Lease Option a Property (from a Seller’s Perspective)

Most of the time, as real estate investors, we are buy on lease option for a property’s cash flow, appreciation potential, or time to get our financing in place. What happens when one of our tenants wants us to option a property to sell to them?

This recently happened with me. I want to share this story with you, so you can see how, as real estate investors, we can sell property by optioning to tenants. Read on as this situation has a unique twist.

My tenant has been in this property three years. This is a nice home in a good family neighborhood 4 bedroom, 3 baths, 3 car garage near schools, shopping, and work. The tenant’s credit score is under 600 due to problems with a judgment and bankruptcy.

They came to me and asked if they could buy the property and have me finance the sale for them.

Why I didn’t want to carry the financing

Though they have made their rental payments on a timely basis over the last three years, if I were to owner finance the sale, a few things would happen that could put my position in jeopardy.

  1. I have a very low interest rate mortgage on the property that is non-assumable. Half pregnant (meaning my loan-to-value (LTV) is well under 50%). I want to keep this mortgage in place and not be in a position of having the loan called. Though most institutions are not policemen, I know of two investors who recently have had the “due on sale” clause called.

  2. The tenants payment would go up over $600 per month with ownership versus renting. Based on my due diligence, I was unsure as to whether they could afford that much of an increase each month. Their debt ratio would have been over 40%.

  3. I know I could get a sizable option consideration payment, but don’t know if they will have the ability to fulfill the contract in the time allotted.

I sat down with my tenants and told them that I would be willing to sell the property to them under an option agreement. This is a separate agreement from my lease for two reasons.

Why an option was better

  1. As many of you know, I have a unique lease. I did not want that lease altered in any way, because it does a good job of protecting my rights and enforces items that are not standard in a typical lease.

  2. My tenants want to finish the basement. That major job had to be addressed. We did so in the option agreement.

A unique option clause

We had our attorney draw up a clause that no work would be done without our written approval, the contractor would have to provide copies of their license and worker’s compensation insurance covering any workers on the job, as well as the tenants proof of financing the job to completion.

In other words, they have to have the money to finish the job. NO MONEY, NO BASEMENT FINISH. Plus they have to post the following notice on the premises:


Notice is hereby given that the owner of the within premises has not ordered any construction or reconstruction or improvements on these premises; and the owner’s interest in the premises shall NOT be subject to any lien on account of any construction, alteration, removal, addition, repair of other improvements to the premises.

Yes, this is attorney language.

Why would we go through this effort? Because we don’t want a half finished basement! The tenant wants to finish the basement. We will only allow this if they have the money and it is done by a professional contractor.

Since I have no idea when they can come up with the money, which may not happen until after they exercise their option, IF they exercise their option, there is no way I want to be unprotected.

A large option consideration

My tenants put up a considerable sum for the option consideration. They feel if they don’t exercise the option within the time period allowed, which is one year with a renewable second year, they would look at the consideration payment as an increase in rent.

Obviously, if they do not exercise the option, I keep the money and have the right to draw up a new option with them if I desire. I keep the same tenant for two more years, and I have options if they don’t fulfill their agreement.

We all win

This is a property that I can live with or without, so it is a good one for me to option. If they exercise the option, I will trade my interest in this property for another. Beside the option payment, I am getting an inflated price for the sale of the property. I feel we all win.

If my tenants get conventional financing, I get to trade up; if they don’t, I get to renew the option with them or just continue to rent the property, and finally the mortgage will be paid down to the point of a very low LTV with a short time left on the mortgage. Plus, since my entity still owns the property, I could borrow against it should I ever need to.

That said, if you ever decide to option a property make sure your option agreement meets your needs. It is easier to explain to the tenant what is needed, since you are in the power position at the time, then to have someone else dictate their rules to you!

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