Thoughts on converting my rental property to a lease option?

[Ashraf Farrag]

I have a fairly steady rental property. It was a former home of mine. I lived in it for 7 years and it has been rented for about 6 years. There still is a mortgage on the property and it has a decent amount of equity in it. I could refinance / home-equity loan to pull the equity out for another RE investment but I am trying to use this an an opportunity to learn how to work the numbers of creative financing to be able to do other deals.

What I am trying to determine is if it makes more sense to go with a lease-option buyer in order to continue to have some residual monthly income but free up the equity in the property so that I have capital to seed additional RE investments. 

I also understand from the proponents of L/O that having a buyer-tenant with more "skin in the game" versus a renter in the house would make the management easier.

From what I read/understand, it definitely does not seem to make sense to seller finance in regards to my options for non-payment (eviction vs. foreclosure).

The problem I have in structuring the deal is if they cash me out "soon" then I don't stand to make as much as I would if I continue to rent the property but I guess the trade-off there is that I would then have all the equity available as capital to reinvest into another investment (or multiple investments) which may offer better returns.

I am curious if:

1) Anyone has actually done this and found it to be a better long-term strategy?

2) What sort of numbers on the lease option did you use such that it worked out for you?

[Brian Gibbons]

I find this information very helpful for all "novice" North Carolina lease option investors.

Another reason why a lease plus ROFR is easier than a Lease plus Option.

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Big Changes to North Carolina Lease Options in 2010
If you, the landlord, ever offer your tenants a lease option to purchase the rental property then you should learn about this new law. 

The Homeowner and Homebuyer Protection Act, Senate Bill 1015 takes effect on October 1, 2010, and can be found at http://www.ncga.state.nc.us/Sessions/2009/Bills/Se....

What options are affected?
The new law affects all options to purchase contained in a lease, or executed concurrently (at or near the same time) with the lease. If you offer an existing tenant an option to purchase then this law should affect you.

Are there any changes to the option contract?
The option contract is now required to be in writing and given to purchaser.
Further, the option contract must be recorded by the seller at the register of deeds within five business days after signing by both parties.

In the alternative, the seller can record a "Memorandum of Option Contract," which must contain the names of the parties, the signature of the parties, a description of the property, the time during which the option must be exercised, and a statement that the purchaser has the right to cure a default once every twelve months.

The option contract itself must contain:
1) full names and address of all parties to the contract;
2) the date the contract was signed by each party;
3) a legal description of the property to be conveyed subject to the option;
4) the sales price of the property;
5) all fees or payments paid by each of the parties including the option fee;
6) all duties whose breach will result in forfeiture of the option;
7) the time period during which the option may be exercised;
8) a statement of the rights of the purchaser, including the right to cure a default once during each 12 month period; and
9) a statement in at least 14 point boldface directly above the purchaser’s signature, that the purchaser has the right to cancel the option any time prior to midnight of the third business day following the signing of the option.

What happens if the purchaser defaults?
In the case of default, as stated above the purchaser has the right to cure once every 12 month period. The seller must be given at least 30 days from receipt of the notice before he is evicted or loses the option. Additionally, the seller must provide a written notice of default that advises the purchaser of:
a) the nature of the default, including the amount if the default is a failure to pay;
b) the date by which the purchaser must cure the default or the option will be forfeit; and
c) the name and address of the seller or the attorney for the seller.
The notice of default must be served by hand, sheriff, or certified mail or equivalent.

What if the purchaser does not remedy the default?
The seller must obtain and record a mutual termination executed by both the purchaser and the seller, or obtain a judgment by a judge of competent jurisdiction that terminates the option and extinguishes the purchaser’s right of redemption. The judgment must be recorded at the register of deeds as well.

After the default notice has been served, and not cured within 30 days if it is the purchaser's first default of the year, the seller may move forward to cancel the option and the purchaser's equitable right of redemption by either:
a)filing an agreement terminating the option, signed by all parties, at the register of deeds; or
b)obtaining a court order terminating the purchaser's option, and filing the order with the register of deeds.

What if the seller defaults?
If the seller defaults on a loan secured by the property during the option period the purchaser may cancel and rescind the option contract. The seller will have to return all monies paid by the purchaser under the option, less the fair market rental value of the property while it was occupied by the purchaser and compensation for any damage to the property by the purchaser that is beyond normal wear and tear.

What are the penalties for violating the act?
A violation of this act is an unfair and deceptive trade practice subjecting the seller to treble damages and attorney’s fees, as well as equitable and declaratory relief.

Are there any other changes taking place?
YES, there are new rules governing purchases with lease backs, and installment land contracts. You should read the act in it is entirety and/or contact competent legal counsel.