A lease option is also called a lease purchase option, and it is a contract between a property owner and a tenant wherein the property owner allows the tenant the right to purchase the property at a pre-determined sale price at any time up until the expiration of the lease period.
An up-front, consideration fee or deposit for the property may be required by the property owner; alternatively, the tenant may be required to make higher than standard rental payments, from which the property owner may set aside a specified portion of the monthly rental payment to be accumulated in a separate fund towards the consideration fee. When and if the option is exercised, the consideration money is put towards the down payment on the property.
The benefit to the tenant in a lease option is the opportunity to purchase the property at a pre-determined price at a later date, but only up until the expiration of the lease period. If the property values appreciate substantially, the tenant enjoys the appreciation with immediate equity. On the other hand, should property values drop, the tenant can choose not to exercise the purchase option, but in so doing, forfeits the consideration fee on the property. The consideration fee would also be forfeited if the tenant is unable to obtain purchase financing at the lease end. The tenant may also risk the voidance of the lease option contract by an unscrupulous seller who sells the property on the open market; this risk can be mitigated by the tenant’s filing of a notice of the lease option in the public records.
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The lease option benefits the property owner because in a down turned market, they may be able to sell the house for a higher selling price and they already have a purchaser anxious to buy. The property owner derives income from the lump sum consideration fee or regular cash flow from the increase in monthly rental payments from the tenant. Finally, if the tenant does not exercise the option, the consideration fee is retained by the property owner. The real risk to the property owner is the possibility of significant property appreciation during the lease period, resulting in a property value in excess of the pre-determined purchase option price. The lease option contract provides that the owner will not sell the property in the open market, because the lease holder is given the first option to purchase.
Sources:
http://www.realestateabc.com/answers/option.htm http://www.realestatejournal.com/columnists/housetalk/20070702-fletcher.html http://www.bankrate.com/brm/news/real-estate/lease-optiona1.asp
