When Options Fail…Lease Purchase, Lease Option?

“I’ll gladly pay you Tuesday for a hamburger today.”  J. Wellington Wimpy – Popeye Cartoon

Lease options, lease purchases and delayed closings sometimes go badly.   As a broker, I always look for potential ways to make a sale, but am cautious as the closing times grow.  A lease option can be worded in a few ways, but is essentially, a way to delay closing for a particular reason.   Usually, the buyer wants time to gather funds, restore credit or even for an acceptable job history.    The owner is taking some risk and I would always recommend considering the negative impact of a failed option.

Sales price trend

Average Sales Price Residential Sales Amelia Island 2012 to 2017.  Long delay in closing should consider changes in market value. Source: NCMLS 4/25/17

Deposits are important, but think about contingency as well.  If a request for a lease purchase or lease option involves substantial time, how much is reasonable?  Have you considered the market and price trends for an area?  I would normally look for around 1% per month, but for longer terms, I might look at the change in price.  Our area appreciated a great deal in the last 2 years.  If the market changes 20% or 30%, what point is there to a lease purchase?    A simple lease makes more sense, given financial means to wait to remarket and sale.  Regardless, there is much more to consider, beyond a simple binder.

Tax implications might be part of the consideration.  Are you selling a homestead?  If you

rent for too long, does the exemption on capital gain diminish or go away entirely?  What about depreciation?  The time you wait can add costs you may not have considered.   Insurance might increase or you might be faced with maintenance you didn’t cover in the original agreement.  In a true lease purchase, longer terms might need to include discussion of maintenance for the property.  What about insurance?

I recently posted a brief update on Flood Insurance Rate Maps and the pending date of August 2017.  What happens if an unforseen change increases a buyer cost?  What happens if, during the long occupancy, a buyer has second thoughts.

Contingencies are usually good for one party, but can cost the other.  Consider a contingency on financing.   Financing for a short agreement is a reasonable contingency.  As the term increases, I would prefer cash or removal of all contingencies, including financing.  The risk of a change in job or circumstance is just too great.  Making a deposit either non-refundable or turning the deposit into purely option money paid to the seller might make sense.  As the agreement grows in length, I would prefer fewer ways for either party to find an exit and a way to compensate the seller for time, lost opportunity, tax consequences and increase in value.

Lost opportunities or opportunity cost is usually ignored in a short agreement, but timing, in longer agreements, becomes important.  The tax code can change or you might be subject to loss of a tax advantage, but consider the other reasons you might prefer to have money earlier.   Look at the increase in stock value in the last 6 months.   Even if you don’t plan to reinvest the money in real estate, the lost interest rates or appreciation of any investment is still a cost.  A hot market can go cold or a cold market can move prices beyond your reach.   In Nassau County, I would far prefer buying at last year’s price or the year before, instead of today’s market value.    I can think of properties 20 or 30% lower in 2015.   Just think about the real cost, before agreeing to terms.  Time to close almost always adds risk and it makes sense to either remove contingencies or be paid for the time.

On a final note, at a minimum, be sure to have an attorney prepare lease agreements for terms in excess of 12 months, have an attorney review with you and make certain to ask questions.  Consult a CPA and consider the tax consequences.    Last,  I always assume longer agreements have a greater chance of failing.    Having a backup plan is prudent.

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