I have never done a lease option before, but I find the method interesting and may want to add it as a tool to use later on.
For the lease option experts out there, what happens if there is a downturn in the property market such that when it gets close to the options expiry date, the property is worth less than the strike price of the option?
For the client, this would mean that the option fee they paid and any credit they accumulated during the term of the option is insufficient as a deposit for them to purchase the house, as the bank will value it less than the purchase price and finance accordingly. The clients may not have enough money to complete the deal.
To me kicking them out after they have been commited for a period of time is not ethical. The other alternative would be to let them buy it at current market value and the investor takes a loss.[blink]
What would others do? The answer to this will determine whether this is a tool I may want to use or not!
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And a couple more I just thought of:
1. Structure the initial Option document so that the tenant buyer has an option to extend the Option for “x” years, under whatever conditions you percieve as ethical.
2. Do the maths on how long it will take your tenant buyer to accumulate, say a 10% deposit using just his/her rent credit alone. Then make the term of your Option that number of years.
The great things about Options is that your solicitor has a pretty good chance of being able to structure them just about any way you desire.
Not one. Although we’d be happy to use the technique in what we regard as the right situation. To date we have used Instalment Contracts. Along with NSW’s Land Tax considerations, Instalment Contracts just seem to suit our clients better than a L/O’s. Maybe it just “in the mind” but an Instalment Contract seems to give them more of a feeling of ownership.
Lease options are normally done with an interest only loan. If you are worried about falling house prices then use a P&I loan. This way at least you are paying some principle. This would bump up the repayments to the buyer but also gives them more equity build.
You can also off set any drop by getting a bigger option payment at the beginning. This way when the time comes to buy you out the house would be cheaper to your buyers. The option payment normally comes off the total price of the house, but non-refundable if they break the agreement. The negative side to this suggestion is you would limit your target area as most people do not have a big deposit.
Another way to approach the problem if your fears were realized and prices did drop would be to offer your buyer a second mortgage carry back on the short fall until prices rose again. This would be fine with the lenders as the buyer still would have X amount of equity already and with a small second mortgage from you the problem would be solved.
Lease options are very flexible it really is your deal in the end.
I would have assumed that there is no need to re-value a property after a contractual lease-option expires, as the contract already dictatess the strike price and the client would therefore have to take a loss, or alternatively, negotiate a renewal of the LO if you were amenable to the idea. Please correct me if i’m wrong, but just as a put option is exercised at the contractual date and value for a stock, as opposed to the market value or inherent value of it on that strike date, so too a market fluctuation downwards for an option strike price in property would be negated. Please don’t take my word for it, I am as much of a novice regarding lease-options as you.
I think the thing to do would be to find out if anyone has ever done one. Gurus can market them and say how great they are, but in my reading, they are really not actualised. One can market anything, and people can even get tenants to buy into them, but how many actually come off, with the tenant actually buying the place?
Check out rick otton’s forum- you can read all about lease options- but as I said, theory is great, but who has ever done one and had it work?