Leasing Real Estate
Leasing property can work well for both buyers and sellers. If you are wondering if a leasing arrangement is right for your situation, here is a brief explanation of two leasing techniques to consider as you decide.
This arrangement is sometimes referred to as a "lease with the option to buy." It provides tenants (future buyers) with the opportunity to rent property for a specified period of time -- typically a year or more -- before they exercise the option to complete the purchase. During the leasing period, a portion of the rent is credited toward building a down payment. In most cases, tenants also pay a nonrefundable sum of money up front as consideration for the option to buy later. If the tenants choose to buy at the end of the leasing period, they would get a mortgage, exercise the option, and buy the property.
The lease-purchase works the same as a lease-option with respect to a rental period, rent credited toward future purchase, and up-front consideration. Also, in both cases, the purchase price and terms are set at the outset of the leasing arrangement; and the seller is obligated to sell at that price and on those terms. The important difference is what happens at the end of the lease period. With the lease-option, tenants have the option, not the obligation, to buy the property when the leasing period is up. But with the lease-purchase arrangement, tenants have a definite purchase agreement stating that they will buy the property for a certain price and terms by a certain date.
Advantages for Buyers
Leasing can be a good way for buyers who can afford the monthly payments, but not the down payment, to live in their desired home while working toward future purchase. Or buyers with less than spotless credit can use this purchase method to move into a home and improve their credit rating over time so that they can qualify for a loan with more desirable terms. Thus, the obvious advantages include:
Smaller amount of cash needed up front
Rental money at work for the future buyer
Chance to check out the home before buying it
Potential for price appreciation beyond the locked-in price
Advantages for Sellers
Typically, there are potential lessees even when the real estate market is slow. So, if your home is languishing on the market and you don't need all your equity now, a leasing arrangement could be a viable option for you. So, what are some other benefits?
Income tax benefits stay with the seller
Above-market rent covers credit toward future purchase
Tenants likely to take better care of property than conventional renters
Non-refundable option money mitigates risk
Pool of buyers willing to pay a premium for home ownership
If you are the seller in a lease-option, you are obligated to sell the property, but the lessee is not obligated to buy from you. If you have a lease-purchase agreement, you could still lose the sale if the would-be buyer does not qualify for a home loan when it's time to make the purchase. And even if all goes well with the sale, you run the risk of making less profit if the property value rises above the price at which you are obligated to sell. As a buyer, if the value of the home goes down, you end up paying higher than market value. If you don't go through with the purchase for whatever reason, you forfeit your option money as well as the amount that accumulated toward your down payment. Also for some buyers, paying above-market rent is perceived as a disadvantage, while others see it as a tradeoff for having the opportunity to get credit toward purchase of a home.
Information is for educational and informational purposes only and is not be interpreted as financial or legal advice. This does not represent a recommendation to buy, sell, or hold any security. Please consult your financial advisor.