lease renewable at the tenant’s option for—say—4 years in the case of a 4-year option. An investor will want the option to run longer than the lease.Often, in the case of a lease-option, a portion of the rent is credited to the purchase price or closing costs if the tenant-buyer exercises the option. It’s all negotiable, but a $1,500 a month lease might credit $150-$250 of that amount to the purchase price…again, if the tenant exercises the option.Usually, depending on how the documents are written, the tenant-buyer has the right to purchase at any point up until the expiration of the option or the purchase agreement.So that’s how a lease-option or lease-purchase works.But an investor really doesn’t want to rent and live in a property for several years until he/she buys it. So there are two basic ways an investor makes money on the transaction.Buy the Property and Offer It as a Lease-OptionIn this case, the investor actually buys the property up front. He/she usually does some rehab on it, then advertises for a tenant-buyer.Example: He buys the property for $100,000 and puts $15,000 into a rehab. The property is actually worth $140,000 on the open market—not really enough for the investor to “flip” the property. So he offers it as a lease-option. Maybe a $10,000 option fee, a purchase price of $160,000, a 3-year option, and a lease of $1,200 with $150 credited to the purchase price. All the numbers are a bit too complex to go into. But, in brief, the investor receives $10,000 up front, reducing his investment to $105,000. Very crudely, he’s getting $1,200 a month from his $105,000 investment, for a return of 14%. If the tenant-buyer exercises the option, the net to the investor will be $144,600 (subtracting the $10,000 option fee and the $5,400 in rent credits). The investor’s cost was $115,000, so the profit is $29,600. Not great, but maybe acceptable.Sandwich Lease-OptionIn this case, the investor lease-options the property from the owner. He then turns around and finds a tenant-buyer to lease-option it to. (The numbers will be similar, but the type of property might be different.)Example: The property is worth $140,000 on the open market. He lease-options it for $115,000 from the owner (whose main motivation is a steady rental income) and signs a lease to pay $800 a month. $150 is credited to the purchase price. He pays a $100 option fee. He finds a tenant buyer who will put up a $10,000 option fee, rent it for $1,200 a month, and agrees to a purchase price of $160,000. $150 a month is credited to the purchase price.The investor initially makes $9,900 on the option fee spread. He makes $400 a month on the rental spread. The rent credits are a wash. If the tenant-buyer buys, the investor exercises his option to buy, then sells or transfers the property to the tenant-buyer. The spread in the purchase prices ($160,000 minus $115,000 equals $45,000 minus the tenant’s $10,000 option fee) is $35,000. There are a lot more moving parts to a sandwich lease-option, but in this case the investor hasn’t had to purchase the property.The investor could have gone into the deal with the owner using a lease-purchase, though a lease-option would have been more desirable. Similarly, the investor could have signed a lease-purchase agreement with the tenant-buyer.So: That’s how lease-purchases and lease-options work with in real estate investing.