6 Strategic Tips for Your Next Lease Option Deal
You’ve found your motivated seller, negotiated your deal, and have it under contract. Now it’s time to contract with your tenant/buyer. Here at 6 Strategic Tips that will help you protect your deal:
Use separate agreements:
Use two distinct documents for your Residential Lease and Option to Purchase agreements. The lease agreement should not make reference to the option agreement.
Keep the term short:
Set the lease option term for a maximum of one year. If the tenant/buyer wants multiple years, give a one-year term with two conditional rights to renew.
The longer the term, the more likely courts are to view the transaction as a “disguised sale” instead of a lease. This would create equitable interest for the tenant/buyer and in most states you would have to foreclose on the property. Most residential leases are set for a maximum of one year and are then renegotiated or renewed. By following that structure, the transaction looks less like a sale. In the event of non-payment by your tenant/ buyer you would be able to evict on the basis of the lease agreement.
Collect a security deposit:
Sellers don’t take security deposits; landlords do. Taking a security deposit will help maintain the landlord/tenant relationship.
If the tenant balks at paying both a security deposit and an option fee, bite the bullet and reduce the option and put that money toward the security deposit. You want to preserve the lease nature of the contract.
Pay the taxes, insurance and any HOA dues:
Pay like an owner! The tenant should never directly pay taxes, insurance or homeowners’ dues. This would make the transaction appear to be a sale rather than a lease.
The tenant may pay other expenses (such as utilities) that are commonly paid by tenants in your area.
Watch Your Language:
Don’t use the words ‘rent credit,’ ‘seller’ and ‘buyer’ in your lease agreement. Instead, use the words ‘landlord,’ ‘tenant,’ and ‘deposit.’
Give full disclosure:
Make sure the tenant has read and fully understands the ramifications of the deal. This may mean reviewing and explaining the contract line by line.
Tenant/buyers having amazingly short memories. One of the biggest court problems for lease option landlords is that tenants claim they didn’t understand the contract or that the landlord took advantage of them. Proactive investors can help avoid this problem through full disclosure and taking measures to ensure the tenant understands the agreement. Create a Tenant/Buyer Disclosure form and have the tenant/buyers sign off on it, acknowledging their understanding.
As always, thanks for reading. Your comments and questions are welcomed below.
Great stuff Bill!
Awesome tips, Bill! Hmm…I never considered the issue with regards to the length of the lease and the ability to evict vs. foreclose. Point well taken.
Great article
@Greg – Appreciate that Greg!
@Shae – Thanks! Equitable interest becomes problematic with longer leases. Use a one year term with renewal options. Make the option to renew contingent upon on time rent payments 🙂
@Erika – Thanks for stopping by and giving us a read!
Excellent post Bill! Great points on the terminology and watching your language.
Howdy, Are you going to be writing a follow-up article? The partner and myself have put in some time browsing over your website and surprisingly enough you discussed something we were talking about just the other month with our neighbour. We often notice ourselves arguing about the smallest of points, isn’t it ridiculous?
Nice work, Bill! Time for me to do some sharing . . .
@Josh – Thanks Josh! I appreciate that a lot.
Could you ask the tenant buyer for permission to make a recording of the conversation going over the paperwork? (To avoid the failed memory of tenant buyers)
@Denise – Absolutely 🙂