Lease-option

A lease option (more formally Lease With the Option to Purchase) is a type of contract used in both residential and commercial real estate. In a lease-option, a property owner and tenant agree that, at the end of a specified rental period for a given property, the renter has the option of purchasing the property.

A lease option is different from a lease purchase contract, in that a lease purchase binds both parties to the sale, whereas in a lease-option the buyer has the option but the seller does not.

The example below describes a typical lease-option for residential properties; commercial lease-options are typically more complicated.

The contract is typically between two parties: the tenant (also called the lessee or tenant-buyer), and the landlord (lessor), who owns or has the right to lease or dispose of the property.

In order to have a valid option the tenant-buyer must in most cases provide "valuable consideration" (a fee) for the option. Generally, sellers will ask for as much as possible--often around 3%-5% of the purchase price. The tenant-buyer usually will want to provide as little as possible--even a token amount of $100 represents "consideration." The option gives the tenant the right (but not the obligation) to purchase the property at a later date. The lease option only binds the seller to sell, it does not bind the buyer to buy. That makes it a "unilateral" or one-way agreement. In contrast, a lease-purchase is a bilateral, or two-way, agreement.

The basic elements of a lease-option are:

1. Buyer purchases the option. The parties agree to what the cost of the option is. As noted above, it can range from a token amount to 5% (or more) of the value of the property. The option fee usually is non-refundable. That is, if the tenant-buyer fails to exercise the option, the money remains with the seller. It is not refunded. The reason: The option fee is not a deposit. The option fee has been used to purchase something of value: the option.

2. The parties agree to a purchase price. It can be decided that the price will be the appraised value at the time the option is exercised. Generally, however, the purchase price is agreed upon at the inception of the option.

3. The length in residential real estate is typically 1-3 years. However, it is often unwise for the tenant-buyer to agree to a short period of time (often 2 years or less). The tenant-buyer often is expecting that the property will appreciate in value, particularly if the agreed-upon purchase price is equal to or higher than the fair market value at the time of the inception of the option. Perhaps even more important, often the tenant-buyer has credit or other financial issues preventing him/her from immediately purchasing. The option period is used to strengthen the tenant-buyer's credit, amass rent credits, and position him/herself to purchase. That often can take several years.

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