Lease option to purchase multi-family

[Jeremiah Chase Wood]

Hey my name is Chase and I'm a newbie looking for my first rental property.  I have done two flip homes but am looking for a buy and hold.  Ive had my eye on one for a while and have negotiated a good purchase for it however my funds are tied up in my current flip and a spec house im building.  I was offered by the seller to do a lease option but I am unfamiliar with it.  Does anyone have any experience buying a small multi-family with a lease option?

[Erik W.]

No direct experience with a small multi-family lease option (LO), but the process is the same regardless of whether it's a SFH or a 1000-unit mega-plex.

I'm going to outline the basic format of an LO, in case you're not familiar.  There are at minimum two parties: the optionee and the optionor.   For the sake of simplicity, let's just call them the buyer and seller, since that's what (hopefully) ends up being the relationship.  The Buyer (optionee) pays a sum of money called the Option Fee (or price) to the Seller (optionor) that gives him the right to purchase a piece of property at a designated time in the future for an agreed upon price.  The option does not say the Buyer MUST buy, only that he has the option to buy...hence why it's call an option contract.  The Buyer can walk away, no fuss, no foul, and all he's out is the Option Fee.

There are several key concepts.

1) Set sale price regardless of what the market does.  This can be good or bad.  If the market goes above the option price, the Buyer is happy.  If it drops, the Seller is happy.

2) The Buyer may include language that he may use the property as a rental to generate income during the option period.  This give him the advantage of getting to "try before I buy".  You can learn about the property and see if there are any deficiencies that would make you not want to buy it.  For example, let's say 3 months after you draw up your option, you learn that there is an old, covered environmental waste disposal site 100 feet from your property line that is causing cancer in tenants.  Yeah, you want out of that deal....yesterday.

3) The option period gives the Buyer time to raise funds to close the deal.  Assuming the option is an "exclusive right to purchase", no one else can step in and buy it out from under him.  Many options are exclusive, but not all.  Sometimes an option is simply an agreed upon price, but the Seller can still sell to someone else if they come along.  Be sure to address this in your option contract by saying it is exclusive.  Be ready to pay a larger option fee for an exclusive right vs. non-exclusive right, though.  You are buying the Seller's right to sell the property to anyone else for a period of time.

4) If the Buyer defaults, it's not like an owner carry mortgage where the Seller would have to go thru a lengthy and expensive foreclosure.  He still has title and can simply declare the deal breached, keep the option fee, and evict the Buyer if needed.

That's very high level and there is much more to say about it.  In uncertain times, a lease option is a great way to help mitigate uncertainty while still doing business.  Done properly, I think it's a great way to buy/sell any real property.