purchase options

Buy a Tenant’s In-the-Money Purchase Option


While options aren’t totally uncommon in something like a commercial real estate development, straight options are rare on houses.  They usually involve a tenant having the option to buy a house within some term such as 3 years.  Most residential landlords would never give a straight option to another investor to buy the house at some point down the road.  They would look at it as limiting their upside while still having an empty house to rent.  However, leases with purchases options are used occasionally.

Let’s take a house that would normally rent for $1,000 a month.  The landlord may allow the tenant to lease the house for $1,300 a month, with the extra $300 being credited toward an eventual purchase within some set period of time, often 2-3 years.  If the market value of the houses is $180,000 at the beginning of the lease, the landlord may set the purchase price at some higher figure, such as $190,000.  Sometimes the price is set at a level that it will only get to if there is substantial appreciation, say $220,000 in this case.

Landlords benefit from the extra cash flow the option money provides.  They also go into lease purchase options many times thinking that a.) the tenant is unlikely to ever qualify for a loan and be able to purchase the house and/or b.) the price is so far above current market value that it is unlikely that the option will ever be in the money.  Both of these tend to be true.  What you want to find as an investor is the rare situation where the house has actually appreciated above the exercise price, and where the tenant is either not in a position to buy the house (due to poor credit, lack of down payment, etc.) or is qualified but does not want to buy the house for whatever reason (relocating, bad memories, found a better house, etc.).

Let’s use the example figures above.  The tenant has been leasing for 3 years and has $3600 x 3 = $10,800 built up as a credit toward the purchase price.  They locked in at $190,000 but the value has actually shot up to $240,000.  If they exercised the option, they could have a $240,000 house for $190,000 minus $10,800 = $179,200.  So they have potentially $60,800 in equity (minus closing costs, etc.).

There are a couple of ways you could complete this deal.  If the purchase option is assignable, you could pay the tenant something for the option.  The second way is that you could find a title/escrow company to perform a simultaneous closing with the tenant buying the property from their landlord and immediately selling it to you.  It is possible that it would not require them to put up any money.  On your end, you would most likely need to pay cash for the property or possibly use hard money.  Conventional lenders would run away from the deal.

Obviously there are a variety of issues to deal with.  Landlords probably aren’t thrilled that someone is going to make money off their rental property.  Simultaneous escrows present a slew of issues that cause some title companies to avoid them.  Finding a deal will not be easy as there is no database like the MLS in which to find tenants willing to sell their options.  However, someone willing to navigate through the issues is likely to be investing in niche that does not have a lot of competitors.

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