How to do a lease purchase and why you shouldn't
"Would your sellers consider a lease purchase?" two separate agents have asked me in the last two days on two separate listings.
And each time, I've explained the pros and cons of such an arrangement to my sellers. Both sellers passed and here's why.
First, the Wikepedia Definition: "A lease purchase contract is a shortened name for lease with option to purchase contract. It is a form of real estate purchase which combines elements of a traditional rental agreement with an exclusive option of right of first refusal to later purchase a home."
The initial challenge of a lease purchase is to make sure everyone knows what they are talking about, even the agents. Often, the buyer is thinking "lease with option to purchase" while the seller is hearing "purchase with delayed closing."
This hybridized contract has come and gone over the years, most recently with the soaring interest rates in the ‘80s, and now with the difficult market we face today. It's a product of desperation, really no better than simply renting a house. In the end, it's like like trading in house futures.
Here's a typical scenario:
Mr. Buyer has a home on the market in another city. But his job - and the kids' school - starts in your market in one month. He wants to get his family settled. He's found the perfect house for $200,000.
Mr. Seller is thinking about building a $300,000 house and has his house on the market. It's a slow market, a soft market and maybe he'll get full price if he agrees to this lease purchase. Mr. Buyer comes along with the lease purchase proposal. Ms. Seller thinks he can rent elsewhere and get started building his new house. The agents negotiate the offer - one part lease and one part purchase -- with Mr. Buyer providing $10,000 non-refundable earnest money if he doesn't close within the year. (In some cases, Mr. Buyer will want a portion of his "rent" applied to the purchase price.)
If you can get past the obstacle of Mr. Buyer agreeing to non-refundable earnest money, then on to the more mundane home inspection issues, here's what the principals and agents could encounter.
Benefits to seller:
- Possibly higher selling price.
- Cash flow, particularly if property is vacant (which is why this may be attractive to some builders.)
- House is under contract (maybe or maybe not)
Cons for seller:
- Equity still tied up in house and seller cannot proceed with his plans to buy, etc.
- Housing prices could rise and the seller is locked into a lower purchase price.
- Market could decline and tenant/purchaser decides house is not worth agreed upon price. Or tenant/purchaser may find another house they like better in the interim.
- Interest rates could rise and tenant/purchase may not qualify for a loan.
- Tenant/purchaser may not keep up property.
Benefits to buyer:
- Making only one move saves time and money vs. renting, buying and moving again.
- Buyer gets to shakedown period to really figure out if they want to buy this property.
- Housing prices could rise and tenant/purchaser now finds he's made a pretty good deal.
Cons for buyer:
- Locked into agreement and they decide house is not worth price or find another property.
- Interest rates could rise and tenant/purchaser sees his payment going up when the house closes.
Money always talks and in this case it's the $10,000 non-refundable earnest money that's keeping this deal together.
The longer the terms of the contract, the more likely that housing and financial markets will change, making what once seemed like a good deal, merely a memory.
For agents, it's a lot of work with little promise that the house will close. Chances are, no one will be happy. Not the buyer. Not the seller and certainly not the agents.