If you are entering into a lease/option transaction, it is imperative that you correctly set out the legal rights and obligations of each party up front. If you don’t, it will be much more difficult for the feuding parties, and for the judge, to untangle the mess later. Use these tips to make your next l/o trade profitable.
Keep the tenant as a tenant
If you are using al/o to sell, it is important to note that the buyer is not a buyer until they exercise their “purchase” option. Buyers have significantly greater rights to claim title to a property than renters. If you’re not careful, a judge could later decide that your tenant was actually a buyer, award you an equitable interest in the property, and force you to foreclose rather than evict—something you don’t want to be a part of.
Here’s how to keep things balanced in your favor:
– Keep the lease separate from the option. – Do not use the word “buyer” in the lease and do not reference the option in the lease in any way. The buyer should always be referred to as the “tenant” in the lease and the “option holder” in the option contract;
– Pay the taxes and insurance yourself – The more expenses the tenant pays, the more it will look like a sale before a judge;
– Do not allow unauthorized rehabilitation – Buyers fix their properties, renters do not. If your tenant wants to fix the property, make sure your documentation clearly states an approval process for those repairs and proper waivers of any rights to reimbursement or claims for the enhanced value of the property.
– Use 1-year terms – If the l/o needs to be extended beyond that, give the tenant additional options to extend the lease and/or option (in separate agreements of course). Prepare new documents each time;
– Get a security deposit – Renters pay security deposits, buyers don’t. Keep the security deposit in a separate escrow account. You can still request an additional option fee under the option agreement, but keep it separate from the security deposit, just as your lease and option agreement should be kept separate.
Don’t let your option rights disappear with the seller
If you are using the l/o to purchase, there could be a significant period of time between the execution of the l/o and the closing of the property. What happens if the seller dies? What if the seller tries to renegotiate the terms at the last minute? Use the following to protect yourself:
1. Attach an EXACT copy of the agreed upon purchase contract as “Exhibit A” to the option contract. This will leave no doubt as to the agreed terms. It will also make closing much more efficient, as each party will simply need to execute the pre-arranged contract and give it to the title company to get to closing.
2. Certify and register the option contract. Most land record clerks will allow you to record this document, and while it is not an official “lien” on the property, the act of recording should act as enough of a “cloud” on the title to create problems for the seller.
3. Consider a “deed in escrow.” Don’t try to do this on your own. Ask a real estate attorney to help you craft this agreement. If done correctly, you may just have to give the payment to the escrow agent in exchange for the deed to the property. It can also be a great safety net in case the seller dies or doesn’t live up to their agreement to sell you the property.
Avoid these lease/option land mines and you will better protect your profits. And always remember to have a good real estate lawyer on your team!
