Why Sellers Offer Lease Options
In the previous post we looked at lease options from the buyers’ point of view.
There are two main reasons sellers will entertain a lease option, profit or necessity. Both reasons attempt to exploit the strong desire for homeownership. The number of buyers that can’t qualify for a mortgage is swelling. The overall economy is not great, unemployment is high, even people that had good credit histories are now being squeezed.
Any shift in the market creates both problems and opportunities. Real estate is no exception. There is an abundance of properties for sale, the amount of inventory far exceeds the number of qualified buyers. Many sellers that are unable to sell their homes are leasing them so they can move on. People relocate for many reasons, jobs, health, family or maybe just to get a better view. The problems created by the recent meltdown have made it necessary for many sellers to take measures they would never have considered a few years ago.
It has also created a niche that is being exploited by many investors out to make a profit. There is absolutely nothing wrong with making a profit, our entire financial system is based on the concept of profit. However, there is a fine line between a legitimate profit and taking advantage of someone’s misfortune. We can find plenty of evidence that is happening on a daily basis.
Some investors understand the opportunities very well and are able to exploit the circumstances. Since World War II real estate has been oversold. The downside of homeownership, the liability factor, has been overshadowed by the industry’s sales pitch. The result is an almost rabid desire for homeownership. The most common forms of mortgage fraud are for ownership, not profit. This extreme desire to own a home is the foundation that creates the opportunities to be exploited. People will do anything in order to own a home.
Many people will try to work around the very mortgage system that protects them. Mortgage underwriting guidelines are actually very liberal in spite of everything you may hear about how hard it is to be approved for a loan. The actual hard line numbers in the guidelines are more liberal today than they were when I first became a loan officer in 1991. If you do not qualify for a mortgage it may be a good idea not to circumvent the system that is protecting you.
However, in the real world that isn’t how goes down. Already mentioned, some people will do anything in order to own a home. This is why we find plenty of investors willing to offer a lease option. They can sell a home without really selling it.
Here is how it works; the investor buys a home at a good price, usually way below market value, makes any needed repairs then offers to lease the property with an option the purchase. The option will usually be at or often way above the market value. The “buyer” enters a lease and makes a very sizable non-refundable payment for the option to purchase. If the buyer does not exercise the option to purchase the investor keeps the money paid for the option. The investor also receives full market rent, sometimes a little more rent than a market rate.
It isn’t unusual for a portion of the rent to be a credit towards the purchase price. The investor knows the likelihood the buyer will actually close on the purchase is slim so it doesn’t matter.
It should be obvious once you understand how it is structured that it can be easy to exploit. The investor can rent a home; collect a huge hunk upfront and “sell” the same house multiple times.
Why do so few lease options result in a transfer of title to the buyer? It starts with the beginning motivation; the buyer doesn’t qualify for traditional financing. Something you may remember from high school a body in motion…
The buyer is overly optimistic and underestimates the seriousness of their original problem. A well-meaning loan officer may have told them they will be eligible for financing in two years. They structure the lease option for how long? Two years of course!
But they didn’t listen closely, the minimum time line was two years, that doesn’t mean “their timeline” is two years.
The profiteer will take advantage of this combination of keen desire and over-optimistic timeline to structure a deal that has a very high probability of not working out for the buyer. The investor wins either way, they get money up-front, agree to sell the property for more than it was worth in the beginning and also receives hefty rent that doesn’t reflect the big down payment. If the buyer defaults the investor wins if the buyer exercises the investor wins.
In the next post we will look at sellers that offer lease options out of necessity.