Lease-Purchase Options: My least favorite transaction

Today, I feel compelled to talk about a transaction type that I generally dislike and often seek to avoid: the lease-purchase option. This is because the new tenants we have in Laveen are my most recent run-in with a tenant that has been tossed a curve ball by this transaction in their past.

To explain the transaction, here is how a lease-purchase option is typically constructed:

• The Tenant agrees to lease the home for a period of 1-4 years.
• An initial down payment on the home is made at lease inception.
• Some of the money that is paid in rent is agreed to go toward the purchase of the home.
• Because some money goes toward the purchase, the rental rate is typically a little higher than market rate.
• The purchase price is typically agreed to in the lease, but may include an escalator clause like, “or market price as determined by an appraiser, whichever is higher”.
• The tenant agrees to be represented by the same agent for the lease, as well as the purchase.
• Real Estate commissions for the purchase are also agreed to at lease inception.
• At the conclusion of the option period, the tenant must exercise their purchase option, or the landlord gets to keep the initial down payment, along with all rental moneys that were slated to go toward the purchase.

Let me give some specific numbers to help explain the financial side of things: The tenant agrees to make a $3000 down payment today, with the option to purchase a home in 2 years time for $275,000. The lease rate is $1350, with $500/month to be applied to the purchase price. Market rental rate for the same home is $1225. If the tenant does not exercise their option to purchase the home, the landlord will net an added $6000 income from this tenant.

As a landlord, the lease-option agreement is a sweetheart of a deal. Landlords know that very few options are ever exercised, and they like the added revenue from the down payments and higher rental rates.

If the tenant does indeed follow through an exercises their option to purchase the home, it may be a good deal for the tenant. But tenants are typically unable to make the purchase, and then become quickly disgruntled when they learn that the down payment and all of the extra rent money they paid are going to be kept by the landlord. The explanation of what happens to those funds may have been glossed over at lease inception, particularly when the leasing company procures the tenant, and the tenant is thus unrepresented in the transaction.

If the tenant attempts to purchase the home, in a scenario where the leasing company was the procuring cause, tenants are also typically surprised that they will not be able to seek independent representation for the purchase portion of the transaction. (To be clear, they are free to get their own agent, but the commission from the seller has been agreed to go to the leasing company at lease inception, so this new agent will need to derive compensation from the buyer directly.)

Every lease-purchase possibility I’ve been directly involved in, I was the procuring cause for my own rental listing. Tenant prospects approach me about doing a lease-purchase, and as a result, my commission, and their representation is well established. Almost assuredly I’m immediately thrown into a dual-agency scenario, in which I know that the landlord is going to be the likely victor. Honestly, I can’t stand it. After a thorough explanation of how the transaction works, I’ve yet to have a tenant prospect agree to a lease-purchase. I should point out that I do think the transaction has merits in certain scenarios, but not nearly as often as the transaction gets drawn up.

The lease-purchase agreement can be a good agreement for both parties, but it’s risky. It’s risky for the tenant and it’s especially risky for the agent, when there’s only one agent involved. As an agent, or as a member of the public, if you don’t like dual-agency, you should especially dislike a lease-purchase agreement where the tenant doesn’t have independent representation. My general advice for tenant prospects that have heard about and are considering a lease-purchase, is not to do one. Take the money you would give to the landlord and save it yourself for a future down payment. Then, when the time is right for you, make a purchase. Or, if you want to make a purchase today, strongly consider a seller carry back. Today, sellers are more open to seller carry backs than we have seen in a long while.

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