An option in real estate gives a buyer an exclusive right to buy a property for a specified time period. These arrangements may vary by state, but the basic structure is similar. There are three types generally used:
- Straight options to purchase – The buyer pays the seller a fee for the right to purchase later
- Lease options – The buyer leases the property for a predetermined period and then has the option to purchase it at the end
- Lease purchase agreements – The buyer leases the property for a specified period and that money goes toward the purchase price
The first caters to investors who speculate on the future value. The second and third are variations that buyers use when they don’t have enough money or some other reason to delay buying.
Option in Real Estate to Purchase
Option to purchase means that an investor or tenant pays a fee for the right to buy a property at some point in the future. The most common type in property transactions is a rent to own contract.
- The tenant rents the property, but the owner gives them the opportunity to buy it in the future
- The owner applies a part off the rent toward the purchase price
- These contracts allow potential buyers to buy a home and put the purchase on hold until they are ready
The advantage to the seller is that they get a fee for stretching out the process. The advantage for the buyer is that they may not have enough money or have other reasons right now to buy the house. However, they can move in and rent, and they know that they can still buy it later.1
Structure of a Lease-Purchase Agreement for an Option in Real Estate
Sellers structure purchase agreements in three ways depending on their and the buyer’s situations. Some owners want to attract investors, while others want tenants. Still, others simply want to help a young couple get their first house. Here are the major components of each:2
In this case, sellers want to attract investors to their property. Straight contracts do not contain a lease option. The important aspects of this type are:
- The buyer pays a fee for the right to purchase later.
- They agree to a set price at the beginning, or the buyer agrees to pay the market price at the end.
- Term length negotiable, but usually one to three years.
- The option money is not usually refundable.
- The buyer isn’t obligated to purchase the property, and if they don’t it expires.
A potential homeowner may do this if they really like a house but can’t at the time for some reason. They may be willing to pay the fee and pay the market prices in the future. This, however, is rare. Usually, investors want to set the price upfront and speculate on the house’s future value.
Lease options attract potential homeowners who can’t afford the price right now, or they have some other reason (such as credit issues) that they can’t commit. The structure works this way:
- The buyer pays the seller a fee for the right to purchase later.
- This money may be substantial.
- They agree on a set price at the beginning or market value at the end. Most buyers, though, want to lock a price at the beginning.
- The buyer rents the home for a predetermined time period, usually one to three years.
- The seller does not apply the fee to the down payment, and it is not refundable.
- A portion of the rent goes toward the purchase price.
- Nobody else may buy the property during the lease period.
- The buyer cannot assign the contract to anyone else.
- If the buyer doesn’t exercise the option, then it expires at the end of the term.
These arrangements may get complicated, so you should write a legally binding contract for this. A good attorney in your area can help you do this properly.
Lease purchases are another structure that allows potential buyers a rent-to-own option. While it is like the others it does have some differences.
- The buyer pays the seller a fee for the right to purchase the property later.
- Usually, they set the purchase price slightly higher than the current market price.
- The buyer rents the home for the duration of the term for an agreed-upon price, usually one to three months.
- The buyer secures financing and pays the seller the entire amount at the end of the term.
- A portion of the rent goes to the purchase price.
- The rent is usually slightly higher than going to market rental values.
- The owner does not apply the fee to the down payment.
- Option money is not refundable.
- Nobody else can buy the property unless the buyer defaults.
- The buyer cannot assign the agreement to someone else.
These agreements work well for buyers who want a particular home, but they can’t complete the transaction immediately. Either they don’t have enough money, or they can’t get a mortgage, or they have some other reason preventing them now.
Final thoughts on an Option in Real Estate
Options are good for investors and potential buyers. They give investors the ability to speculate on the future price of land. A buyer may use it to keep a lot available to them to build a home. With these, renters can buy the home they lease.3
While these present opportunities, they come at a cost. You should carefully learn exactly what the contract says, and you need to understand the cost of not exercising the option.