If you have ever done a Lease with a 2 year Option to Purchase agreement,...what determines the amount of Option Money? Is it a percentage of the selling price or what?

Nicole,

With Lease/Options you get to evict,...not foreclose. This is one reason Lease/Options are preferred over Owner-Financing where a foreclosure is necessary.

The option money, like the purchase price, terms, etc. is negotiable like anything else.

You, as the Seller/Optionor, want the highest amount you can get obviously because that makes it more likely the buyer will follow thru.

The Buyer/Optionee will want the lowest amount that you will accept obviously because that means less $$$ out of their pocket up front, and typically the reason people buy using this technique is that they do not want to tie up a bunch of cash.

Oops, hit 'Submit' too soon.

What determines the amount of option money? As much as you can get. I always advertise for and ask for more than I want. I have mostly done them in the past for 2-3% but have done them for about 1% as well when the housing market was slow. Today I would advertise for at least 5% and not sure I would go much below that in the market that were in now.

Why is an option fee even required? “A few reasons. One is you are paying me not to sell the house to someone else for the next two years. Even if someone offers me twice what the house is worth, I legally can’t sell it to them. You’re also paying me to be obligated to sell you the house at anytime you want during the next 2 years. Additionally, you’re paying me to agree to keep the price the same for the next two years. History shows us that real estate prices increase over time but I’m agreeing to give up that potential increase in exchange for a small percent of the purchase price paid today.”

Option charge is to lock in the price. It will be used as part of your down payment. Will convert to S/dep if you don't follow thru.

Have 2 separate contracts: 1 for sale price explaining whats needed and one RENTAL contract-- don't want the waters muddied up with he said she said in case they don't buy.

Sid,

Yesterday I sat on the living room sofa with my tenant who wants to buy the house she has rented for the last 18 months. I quoted her $65K which I believe to be market value. She has a 401K in which she said she wanted to pay all cash but only has $35K right now. She told me she needs about 2 years to save enough up to get to the $65K number. I can wait two years.

I told her about my 2-year Lease/ with Option to Buy agreement (this will be my first one actually) but did not give her any $$ details. I told her I needed time to meet with my attorney to draw up the papers.

So, if she intends to pay all cash, then this seems like an ideal situation. Since she has a great paying job, she could get an mortgage in 2 years if she wanted too. Her current credit rating needs some improvement but I feel sure she will get that up to par in the next 2 years.

Her current lease ends at the end of June and I don't want her to move out and find some other LL who will entice her with some sleazy RTO deal. She is young and naive.

Roy...okay. Then whatever deal works best for you both. In my town, a $65K house would probably require a $3000 option fee.

Make sure she understands that this fee is LOST if she fails to close you out in 2 years. Sob story or not, she is paying you for giving up certain rights. You might consider making a checklist/dummy acknowledgement that she initials & signs.

I, Ms. WannaBe Homeowner agree that I am paying a fee of $3000 that is not refundable for any circumstances. In exchange, Roy is giving up his rights to:

___ sell the house to any one else

___ increase the sale price

___ etc.

I hereby realize that I am not paying a deposit. If I close the deal as agreed, the money will be applied toward the purchase price of $65,000 and I will still owe Roy $62,000. However, if I fail to close the deal during the next 24 months for any reason whatsoever, to include but not limited to sickness, loss of job, family emergency, personal emergency, medical emergency, financial emergency, etc.... Roy gets to keep this money and I will graciously and cheerfully leave the premises at that time in a clean, undamaged condition.

Roy, be careful that an eviction during the 2 yr option time does not allow her to continue the option and thereby prevent you from another RTO or rent to another tenant or sell to someone else.

Roy, Get as much option money as possible. Reason is if you don't the tenants will treat the place like a cheap rental. They will say "we are buying it so we can do whatever we want". This will include moving a bunch of friends (deadbeats) in, doing modifications to the place, junk accumulation, not fixing anything, and not letting you have access. Then when they don't pay, they will tell the court they are buying it.

So, separate the lease from the option. Get as much as possible up front. Make the term of the option short but renewable/extendable if they meet your rules. Don't let them get behind. Keep a tight grip on the rental side. Put in both sides (option and rent) that any violation of your rules voids option. All option money is considered fully earned and is non refundable, period.

"Make it stupid proof".

This is why I need my RE attorney to create the paperwork. I have always told my attorney to create documents for me that a tenant with a 8th grade education could understand...written in plain English and no legal jargon.

Richard: I have rented to this lady for 18 months and when I was at her house yesterday it was spotless. She is my only Class B tenant and I want to hang on to her as long as I can.

Again, my attorney is a specialist in RE deals and all of the paperwork that goes with it. All of my interests will be protected in any document(s) he creates for me. This attorney has closed most of the fixer-uppers I have bought and so he is well familiar with rental properties.

Razorback - thanks for those helpful tips. Hope to see you at the next convention.

The lease takes precedence over the option. They remain a tenant until they exercise their option. If they breach any terms of the lease it generally renders the option null and void.

Nicole,

Down here, 20% equity gets tossed around a lot. If the tenant has paid enough to create a 20% equity stake, then foreclosure rules apply. Less than 20%, LL/Tenant laws applies.

DO NOT STEAL IN SLOW MOTION

Roy,

I think Ken has a point. She can pay 35,000 down now and if you hold a five year note at 5%, the payment is a bit under $ 600 a month. I believe you mentioned your rents are generally around that amount, so your cash flow would remain the same and she'd be done with a fully paid house in 5 years and you'd maintain the same cash flow over that time with $ 35k in your pocket. I know she wanted to do two years, but if she's a saver she'll be able to put away money anyway. If it were me, I'd take the money and straight finance it.

GKARL,

Roy,

My head is spinning! So many different versions!

We ONLY do Lease with Option on SFHs.I estimate we've done 1,000.

We do it for 3 reasons: I can keep their OPTION FEE, it's a hook to separate me from the competition, attracting a better res to care for my investment and pay. "Stepping Stone to Home Ownership".

The Lease and Option must be 2 separate documents so I can evict on the lease.

We do NOT give the deed until they are totally paid up.

To steer clear of Dodd-Frank laws I suggest NOT calling this seller financing or taking money as equity. We call it Non-Refundable Option Fee.

We do NOT apply any of the monthly payment toward equity because that gives the equity which I'll have to return if they move out, and again, compliant with Dodd-Frank lending laws.

In Indiana we have a specific law that says an ooption fee is not a deposit and does not need to be refunded. Check your laws (under DEPOSITS)

Out of 1,000, 3 have bought the home.

Get as much Option Fee as you can. On lower end homes we add $1 to the normal deposit (same as a month's rent).

Always ask because one put up $60,000 on a $120K house. I think they'll stay a while!

BRAD

"The law will not enforce a completely one-sided agreement if the party that is required to perform gets nothing in return for the promise to perform. An option, where the seller is required to sell his property at the election of the Purchaser, but the Purchaser is not required to buy, is a one-sided or "unilateral" agreement."

In other words without a non-refundable fee the court will disregard the contract.

Brad20K,

Thanks for your very valuable words of wisdom which reflect your own experiences with L/O agreements. Some of the replies here on this post will be printed out and shown to my attorney to make sure those points get covered in my L/O paperwork.

One other thing, my L/O agreements will only be offered to my existing tenants who have rented from me for at least 1 year and have paid their rent on the due date. In the past, when a new tenant asks "Do you do RTO?" my reply has always been,.."Rent from me for 1 year, pay your rent on the due date, and take care of the property. If you can prove to me you are capable of those 3 things, only THEN can we talk about a doing RTO or Lease Option agreement. In other words, if you can't pay rent on the due date, then you have no business doing a RTO or L/O type deal. With me, you have to crawl before you can walk. And you have to walk before you can run.

Brad20K,

Do you give your L/O tenants rent credits that are applied if they exercise their option to buy? If yes, what portion of rent goes to a rent credit?

Also, does your L/O agreement actually attract a better quality tenant than just a straight rental agreement does?

One more thing,...under a L/O agreement, does all maintenance shift to the L/O tenant? If the Central A/C unit dies,...who pays for a service call?

Roy, if the tenant cashes out her $35,000 IRA, after income taxes on the withdrawal (unless it’s a ROTH IRA) and the 10% penalty on the amount above $10,000 she may well net out less than $25,000. Add in a $3,000 option fee and 1/3 of her life savings is gone for nothing of benefit to her other than the option to buy your home at market price. Keep that in mind when deciding if this is going to be enough and if it is OK with you to be a party to her making an unwise financial decision.

JR (ME)

I appreciate your thoughts on this matter. Most likely, I will be following Brad20K's advice and my attorney's advice (which I will have to pay $400.00 for) here on L/O's.

The #1 primary reason I want to start doing Lease Options with tenants is to test out a theory 'that a L/O agreement attracts a better quality tenant than a straight rental agreement does'. If I find this not to be true,...I will revert back to the straight rental agreement which I have doing for 12 years!

Hi Roy

I have always discussed it with the buyer. But required a minimum of equal to 2 months rent. If they can do more that’s great. It’s less they have to try to get loan approval on later.

Also I tiered my 5 year sales prices,so year #1 it was one price the next year it would be 5%higher (national average of appreciation rate) or more if you live in Denver. ;)