Rent with Option by Real Estate Investors Society

Rental Management Edition

When it becomes hard to sell property, Rent with Option seems to become increasingly popular. If only everyone knew what it was! Contracts commonly referred to as Rent with Option actually include three forms that are very different, often confused and most people don’t know the difference.

In a pure Rent with Option, we have a “unilateral agreement.” That is, only one party is obligated to perform, hence the word “option.” The tenant/buyer has the absolute option NOT to close the deal. Correctly done, the contract would have an up-front payment, non-refundable, deemed to be the Option Fee. There could be other fees, benefits, penalties or incentives, but in the end, the seller does not have the right to sue the buyer to perform.

The next contract in the trio is the First Right of Refusal. Here, there may be no obligation by either party to do anything except, the landlord must offer the property to the tenant before selling to anyone else—that includes mom, brother, cousin—the tenant has the first right. What is too often the case is that the contract just says “Tenant has the first right of refusal.” What the heck does that mean? What if I offer it to the tenant at $120,000 and he says, ”No.” I then list it for $120,000 and get an offer of $110,000 (or $119,500 or any other price.) In all likelihood, I must return to the tenant and re-offer the property at the lower price before I can accept the 3rd party offer. How long does the tenant have to decide? Does the right expire when the lease is up? What about an extended lease, month-to-month for several years after the initial lease? Failure to adequately cover these scenarios and questions would likely be deemed to be granting the tenant an indefinite First Right—something Tenants in the District of Columbia have, by law.

Finally, there is a Lease Purchase. This is our favorite. This hybrid or combination of a lease and a contract of sale covers everything. The lease governs the tenancy as if the sales contract did not exist. The contract governs the purchase as though the lease did not exist. Both are tied together with a simple one-page document. There can be up front money, or not. There can be rent credits, or not. There can be a change in price depending upon how quickly the buyer closes. There most definitely would be penalties of the buyer did not close.

There are laws governing all of these instruments and, if not prepared correctly, either party could be in deep trouble. Again, our favorite is the Lease Purchase and it works best when prices are stable (like now) or changing very slowly and reasonably predictably. Should the contract go two or three years before closing, there could be changes in appraised value or changes in mortgage qualification or structure. Interest rates could also be a factor. The shorter the fuse, the better. Incentives to encourage a fast close are advisable. Remember, whatever you call it, a tenancy over six months is a tenancy that requires rental licenses and lead paint compliance. These tools are best used to help a tenant who is a bit short on cash to close or has very minor credit issues that can be quickly resolved. It is NOT a way to get a large, non-refundable deposit from a person who has no possible way to close—if you’re thinking about that, you better consider how you look in an orange jump-suit or strips.

Chris Majerle, PCAM

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