Pennsylvania Lease Agreements with Options to Purchase
Back in May of this year, I wrote a blog called ‘Rent to Own Contracts in Pennsylvania’ which you can read here. I couldn’t think of a clever title for the blog, because Rent to Own Contracts might be the most boring topic I could possibly blog about. Ok, that is not necessarily true, but it certainly doesn’t lend itself to a clever title. This is the reason I’ve titled this blog ‘Pennsylvania Lease Agreements with Options to Purchase’, because the topic is so similar and so equally dry that I am not going to try and fancy up the title. I’m glad I’ve got this off my chest.
There is another way to bridge the gap between renting a property and achieving the American Dream (note: American Dream arguably still exists?) of buying a home. With a Rent to Own Contract, you enter the agreement with the sole purpose of putting money towards equity in a home. Maybe you didn’t have or didn’t want to put down a large payment, but you were able to enter into a contract that bought you, albeit slowly, and with interest, a property that you were living in.
There is another way to achieve this result, and this is the OPTION CONTRACT. In general contract speak, an option contract is a contract entered into wherein the seller of an asset agrees, in exchange for something, not to revoke an offer to a buyer once the offer is made, for a specific period of time. In real estate lease option agreements, the homeowner (or landowner, or factory owner, etc…) extends an offer to an interested potential buyer, and this offer stays open a certain amount of time. Here is the twist: the potential buyer is either currently renting the property or is interested in renting the property during the period of the open option. The concept allows a potential buyer to “try out” the property, kick the tires, and see if it is a good fit. Instead of having mere days or weeks to do your diligence (as with a typical real estate sale), now you get a year, or two, or more.
The parties decide on the purchase price in advance, which is tricky especially if the option is long. The rental payments you pay during the option period are considered rent, up until the point the buyer decides to exercise the option, at that point the money becomes equity payments towards the purchase of the property. So that $24,000 you paid over the last year in rent is not $24,000 off the purchase price you agreed to a year ago.
If, during the option period, a buyer “exercises” their option to purchase, a binding contract for sale is created. At that point, legally the seller must sell and the buyer must buy the property for the cost and on the terms stated in the original option contract.
The option contract is not for everyone, and it typically favors the buyer. Why? Well first let’s look at what each party is bargaining for and receiving in your typical option contract. A seller gets money up front. A lease option contract has two parts, the first part is the lease, and that part is handled like any lease, money down and you move in. The second part is the option, a buyer has to consummate receiving this option by giving something of value to the seller. With real estate, it is almost always a down payment on the house, typically at least 3% of the cost of the property. This option payment, if the buyer decides to exercise the option, goes towards the purchase of the property. This benefits the seller because, even though a property sale would get him his money sooner (assuming he can find a buyer), here he gets a lump sum option payment that, if the buyer fails to exercise his option, in most cases the seller does not have to return that initial payment. The option payment in that case left the offer open to the buyer, the buyer didn’t exercise it, and has to forfeit that money and move on.
The benefits are greater to the buyer. The buyer gets time to secure financing or save up a down payment to get a mortgage to eventually pay off the seller. The buyer gets to try out the property, to investigate what options he has for it, what zoning issues might exist and make a far better decision about a purchase. On top of that, buyers oftentimes will use their option to turn a profit. If you have two years to make small or large upgrades to a property, you can then find another buyer who is willing to pay you the option price plus X, and then it’s as simple as exercising the option and flipping the property from the seller to the new buyer. Everyone wins. Finally, in an option contract, the buyer does not have to buy unless and until he exercises the option. Only the seller is bound. A buyer can walk away and lose his option deposit, but he can cut his losses.
Legally, here is what you have to remember. An option contract CANNOT be verbal. This is true with virtually all real estate contracts (not residential leases in some cases). The contract has to be signed! You would be surprised at how often I get unsigned contracts on my desk. At the very least, the seller has to sign the agreement. The option portion must be consummated with consideration, as I mentioned above with the option payments. If the seller gets nothing, the buyer cannot be given a secured option to purchase.
As always, there is so much more to talk about with these contracts. What happens if a seller breaches? Or a buyer wants his money back? Please feel free to reach out to me with any questions you might have, or if you think a lease with an option to purchase is for you. My phone number and email address is below.
Joe Console focuses on all real estate law matters including purchase/sale, leasing, investment, probate and tangled title. He can be reached at 267-603-2493 or [email protected].