Thought About Lease-to-Own Transactions?

By Robert Freedman, Senior Editor, REALTOR® Magazine

The news on housing has been good lately, with existing-home sales up for the last several months, but we’re still in a very difficult market, particularly with move-up homes. Not only have prices not recovered but financing remains a challenge and appraisal issues continue to pose hurdles to getting transactions closed. One quick look at the comments generated by our post a few days ago on the home valuation code of conduct (HVCC) makes that evident. (More than 135 comments have been submitted so far.)

For these reasons and more, it makes sense to start looking at lease-to-own transactions. In putting together a webinar on that topic to be held later this month, I talked to two specialists in the niche and what they had to say was eye-opening.

One of their main points was this: even though the market is recovering, the long-term trend points to a continued tough climate for borrowers. Households with less-than-stellar finances that could have obtained financing three years ago won’t be able to count on getting financing today or tomorrow despite improving conditions.

Given this, you might be tempted to say, “Fine, I’ll just work with households that I know can qualify for financing. Anyone else will be a waste of time — theirs and mine.”

But can you afford to write off such a large portion of today’s households, especially since these households still need housing?

This is where lease-to-own transactions come in. Structured right, they can get you immediate income from handling the rental part of the deal today and put in place a structure for generating later income as they move from renter to buyer tomorrow.

The key is in structuring the deals right, though. Lease-to-own transactions can be complicated. There are different ways to structure compensation. You need to get your documents right so each month the proper amount of money is credited toward the purchase. What do you do if the owner goes into foreclosure? Does the lease-to-own tenant have any options?

It’s complicated but not unreasonably so. If you think the lease-to-own niche is worth exploring, you might find the upcoming Webinar, which is free, helpful. It’s Thursday, August 27, at 3 p.m. Eastern Time. The two presenters are Brett Furniss, broker-owner of BDF Realty in Charlotte, N.C., and Wendy Patton of Limitless Options in Clarkston, Mich. Both are veterans of these kinds of deals and authors of books about doing them right.

Hre’s a link to the webinar registration page. It provides more details on them and what they’ll cover.

Robert Freedman

Robert Freedman is director of multimedia communications for the NATIONAL ASSOCIATION OF REALTORS®. He can be reached at rfreedman@realtors.org.

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Comments
  1. Dan Cornett

    Lease-to-own is an old concept that many young hope-to-be buyers have in their vocabulary because they have been suckered into the rent-to-own furniture deals. We have seen how these furniture scams have cost these young people hundreds or thousands of dollars on poor quality household items. Our recommendations to these people whenever we can offer our advice, (which probably goes in one ear and out the other) is build up your credit, don’t take on more than you pay, go to garage sales, be a scrooge with your spending, be willing to buy and live in something much less than your parents own, later buy up as your resources dictate.
    All of us can live simpler and be just as happy. Many of us expect too much, and want it now. If this economy is to ever recover, our younger families will have to change some terrible spending habits and social and moral habits. Eat healthy meals at home, drive cheaper cars, stay out of clothing stores, be frugal with cell phone costs, TV costs, going out. Get to know your neighbors, stay with a job, and above all else, get an education. Oh! I almost forgot, If you need a hero, and it can’t be your parents for one reason or many, for God’s sake don’t use a rock star, football player or movie star to worship. Maybe you should visit a nursing home and talk to some of the residents who still have their senses (there are many who still do) and find out about their backgrounds. They would make an excellent role model.

  2. With as many foreclosures that there are, I always advise people not to go this route. I always advise to rent.

  3. Vanessa Morales

    I agree with Dan above. I thank him for telling it like it is/being realistic. Many renters are still under the wrong impression about buying a home and the responsibility that comes with it, so I’m not sure that rent to own is the best choice, especially for first time buyers.

  4. I agree we are about to be flooded with a lot of unfortunate folks wanting to “Rent to Own” I personally will not get involved in any transaction that is not a clean Owner finance, where the seller is Selling a paid for home. All these Texas Wraps are quasi legal scams…
    The Buyers will be burnt and the realtors too.

  5. Sherry Stoppelbein

    I own 3 commercial acres with 3 commercial buildings and am wondering lease to own
    deal for one of our leasees. I want to know the benefits and downsides of the arrangement for us. We were thinking that with a decent deposit he could purchase the property thru lease to own and not cost him anymore than he is paying now. the other 2 buildings are leased as is some of the property for equipment storage.
    Sherry Stoppelbein

  6. I’ve never handled one but I am also hesitant to recommend lease/purchase to a buyer. I might consider it if the seller were really building up a “kitty” for future down-payment and/or closing cost use. But an upfront, non-refundable deposit would signal a large red flag. Also anything with rents more than 10% above market comps seems to be quite the scam. And how do you handle repairs/maintenance/upgrades in the mean-time?

    Our local board doesn’t supply us with a template lease/purchase agreement and urges us to have our lease/purchase buyers consult their own attorney. I find the odd. It seems as though lease/purchase buyers are pretty unlikely to have attorney relationships in the first place. Also, the cost to hire an attorney to draft your contract would be exorbitantly high for this type of buyer.

    I’m interested to hear your webinar recommendations regarding the compensation aspect.

  7. I have successfully completed a lease to own transaction. It helped the seller move on and the buyer was able to get the home that they needed. This occurred during the crazy sellers market. The buyers obtained their home inspection and were clearly cognizant as to the repairs that the home would need. They seller consulted his attorney as to how to protect his interests as well.

    I guess that I do not see this as an issue because when a home buyer obtains a home loan from a bank, they are pretty much buying (leasing) the home from the bank (seller of money to get the house as collateral).

    Because most Realtors are not attorneys, one needs to be consulted to protect both partys’ interest. I have no problems skipping the banks to help my clients. We should all be more willing to work out of the box.

  8. Todd Hawkins

    I’m a former mortgage banker and current agent. If you can afford to rent, in most cases you can afford to own or rent-to-own. Some of the commenters are assuming these are non-creditworthy borrowers which isn’t necessarily the case. One of the factors that led to the growth of non-conforming loans of all types, including sub-prime, is the increase in self-employed, or more accurately, non-conforming employee (e.g. Realtors). There are many buyers who have assets and otherwise outstanding credit profiles (not just scores) who don’t qualify for Fannie/Freddie loans. I can promise that lending is getting more restrictive and will shut out many who would otherwise be successful owners. Rent-to-own is a viable option these folks with atypical circumstances (e.g. divorce, medical hardship, period of unemployment), not just crummy scores, can get credit for paying rent and one day own. To me, they’re more committed in many ways because they have a goal and an awareness that they don’t own (yet).

  9. Lease options can be a viable and prudent option in many situations. While all of the commentary on what first time home buyers “should” be doing is probably right on, it does not mean that this structure is the problem.

    In some instances, it can offer the seller a good interim option until values are restored to a level more acceptable to them. For buyers, it can lock in a good price. In many markets (mine included), it’s pretty much a cost wash compared to a pure rental situation and “optioners” will usually take better care of a property than renters. Option money can be abused, but should be factored into the deal to create a total and periodic (monthly) cost of occupancy, which would be compared to cost of ownership for the same property.

    For example, we recently completed a lease option with a $5000 option fee on a home renting at $1400 a month with an option purchase price of $400,000 any time before 2 years. It will cost this family $21,800 or $1817 a month to live in this home as optioners exclusive of operating costs. They will add a renter’s insurance policy for about $500 a year.

    For them, it offers a far better home at a far smaller price with the benefits of ownership (exclusive of taxes) and locks the purchase price at today’s level. For the seller, it created an income stream on a free and clear property that had high upkeep and had not sold. We, the Realtors, do not collect a full commission unless the option is exercised but did receive the first month’s rent for our time, credited to the seller later in the event of a deal.

    It is not for every deal, but is a great solution to certain challenges for residential and commercial.

  10. Shelly Stradling, GRI, Associate Broker

    I have done many lease options to purchase and with regard to compensation for doing all that work up front and the term being out a ways before the close of the purchase, treat the transaction as 2. Fee for the lease and fee for the close of purchase OR split the commission wherein 1/2 is paid at acceptance and the other 1/2 paid a close of purchase OR charge a flat consulting fee for the lease portion and a commission at close of purchase OR a portion of each month’s payment could be obtained for the lease term, similar to a deferred commission scenario.

    Additional up-front “option” moneys are usually obtained from the buyer and paid to seller in consideration of seller granting the option to (accepting a lease option transaction) the buyer and most times they are non-refundable. This accomodates the seller who takes his property off the market longer than a normal purchase transaction contingent upon inspection, financing and even sale of existing.

    In a lease option if the later purchase portion of the deal does not happen then no commission is paid. We should get paid for all of the work we do. Attorneys are paid very well for their acquired education & knowledge in a little as 30 minute consultations, why should Realtors be any different. We do have access to a few good forms (attorney reviewed or prepared) for general,simple leases but they may not be suitable for more complex transactions. We always recommend parties seek legal council.

    In these types of economic conditions and the tightening of lending, owner finance transactions become more prevelant. Lease options enable the commitment and responsibility a buyer wants to give to a property when they might not be quite able to qualify for the financing or don’t have all the larger down yet that might be sought on a seller carry back. Risk to buyer is the same, loose all paid if not committed to the property & its maintenance and seller retains the asset for re-sale should the buyer default on his performance under the terms and conditions of both the lease agreement and the purchase contract.

    Lease-options are lengthy in documentation and should be very clear as to the obligations of each party. Any changes must be documented in both the lease and as an amendment to the purchase contract. Both parts need to reference each other’s terms and conditions identically to tie them together. Monthly payments are typically manageable, but buyer should expect to pay an extra fee to get a lease option. The lease should be set up in contract collection (preferred) or payments evidenced and tracked by the Broker so the accounting is is tracked through to the close of the purchase and funds paid can be appropriately applied toward the down payment.

  11. In my opinion, the risk far outways any benefit for the ‘lease/rent to own” for either the buyer or the seller excluding any liability to us . The judges in the state of South Carolina can consider this type of transaction as the buyer having an equitable interest in the property which could require a full foreclosure process to get the buyer out of the property if they did not make the payments to the seller rather than a simple rental evicition.

    If there is an existing mortgage, what happens if the seller does not make the mortgage payments or takes out additional mortgages to get equity out of the property. When the option is excercised, you find out their is not sufficient funds to pay off the loans, what are the parties going to do.

    Financing for the buyer could not be guaranteed in the future. How can anyone determine the future appraised value of the property? Since most buyers finance their purchase, most will not pay above the current appraised value.

  12. Karenina Stovall

    So, what happens when a Tenant/Buyer met up with a Realtor who is fully aware that the property is on Short Sale and Realtor did not disclose it to the Tenant/Buyer, Tenant/Buyer paid a hefty sum to keep the Lease Option to Purchase and then after having made rental payment on time, found out that the property goes into Foreclosure.

    Can Tenant/Buyer sue the Realtor for not disclosing facts about the property/Seller?

  13. LEASE/ OWN DEALS ARE GOOD FOR SELLERS WHO CHARGE A OPTION AND TAKE IN A PRE APPROVED BUYER. BUYERS BEWARE SEEK LEGAL COUNSEL IN PREPARING THIS AGREEMENT.

  14. Bob Golden

    I am a Realtor and have done lease option transactions before. My broker wholeheartedly supports them. They are a great way to find buyers in this difficult market. It’s also a great way to help sellers when conventional sales aren’t working. Let’s face it, the market is tough and we need to offer clients options instead of trying to force them into a model that isn’t working.
    I love seeing all of these negative comments from other agents because I know you are the ones turning away business and commissions so these people come to me instead.
    What’s funny is that if you read the negative comments pretty much none of them have ever actually tried to do a lease option deal. It’s much easier to be a naysayer if you don’t know what your talking about I guess. It’s fine to have concerns about how things are handled if you take the time to find out. But if you just voice those concerns as an excuse for not doing anything, myself and all of the other agents who do lease options thank you for sending more business our way.

  15. We have done several lease purchases, some with good outcomes, one with not such a good outcome (but structured so well the Seller was ok). Our offices now do not allow us to work the lease part of the transaction. We did learn very early in that we charge a flat fee up front when the lease is negotiated, because the sales contract is negotiated at the same time. If the property closes the up front fee is credited to our commission, if it doesn’t close we received payment for the time spent showing homes and doing paperwork. I agree that there are sometimes buyers are looking for more, but the reality is that if they are doing a lease purchase, and the seller does not own the property free and clear the lease payment is paying a mortgage payment (even so in rentals). To penalize a buyer because they may need 6 months to get through a lending process that has become quite complex is not fair. As REALTORS we are all independent contractors and stated income loans are non existent, we may find ourselves in a position where getting a loan takes longer than 30 days. This is not a reflection on a “have it now” attitude but is a reality of the process of obtaining loans in this market. Our policy is we do not show homes unless the client has already met with a reputable lender, we have a buying power number, and an estimated time-frame based on the application. Lenders will not begin the loan process without a contract and identified property, but we do a little more than pre-qualify, we have our lenders get a good handle on the loan situation. If we enter a lease purchase situation, we negotiate the sales contract but have the buyer and seller meet with an attorney to handle the lease negotiations and lease document. There are a lot of items to consider, being sure the seller is using the money to pay the mortgage, late payments incurred if the buyer is late with a payment, NO remodeling, painting etc. before close etc. This is best left to an attorney. If a seller is willing to do a lease purchase then as REALTORS I do not feel we have the right to make a snap judgment about a buyer’s “motive” potentially costing both a buyer and a seller not to reach their goal. This is a new age in real estate and we have to be constantly learning the options we can offer both the buyer and the seller. Our fear of something we are unfamiliar with should not become a fear we project on our clients. Our goal should be to learn and educate ourselves to the options, and be sure we have a good understanding of how we fit in the picture. Having a great real estate attorney is a necessity for items such as this.

  16. My other site is lifechangelending.com. I have been a lender for 20 years and recently
    changed to the real estate side. I found rent2own to be a very successful alternative
    provided you had a loan officer like myself who worked with the tenant through the entire process and helped them to purchase the property within a one or two year
    period. Without support and direction nothing really changed .

  17. alvara

    what are the steps to structuring a lease option?

  18. steve mincer

    after two failed lease options when the tenants couldn’t get a loan to purchase the house, and then they came back and tried to blame ME for it, i will never, ever, work any lease option deal ever again.

    i would encourage my fellow realtors to let these lease-options stay in the realm of “for sale by owners” and the weekend “get rich with foreclosures” seminars.

  19. Lease purchase are no more complicated than any other. The quirks in any deal are due to someone attempting to outsmart another party to the transaction.

  20. Linda Leymann

    What is the transaction fee at the tune of $349.00,an inspection fee of $60.00 and a commision of $900.00 for renting out Robert’s home for 1 year.The home is fully furnished and impecable as seen by the agent.The market is in the pits and my husband is upside down at this point and this home belongs to my husband Robert Augustyne and has moved in with me besides as recently being married as to not give the place away.The realtor told us there was a high demand for rentals.Two dead end inquires.This is “blowing smoke”.Please advise.Linda Leyman Augustyne

  21. Paul Davidson

    Great article. Thanks for the info, it’s easy to understand. BTW, if anyone needs to fill out a lease agreement contract, I found a blank template form here http://goo.gl/5gBmGL. This site PDFfiller also has some tutorials on how to fill it out and several lease agreement contract template that you might find useful.

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