Attention: Property Buyers, Sellers, and Real Estate Sales Agents - Learn How To Profit from Lease-Options (Rent to Own)

By Larry Benton CMC, CSA

 If there are any unsold houses or condominiums near you the following will show you how to profit from Lease-Options (rent to own) as a Buyer, Seller or Real-Estate Agent.

 When you drive through town do what do you see? Several houses and condos up for sell, right? Unsold houses are sitting for sale even in the few cities that enjoy a fairly healthy real estate market. There is always an extensive inventory of homes for sale no matter what the market is like.

 You can easily figure out how healthy your local real estate market is by getting the total number of homes and condominiums listed for sale in your local MLS (multiple listing service) and then dividing that number by how many homes have been sold in the last 30 days. This simple calculation will tell you if it is currently a "buyer" or "seller" market and if you are unsure of how to get the necessary information ask for help from a MLS member real-estate agent, as they can pull it up for you quite easily.

HOW IS A LEASE OPTION DEFINED? You'll hear many complaints from realtors about the softness of the market, and the market is down quite a bit from 2005 and 2006; however, the reality is that few of these agents are changing their business practices to conform to the new market reality. If the smartest agents have to earn well, they know that the marketing trends used in selling homes about one or two years back, may not be successful at present. Mortgage lenders have changed their lending requirements recently making 90%, 95% and 100% mortgages very difficult or even impossible to obtain, even if you are a well-qualified borrower.

The lease option or "rent to own" technique combines a sale, a real estate rental, and financing. More than anything, this is a lease, with the tenant paying rent to the landlord every month. Secondly, a lease option purchase gives opportunity for the tenant to buy the property from the landlord making an agreement on the price and terms, although the lease option does require the landlord to sell the property, the tenant is not required to purchase it. It is a unilateral contract, which is a promise from the owner to the tenant to sell the property to them on stated terms. The lease-option becomes a bilateral contract, a guarantee to sell for a promise to buy, once notice is given that the tenant plans to purchase the property.

Realize that a lease-purchase plan is also an option; an installment sale is also named this. The tenant must buy when a lease-purchase plan is selected, typically within a 12 to 24 month period.

I have been able to use lease-options as a buyer and a seller and it has been a great for all markets at all times. As many subscribers will remember, I acquired my residence through a lease-option. The stark truth was that I just didn't have the funds for the typical 20% down payment and I certainly didn't want to pony up for the expensive private mortgage insurance that I would have to buy if I only put 10% down.

Make sure that both the seller and buyer of the home benefit from the lease-option. They are good transactions for both the parties; hence it is unnecessary to take advantage of the other party in the transaction. Sometimes landlords take advantage of new renters by offering a 10% credit, which is hardly a good incentive for purchase.

BENEFITS AND DRAWBACKS OF LEASE OPTIONS:

One of the drawbacks is that there is always an abundance of lease-option buyers but always a shortage of lease-option sellers. The reason for this is mainly a problem with education, since most real estate agents are clueless as to how lease-options work, which is the only reason they don't often recommend them to their client buyers and sellers. Once you have read this special report you will know how to put a lease-option sale together, which will give you a great advantage over your competition.

If your house or condominium is already listed with an agent, don't hesitate to talk to them about your lease-options. Be sure to show him or her this special report. If a listing is about to expire and no prospective buyers have been produced, it may be prudent to sit down with your listing agent and explain that using a lease-option to create a future sale is better than not selling the home at all. If you don't currently have your house listed with a real-estate agent it is possible for you to still sell your private property with a lease-option sale. After reading this special report you will know more than a lot of professional real-estate agents about lease-option benefits.  Make sure you are working with an agent that has lease option experience.

 As a quick note, I recommend working with a real estate agent anytime you are looking to buy, sell, or rent a home.  You wouldn't go to court without an attorney to represent you, think of this the same way.

I will explain how real-estate agents and private home sellers easily market their lease-option property, and then I will describe the pros and cons of lease-options (please note that lease-options can be used to sell commercial properties, however they are predominantly used with private property).

An effective ad would read something like this (using applicable numbers for your situation): $5000 moves you in! 3 BR, 2 BA home, Rent-To-Own, $500 of $2000 Monthly Rent goes toward total purchase price, Open House Sunday 1-3 PM, Come ready to sign, Won't Last! -777 Easy Street, Pleasant Heights.

 One thing I suggest is to run this ad every Friday, Saturday, and Sunday in your local newspapers in their "Houses for rent" AND "Houses for sale" sections. To spread the word, talk to anyone who might be looking to buy a home, including friends, neighbors, and relatives.  If you were looking to buy a home, or if you were a real estate investor, would that ad grab your attention? Of course it would.   Using the example above, the complete lease option move in total should include the first month's rent ($2,000) and non-refundable option money ($3,000). In order to succeed, you must keep this total amount within acceptable limits.

 Before I finish, let me emphasize that you should AVOID putting your phone number in the advertisement. By advertising my number, my phone rang almost constantly with people asking questions.

 A suggestion I have is to post an information sheet in the front window of your house because usually you will have "early birds" that will drive by a day or two before you have your open house. One thing you can do to judge the prospective interest level in a buyer is to place your phone number on the window information sheet and then if they call you they are showing you their interest.

  1. Advantages and Disadvantages for Lease-Option Sellers

There's a perception among sellers and realtors that lease options benefit the buyers and hurt the sellers. I certainly do not agree with this. For me, lease-options have been very good to me both as a buyer and as a seller. As a seller you will have the pick of the buyers if you market your lease option correctly. This is a great opportunity as a seller.

The following are seller pros and cons for a lease option:

 A - Seller Benefit: There are significantly more buyers than sellers with lease-options. The buyers who are serious are not dummies. They are often more connected to the neighborhoods and understand market values of the homes better than the real estate agents selling homes there. When a lease-option is structured properly you will be surprised at the buyer demand for the property no matter what its value or location.

 B - Seller Benefit: The tenants will usually treat the house as if they own it since they will probably buy it when the lease-option terms are up. The importance of screening potential tenants is something that landlords must learn. The same concept is valid for lease-option homebuyers. The lease option applicants that I have seen tend to treat their houses well, since they would like to own their own home someday. I've had good experiences with lease-option tenants except one. Since I failed to conduct a thorough check on my applicants, this was my own responsibility.

 C - Seller Benefit: If you apply a portion of the rent as a credit towards the overall purchase, the tenant will generally be willing to pay higher than market rent. The tenant who chooses a lease option knows that it is a good bargain; hence they are ready to pay a rent which is higher when compared to the market rent for a similar house. How much more? I don't possess this knowledge. Start at 10% more, but realize it can often be even higher than this. People who enter into lease-option agreements realize that this is an excellent way for them to have the home they have always wanted. Even if it isn't the home they want to stay in forever, it will allow them to improve their Fair Isaac Corporation (FICO) credit score and improve their overall financial situation so they can qualify for a mortgage loan in the future.

Lease option sellers also need to record all monthly rents they receive as rental income on Section E of their 1040 income tax forms. The IRS cannot claim a landlord didn't report all rental income if a tenant chooses not to utilize their purchase option. The landlord can equalize the rental income making it essential tax-free by using the Schedule E form, which accounts for the rent received less the applicable expenses for lease-option property such as insurance, property tax, repairs and depreciation.

 D - Seller Benefit: When a tenant decides to purchase the property, they will be given an "adjusted sales price" which is the gross sale price minus the rent credit that was accrued while they were leasing the property.

 Depending on the circumstances, especially when you are the lease option buyer, it may be advantageous to negotiate for the buyer to pay for all repair bills. As a lease-option buyer, it is wise to have complete control of what happens to the property so that you can decide how and when to make repairs and improvements.

 E - Seller Benefit: One of the advantages for the seller is getting the non-refundable money for the option and possibly pre-paid rent as well.

 To have a valid option to purchase a property, the buyer-tenant will have to pay a form of non-refundable option consideration, which is usually money. One dollar would be sufficient.

Experience shows that if the amount of option money is higher, there is a greater possibility of the tenant to purchase. I usually try to get several thousand dollars in non-refundable option money as an incentive to the buyer. These funds act like a security deposit in a regular rental agreement, except that deposits cannot be refunded with a lease-option.

Until the exercising of the purchase option, the option consideration money does not need to be reported as income to the IRS. This is because if the money is used as part of the buyer's down payment part of it becomes non-taxable return of investment and the other portion is taxable capital gain. The non-refundable option money becomes taxable income to the landlord if the tenant decides not to buy the property.

Some tax advisors will recommend the option for the money to be reported to the IRS in the tax year of its receipt by the property owner. Yet many don't understand what to do if the option to buy is not exercised and the money has been reported and taxed as regular income. It is also unclear how to account for a situation where the property is purchased and a portion of the money is used as a non-taxable return of investment and part of it becomes capital gain.

F - SellerBenefit: Lease-option buyers will ultimately pay the maximum for the option purchase price. As a long-time seller of houses using lease-options and determining my option purchase price on recent sale prices of comparable nearby homes, buyers have not questioned the prices I have set. I make the price at the high end of the going rates for the location. Lease-option buyers are thrilled to find a lease-option, so often buyers won't argue over the price or terms, unless they are unreasonable.

Sellers would probably prefer twelve-month lease options. However, as a buyer, the longer term you have the better so that the option purchase price is locked in and you have a better chance of cashing in on any appreciation of the property. My experience has shown that when the lease-option expires in 12 months many of the tenant-buyers are not ready to exercise their purchase option. I think that's great!

At that time, we can renegotiate the (a) monthly rent, and/or (b) option purchase price. In a rising market, it is especially important. When selling, I have often extended an annual lease for up to as long as five years, but usually with different terms.

G - Seller Benefit: Throughout the terms of the lease, the person selling the property gets to take all tax deductions, including income and depreciation. Purchasers and real estate agents should strongly emphasize this point to potential sellers, for it is a great benefit to lease-option sellers. However, once the property is purchased, the seller has to report the sale on Schedule D of their income tax return and include any "recapture" of depreciation that may have been deducted while the property was rented.

It is important for the seller to remember the major tax benefit of Internal Revenue Code 121 if the house or condo has been their principal residence. The seller who has lived in his home for at least twenty of the last sixty months before selling it, then he is eligible to claim tax free capital gains to $250,000 and till $500,000 for a married couple who fulfill the occupancy test. This tax break will be lost to the seller if he uses the lease option for more than three years after moving away. It is highly recommended to consult with a tax advisor.

If an investor owns the lease option property, he can make a tax-deferred exchange under Internal Revenue Code Section 1031 when the tenant elects to buy the property. The property must be of equivalent value, combining cost and equity, in order to qualify to find out all the pertinent information, please check with the person who advises you on your taxes.

H- Drawback for Seller: There is no immediate sale for cash. A leash option is not a good idea if you need an immediate cash sale of your property. Although, if you are not in a hurry to sell but need revenue to cover the mortgage payment, taxes or other expenses a lease-option will give you all of the benefits explained previously.

If the property market skyrockets in value during the lease-option term, the tenant-buyer benefits. This is the reason why I recommend that owners only sign one-year lease-options. In order to avoid unforeseen difficulties, I would never advise entering into a lease option, which allows for the option price to be negotiated or determined by an appraisal. Instead, as the seller, be happy for the buyer if the market value goes up, even if you don't receive absolutely top dollar for the property.

2. The Advantages and Disadvantages of Lease Options From a Buyer's Prospective

We will direct our attention to lease-option advantages for prospective tenant-buyers:

 A - Buyer Benefit: It is less expensive to rent than it is to own. As a person who considers himself to be a real estate investor, I prefer to lease option a house rather than to hold its title. Typically out-of-pocket expenses are significantly less to a renter than to an owner.

B - Buyer Benefit: The meaning of buyer advantage is that the market value appreciation benefits the buyer. If while you are leasing the property it appreciates in value, then you as the buyer will benefit because your option purchase price was locked previously. Obviously if the property loses value, the tenant will not take advantage of their option to buy it.

 C - Buyer Benefit: Little cash needed up front. Depending on the seller's cash needs, he will usually require one to five percent of the purchase price for a lease option tenant to move into the house. This is a great alternative to the 5-10% cash and mortgage financing stress that is often required when assuming a title to a property, which is why I prefer the lease-option.

D - Buyer Benefit: Controlling a property with a lease-option is far less expensive than owning a property which can often require significant out-of-pocket cash. As a lease option buyer, you get CONTROL of the property without the burden of holding title. With the 15-year lease option, I benefited from the house because of the value appreciation in the gradual market. Also, by renting, my overall expenses were about half of what they would have been if I held the title and had a mortgage.

It is, however, important as an investor-buyer who will not be residing on the premises that your lease option terms allow you not only to make renovations (such as painting, carpeting and landscaping), but also to sublease the premises to sub-tenants. Many of the lease option owners may allow their tenants to improve the property, but in order to avoid misunderstandings it is important to get the permission in writing as part of the lease option.

E - Buyer Benefit: Making sure the property is what you want before assuming the liability. Have you ever been the victim of a bad real estate deal? I have! Even though you have a professional inspection done before making an investment purchase, they may not catch an unexpected problem that lies within the house or condo.

If you have never seen "The Money Pit," you should rent it. Even though this is supposed to be funny, financial investors can view this more of a nightmare situation. A lease-option can help prevent the mistake of taking a title to a money pit property.

F- Buyer Benefit: The buyer advantage is the credit toward the purchase price that comes from the rent payments. This is a big advantage to be a lease option buyer. Lease option tenants explained to me that they saw their rent credit of $500 per month (one third of each month's rent) as forced savings toward their down payment. The rent credit would be lost if their purchase option is not exercised.

Some States do have laws that require lease-option sellers to put aside rent monies in a separate account or escrow. There is no need for an escrow account since the tenant-buyer doesn't get the money back so this isn't recommended unless your state law requires it.

Be careful to read the lease-option form that you are using, often it will clearly state that your rent credit is non-refundable to the tenant under any circumstance. Some landlords give tenants that don't use purchase options a refund, as a good will gesture.

In this section we will show how to the rent credit can be determined. The tenants find the larger the rent credit, the better for them. The seller's point of view, the smaller the rent credit, and the better it is for them. Everything is open to discussion.

There was one situation with a house I had purchased with no down payment where 100% of the lease-option rent went to a credit towards the tenant purchase because the house was in poor condition and I didn't have the cash on hand to make necessary repairs.

In retrospect, I should not have been so generous; prior to exercising his option, as a tenant, he was able to perform wonderful updating of the premises. The rent credit that is most equitable to both the landlord and the tenant is about a third of the total rent. A few landlords provide just a ten percent rent credit, which is insufficient for the tenant exercise the purchase option.

G - Buyer Drawback: A disadvantage that the buyer faces is that he cannot itemized tax deductions. Some potential lease-option buyers have approached this subject with me. I simply remind them that the benefit they receive through rent credit is far more helpful long term than a once a year tax deduction that can be taken as a homeowner.

H - Buyer Drawback: There are some mortgage lenders that won't allow you to use your lease-option rent credit as your down payment. Fannie Mae and Freddie Mac, who are the major purchasers of conforming home mortgages in the secondary mortgage market, (up to $417,000 in the last year) have an intriguing practice that lease-option rent credits count in the down payment formula only if the actual rent paid was higher than the market rent for the house or condominium in question.

 There are ways to work around this regulation if it becomes an issue once the tenant decides to make a purchase. For instance, I found out that the rule doesn't appear to apply to adjustable rate mortgages held by lenders, so a buyer may want to obtain that instead. You can also provide a repair credit at the closing, or the seller can cover some of they buyer's one time closing costs.

 SELLING DEVOLOPED PROPERTY ON A LEASE OPTION: Running a newspaper ad, like the one suggested earlier, is the easiest way to market a lease-option property especially if you are on a time constraint as a seller or real-estate agent.

 The house should have a listing that says, "Seller will lease-option (rent-to-own)" if it is listed in the local MLS.  On this subject, let's discuss how you will pay your agent their professional fees due to them.  Many agents will want their sales commission paid in full before the buyer actually uses the purchase option. On the other hand, it is suggested that the selling party pays only a typical leasing commission (1 months rent) up front and the remainder, at the time when the tenant comes forward to exercise his/her option to purchase the property.

 Don't skimp on preparation when you hold your open house on Sunday afternoon. Good marketing will give you 50 to 100 visitors to a Sunday open house if you are the seller or real estate agent. In order to give detailed flyers to all of your visitors, have enough on hand. Your advertising flyer needs to tout all the benefits that a lease option confers to the buyer and include all other necessary details as well.

Provide a rental application form with each flyer to make the selection of the best applicant easier, and to avoid any accusations of discrimination. Require a $1000.00 or more refundable check for a deposit along with the rental application. The seriousness of the applicant is shown by the deposit in which is made. Clearly mention that the deposit will be returned if the prospect is not accepted after running a credit, income, and background check. Only take a rental application with a large deposit.

By the end of the Sunday open house, if you have timed the option correctly, you should have at least two deposits and completed applications. The first thing you should do when you get to work on Monday is to run each person's credit report including FICO score. Be sure to check their references, and don't forget to check previous landlords as well. Now have the top applicant sign the lease option agreement as quickly as possible. It is important to treat all applicants equally and not discriminate.

Once you have received your full CASH payment and have a lease-option agreement signed then immediately return all deposit checks to the applicants who were not selected. But don't tell them why you are turning them down.

Locate HOUSES AND CONDOMINIUMS Available to buy with lease options. The least used resources for advertising lease options are the newspaper classified ads or local MLS ads.

1. One of the several methods that may be effective starts with looking for houses for sale or rent in your local newspaper. Particularly, look for houses or condos that have been for rent or sale for more than 30 days. Follow up on these ads. Many landlords would prefer to sell, but due to the current buyer's market they haven't been able to.

When examining a potential property don't be afraid to ask if the owner or listing real estate agent would be interested in a lease with the option to purchase and if they are you can explain the extensive benefits such as higher than market rent and continued tax deductions.

Don't let a real estate agent discourage you. Good agents know that lease options are a good way to get results when the market is down, whether you are a seller or a buyer.  Make sure you are working with an agent with lease option experience. 

Remember, I recommend working with a real estate professional anytime you are looking to buy, sell, or rent a home.  You wouldn't go to court without an attorney to represent you, think of this the same way.

2. Run your own classified ad under the "House for Rent Wanted" heading. A friend of mine taught this strategy to me. He suggested publishing a 30 day low cost "rate holder" classified advertisement in a newspaper under "Houses Wanted" or "Houses for Rent Wanted" column like "Executive needs 3 BR, 2 BA house on a five year rent-to-own" scheme. It's $5,000 option money. You probably won't get many phone calls but all you really need is one or two from motivated home sellers, landlords or real estate agents.

LEASE OPTION SELLERS: Be sure to disclose all known defects in the property and sell "as is" which eliminates your liability. Currently, most states mandate that anyone selling a house use a Seller Transfer Disclosure (TDS) form. A tenant with a lease-option must be given a state specific TDS disclosure form. Lease-option buyers should be certain to get a professional inspection of the house before they take up residence so that they will know about any problems that the seller may not have mentioned.

If you are planning to include any rental appliances such as refrigerator, dishwasher, washer and dryer, be sure they are in good working condition. A specification needs to be included in the lease option that any repairs of the appliances are the landlord's responsibility. It must be specified in the lease-option contract which repairs the tenant must cover, whether it is all repairs or just those costing less than $100.

It's also a good idea to include a gardener's services as part of the rent, and the gardener should tell you if the tenant isn't watering the lawn or is otherwise failing to maintain the property.

Regarding the "as is" sales term, in the terms and conditions section of the lease option I suggest wording such as "When the purchase option is exercised, the property is to be sold in its then ‘as is' condition and the seller is not responsible for any appliance or other repairs." Of course, unless agreed otherwise in the lease option, the landlord remains liable for major repairs, such as roof leaks, during the rental period.

CONCLUSION: Both buyers and sellers generally benefit from the lease option or "rent to own" plan. These work for both private and commercial properties, especially when the market is slow and buyers are scarce.

A real estate agent that understands how a lease-option can benefit both the buyer and seller will stand apart from other agents and they will lose far less listings due to expiration. If there is ever any question about legal issues or taxes surrounding lease options it is wise to consult a real estate agent, tax advisor, or real estate attorney.