For some renters longing to enter the housing market, the likelihood of coming up with enough cash for a down payment may seem like a pie-in-the-sky notion.
”A lot of people want to get into the market now who have good incomes, but they`ve never saved a lot of money,” says Barbara DaVee, a real estate agent with Beliard, Gordon & Partners in Chicago.
Still, even if you fall into this category, you may be a candidate for a lease with an option to purchase, a lesser-known means renters can use to acquire a condominium or house-gradually.
Under a lease-option agreement, as it`s commonly called, the owner of the unit grants the renter a lease (for a specified term) that gives the tenant the option to purchase the unit when the lease expires.
As in other rent situations, most owners require a security deposit to cover any renovation or structural changes made by the tenant during the lease period. And, though the tenant is not required to make a full down payment initially, the renter usually pays a consideration for the option that may range from several hundred to a few thousand dollars. In addition, a portion of the tenant`s monthly rent (commonly called a ”rent credit”) is set aside by the owner to be applied to the eventual down payment-if the tenant exercises the option to buy at the end of the lease.
In return for the flexibility offered by lease-options, tenants are charged higher-than-market rents, with their monthly payment covering not only the owner`s expenses but also the contribution to the down payment. These tenants run the risk of losing the rent portion that`s set aside toward the down payment; more often than not, neither that money nor any consideration paid upfront is refundable if the tenant decides not to purchase the unit. For that reason alone, real estate experts say, the prospective tenant should be fairly certain he or she will indeed want to exercise the option at the end of the lease.
Time and flexibility
What the tenant gets out of the deal is first rights to purchase the house or condo in which he or she has been living, at a predictable price (set at the time the lease starts), without having to put down a major chunk of cash upfront. The arrangement also creates a sort of forced savings plan in the form of the rent credit and buys time and flexibility for renters interested in a particular house or condo unit, but not yet ready to commit to a mortgage.
This group might include, for example, transferees from out of town who want to try out a neighborhood before buying; those with a specific, temporary cash flow problem such as medical bills; or those with the good prospects for a sudden increase in earning power, such as the impending completion of medical school.
Josie Vondra, a sales associate with Cyrus Realtors in Evanston, worked with a couple considering a lease-option for still another reason. ”They had lived all their lives in a larger space and weren`t sure yet they`d be happy in something smaller,” she says.
A little TLC
The lease-option offers many benefits for owners, too. The owner gets an assured income from his property in what may be a sluggish housing market, plus a tenant who`s likely to show the kind of tender loving care to the unit that`s usually accorded by owners, on the theory that they may one day be the owners themselves. Also, even if the deal does not work as planned, the owner in most cases gets to keep any consideration or rent credit that the tenant has paid over the course of the lease.
However, the owner also absorbs a certain amount of risk. The tenant may not turn out to be the sort who respects the property, yet the contract allows him or her first rights to purchase. Another problem is the volatility of the housing market; if prices suddenly and unexpectedly soar, the owner must stick to the terms of the contract, which allow the tenant to exercise the purchase option at what may have become an undervalued price.
Ultimately, say real estate agents and attorneys, whether or not a lease- option is a good deal depends on a mix of factors, the most important of which are the individual needs and objectives of the renters and owners involved.
John Baglivo, a recent first-time buyer, saw the lease-option as a way to ”test-drive” not only a particular condo unit but the feeling of home ownership as well. The 30-year-old marketing manager in August exercised the option to buy the two-bedroom Lincoln Park condo in which he`d been living for the last year.
”I was mixed on whether I wanted to buy yet,” he says. ”I was hoping to build up more toward a down payment, maybe give myself time to get another raise at work first.”
But when the owner of the condo where he had been renting on a month-to-month basis unexpectedly told Baglivo he would have to leave at the end of one month, buying suddenly started to look good.
A down payment at the time, however, ”would have wiped me out,” he says. But the seller of another condo, the one Baglivo now owns, was eager to move the unit and receptive to the idea of a lease-option when Baglivo brought it up with the real estate agent.
For the next year, Baglivo paid $1,250 per month in rent, 25 percent of which was applied to his future purchase of the unit. When the option was exercised, at a pre-set time and price, that money, plus his security deposit, was applied to the purchase price; he put up additional funds to bring his contribution up to 10 percent of the purchase price.
”It really went smoothly,” he says.
Sold on the concept
R`the most underused and least understood residential real estate sales and financial device.” Bruss, who has been involved in a number of such deals personally as an owner, says he typically applies one-third of the rent to the down payment, although in some cases he`s gone higher.
”It`s a great way to get people into houses in a buyer`s market, where there are more residences for sale than qualified buyers who want to buy them,” he says.
Bruss also believes the lease-option brings in ”top-quality” tenants who treat the house as their own. In one of his houses, the tenants installed high-quality Berber rugs at their own expense while still in the lease period. ”Renters don`t do that,” he says. ”Tenants who are renting to buy will.”
However, many agents are less enthusiastic about lease-options, saying they tie up the seller and complicate the eventual sales transaction-and delay the commission they would receive on the sale. Agents polled from areas as far-flung as Chicago`s Southwest Side, Lincoln Park, the North Shore and Naperville say the practice remains uncommon in their areas, so tenants interested in such an arrangement may have to push for one with house or condo sellers.
Mary Kay O`Shea Ellis, broker-owner of Red Carpet Contempo Realty in Oak Lawn, has offered lease-options on several properties that she owns herself. Still, this arrangement hasn`t always produced buyers at the end of the lease. ”Their intentions are to go through with the purchase, but most people not capable of coming up with the down payment will not be able to buy at the end of the option,” she says.
O`Shea Ellis also had an experience that serves as an object lesson to property owners considering the lease-option. One of her tenants said he wanted to make-and pay for-what he described as minor changes to the property, to which she agreed. But the tenant embarked on much more extensive work than he had indicated, including the installation of a high-powered exterior lighting system that got the neighbors up in arms.
When the tenant vacated the house after only four months for various personal and professional reasons, O`Shea Ellis found that about $7,000 of work had been ordered but not paid for, and contractors put a lien on the property until she paid the bills herself. Now, she scrutinizes her lease-option tenants even more closely and requires a security deposit upfront.
Hire a lawyer
Most real estate professionals say that if owners and renters pursue a lease-option, both sides will benefit from having their own lawyers involved in drawing up and reviewing the contract.
The comments of Glenn Browne, a lawyer with the Chicago firm of Braun and Schecter, show that it behooves both sides to inspect every contract detail.
”When I`m drafting (a contract) for a seller, I tie the lessee down as much as possible,” he says. ”There may be a provision in the contract, for example, that requires that the property not be vacant for more than 48 hours. Owners will be reasonable about that sort of thing, but I want to give the seller as many rights as possible.
”I`m not saying there`s no place for the lease-option,” he says, ”but it doesn`t always get people what they think it does.”
