Lease option techniques to sell to a tenant

[Austin M Kauth]

I have a current tenant who would like to buy a rental house he's leasing. I'm thinking of doing a 2 year lease with option to purchase.

I'm curious the opinions of the group

1. How much down?

2. How much rent credit each month?

3. What happens to original security deposit from original 12mo lease?

4. How did you decide on a fair purchase price looking forward a year of two?

[Kevin Sobilo]

@Austin M Kauth, these kinds of deals tend to be messy and are often unlikely to conclude with a completed sale. So, why would you want to enter such a deal as a seller?

1. Are you trying to gouge the unsuspecting tenant and get a higher price from them than you could get anywhere else? This is common. The seller sets the price higher than market price and between the down payment and any monthly principle payments the price eventually gets down to market price by the time the tenant could potentially buy the house. Of course then the tenant still needs to come up with another down payment to close the loan.

2. Are you intending to take the house back? A lot of sellers who offer this kind of deal know full well that the tenant is VERY unlikely to correct their situation and be able to get a loan to close the deal even 2 years later. So, they take a large up front payment, pawn things like maintenance off onto them and in 2 years they take the house back?

3. Are you prepared for when things go sideways? What happens when the tenant has an employment disruption and doesn't pay rent? Do you evict? Do you owe their principle payments back?

4. What happens if they don't close within 2 years? Do you have to pay back those principle payments? Do you owe them interest on that money? This could be state dependent, but just illustrates some of the unnecessary complexity in a deal like this.

If I was going to offer to sell a tenant a house like this, first I would want to know why they can't buy it today and understand that they have a solid plan to rectify that. I don't want to knowingly enter into a deal that isn't good for both sides.

Then I would only offer a deal that was SIMPLE. A lease and an option are two SEPARATE things. They would lease from me as normal! I would sell them an option to purchase within a specified time frame at a set price. The price would be today's market price as negotiated between the parties. Neither of us can predict the future price (nobody can).

This way you still get a security deposit from them and evict if they don't pay. You still maintain the property as usual and you don't have to track how much money is being paid down on the purchase. If they want to put money towards the purchase, they can set it aside and save it as they will need money for a down payment and closing costs when the time comes.

If they don't complete the deal in 2 years, there is no messiness as their option period simply expires and the purchase portion of the deal is done. They could still continue to rent. 

[Matt Brown]

I have done this several times and is my primary method of providing rentals which if done correctly, actually does help people. There are several components to keep in mind, none are too complicated.
Provide a Purchase Option and a Lease Agreement as separate documents, if they dont pay rent, you can just show the lease agreement to the courts (without showing the Purchase Option and complicating the eviction). Id suggest 2 or 3 yr term on both. 

Set a minimum non-refundable “Option Payment” of around $2,000-$3,000 (affordable) with a $50-$100 monthly rent credit. For every $1,000 above the minimum that the tenant decides to initially “put down”/pay toward the Option Payment, reduce the monthly rent by $50 and increase the monthly rent credit by $50-$100. This way, if the min. Option Payment is $2,000 and they put down $6,000 but eventually dont buy it or move out, it is as if it was just a normal rental, the money they put down wasnt lost but rather it reduced the monthly rent by $200 for those 2 years. As if its prepaying a portion of rent at a discount. If they decide to renew/extend, you can/should accommodate them by just rolling the Purchase Option payment and rent credits forward but sign new paperwork, new floor price, new mo rent credit.

Take $1 for security deposit so it is a separate transaction and security deposit not confused by a tenant with the cost of the Purchase Option contract. 

State that the sale price will be determined by an appraisal at the time the tenant wishes to exercise the Purchase Option and set a minimum floor price around current market value or slightly below. 

If/when tenant does decide to buy it, lets say the total sum between rent credits and purchase option payment was $8,000, you can either take $8,000 off the purchase price or as i would prefer, keep the purchase price but produce a receipt as if the tenant already gave you $8,000 in EMD toward the purchase price so it would count as part of their down payment and make it more manageable for the tenant financially to execute the purchase. Again, purchase is determined by an appraisal.

Some people take a very large down payment up front like $30k+, the argument can be made that it makes it easier for tenant to actually buy when it comes time having made a large down payment. However, taking large down payments are often practiced as a predatory method. 

**This should be offered responsibly and should be mindful that the tenant is NOT made to be in a worse position in any scenario as a result of leasing from you. Thank you