Lease Option Pitfalls to Avoid

You can’t buy a parachute after you jump out of an airplane. Likewise, jumping into real estate investing without the proper education can be a more costly real-life “seminar” than the one you chose not to attend.

Some may say, “The seminar is too expensive.” I say, “Compared to what?” Compared to making a costly mistake, the seminar is cheap. Here are a few lease option pitfalls of which you may not be aware:

Make sure the owner is making payments

If you are in a “sandwich” position wherein you are leasing a property from an owner (with option to purchase) and subletting to a tenant, you want to make sure the seller is paying his mortgage.

If he doesn’t pay, you can get wiped out in the event of foreclosure. You can always make up his payments and deduct it from what you would otherwise owe him, but this could be more money than the deal is worth. You want to find out early if the seller is not making his payments.

The easiest way to make certain that the seller is making his monthly payments is to setup an escrow. There are companies in every city which, for a monthly fee, will collect your payment and make the seller’s payment for you.

Some banks now have a 24-hour toll-free customer service line that permits you to enter the borrower’s loan number and social security number to verify when the last payment was made.

Federal disclosure requirements

It amazes me how many lease option “gurus” forget to teach their students about disclosure requirements. Even if you are not the owner of the property, you are required to disclose.

Federal law requires that the lessor of any rental property constructed before 1979 disclose the presence of any lead-based paint or hazards known by the lessor and provide the lessee with all reports in his possession. This applies even if you don’t own the property and are just “sandwich” leasing.

In addition, the lessee must be provided with an EPA pamphlet entitled “Protect Your Family from Lead in Your Home,” and be given a 10-day period to conduct an inspection for lead-based hazards. It is advisable that you have your tenant sign an acknowledgment that you have complied with these requirements.

State disclosure requirements

Disclosure is the name of the game in real estate today. When in doubt about whether to disclose something to the tenant, do it and do it in writing. Some states have extensive disclosure requirements on leases and sales. For example, California requires disclosure of “seismic hazards” in certain areas.

Many states now require Radon Gas disclosure. One student of mine recently emailed me that the state of Ohio requires written property disclosures about the condition of the property upon the execution of a lease option agreement.

The point is that a lease option may be construed and/or confused by your state officials as a sale. Thus, when you lease option, you should disclose to the tenant any item that may be required to be disclosed if the transaction were an outright sale.

Buyers have a short memory

It’s easy to find a tenant/buyer for your lease option properties. The cash they give you up-front is non-refundable and tax-deferred income. If the tenant does not exercise his option to buy, you keep his money and find a new one. Sounds rosy, doesn’t it?

What the “gurus” don’t always tell you is that tenant/buyers who don’t exercise conveniently “forget” that the money isn’t refundable. They often sue you to try to get it back. This is why it is important to make sure your paperwork is in order and that everything is clearly spelled out. Consider tape recording your conversation with the tenant/buyer, so you can “refresh” his memory.

Ignorance can be more dangerous than education. Of course, “doing” is as important as learning. You don’t need a “PhD” in real estate investing to do your first deal. Read some books, take some seminars, join a local investment group, and visit CRE Online often! Then . . . take ACTION!


By CREOnline Contributor

A content contributor to the original