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What is a Lease/Option?
A Lease/Option simply describes the coupling of a standard residential tenancy lease with a call option contract. The option will be a legal document signed by two parties, a prospective purchaser and a vendor, for the possible acquisition of the given property.
I say possible because an option will provide the prospective purchaser the right to purchase the property within a given period, but will not bestow on him the obligation to do so. The purchaser simply has the option to purchase, whereas the vendor will have the obligation to sell at the agreed price should the purchaser exercise that option.
An option has three primary components:
Therefore, a Lease-Option simply combines a standard Lease (Tenancy Agreement) with an Option, allowing the prospective purchaser to control and possibly occupy the property for a given period before he elects to exercise his option to purchase or not.
How can they be used?
If you are wishing to purchase a property, an Option or Lease/Option will allow you to control a property for very little down payment. As an investor, this can be great if your research has identified that a particular market is on an upward trend. You could take out an Option to purchase at a given price in 2004, allow market growth to increase the value of the property, and qualify for 100% finance (read: No Money Down) in 2006.
For example, you may wish to purchase a property for $150,000 in a given area. You find a vendor who is either a disgruntled landlord, hard pressed to find a buyer, or who is adamant about achieving his asking price, and he is not fussed about getting all of his money now.
You enter into a 2yr Lease/Option with him. You pay him $2,000 as an option premium and $250 p/w rent. He is now earning positive cash flow on his property. As he would normally only expect about $190 p/w rent for his property, you arrange to credit $60 p/w of the rent towards the purchase.
At the end of the 24mth period, you have $8,240 in credit towards the purchase (($60 x 104 weeks) + $2000 deposit). Assuming the property is now worth $171,000 two years later (7% pa growth), you now have $29,240 towards the purchase ($21,000 capital growth + $8,240), sufficient to cover a 10% deposit, LMI, stamp duty, transfer fee, legals, and have cash to spare (you could even avoid the LMI – see the article on Second Mortgages). Admittedly, you will need to find a lender who will lend on the valuation and not the contract price, but as you could show that the price was set two years ago, this shouldn't be too much of a challenge.
This is only one possible scenario of many, and the option fee and rent/rent credit proportion which you allocate would depend on whether you are buying or selling, and whether it is an up, flat, or down market.
As Lease-Options enable you to control a property, they can be used for investors wishing to occupy and do a renovation. Once the renovation is complete, a new valuation can be ordered enabling you to achieve 100% finance once you decide to excercise your option to purchase.
If you are wishing to sell a property using a Lease/Option, the use of this technique will open up a whole new market of prospective purchasers for you and will increase your chances of achieving your asking price.
Why? Simply because you can now offer your property to the 30%+ of Australians that are renting, and allow them the opportunity to purchase a home without the need for them to fork out a large cash deposit and stamp duty.
You could set-up a similar scenario for your purchaser to the one provided in the example on "Buying". You could create an Option valid for a two year period with your purchaser, and at the same time enter into a two year Lease on the premises with them. They obtain immediate possession of the property, but pay you a higher than average rent, with a component of that rent going in as credit on the purchase.
The aim at the end of the Lease/Option period would be for them to have built up sufficient credit (equity) to qualify for conventional finance (at least 95% LVR) and purchase your property. If the property increases in value during that period, the additional equity can be combined with their rent credits enabling them to exercise their option to purchase the property even sooner.
To this end, you should perform your research diligently to assess whether your target area is moving into an upward, downward or flat cycle. Then you would construct the variables for the deal (your option fee, validity period, and rent credit) in such a way that the purchaser will indeed have sufficient equity to realise a purchase at the end.
If for some reason they decide not to exercise the option to purchase, you have at least done all you can to enable them to do so. You will have collected the option fee, as well as an above average rent and positive cashflow for the period of the tenancy. It should be noted that the use of this technique will also open up your rental prospects if you have a property that you have difficulty renting, as you will be able to draw in people interested in escaping the rent cycle.
Advantages:
Few to mention if you have performed your research and set-up your variables correctly (option fee, exercise price, validity period, and rent credit).
The Lease aspect of the agreement is quite tightly regulated in Australia, as you will normally be using a standard state based REI or equivalent Lease.
As an example, when selling, if you wish to pass on your maintenance and rates costs to the prospective purchaser during the period of the Lease, this will need to be incorporated into the Option contract. If they fail to comply with their obligations, all it may do is to possibly render the Option contract void, but you will not be able to enforce their payment of any maintenance or terminate their Lease as a result of this. They will be protected by the standard tenancy legislation in your state or territory, and you will not be able to shirk your responsibilities as a landlord.
Want to know more?
Check out The Australian Guide to Property Lease Options. The cost of purchasing a home, and of meeting the associated establishment costs, is a major issue of concern to first home buyers and is becoming increasingly so in Australia.
This presents us with an opportunity. Every business book on the shelves of your local bookshop will tell you the key to success in business is to find a problem and solve it. Lease Options is a solution to this problem, and this guide is the definitive Australian work on the subject.
The Australian Guide to Property Lease Options is highly thought provoking, stimulating, and provides in-depth detail on the different ways Lease-Option investing can be used in Australia, as well as including many illustrative examples of structuring Lease/Option variables. This strategy is comparatively simple to implement, requires little cash input, and can be developed into a very profitable business. Australian property investor Rick Otton also has a comprehensive course covering this strategy called the Massive Passive Rent To Own Pack.
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