Real Estate Investment
What is a Lease
Option?
A lease
option is usually made up of two parts:
o Lease or rental agreement
o Option
The lease option may
be written together as one contract or else as two separate contracts. The
Lease is simply a rental agreement between the owner and the potential
lessee also known as the tenant and most often, these leases will be
'triple net lease' leases or the NNN leases in which the lessee or the
tenant is responsible for paying for the taxes, insurance, maintenance,
and upkeep of the property. The lease payment is normally 5-15% higher
than what might be the rent for the same property. This type of lease can
be structured so that the lessee can make use of the tax benefits as if he
were the home owner.
What is a
Sandwich Lease Option?
A lease option is
referred to as a sandwich lease option when it is simply using a lease
option to buy a property and then immediately selling it on another lease
option. Generally as the seller you would collect a larger option premium
and a proportionately larger monthly lease amount, which would keep the
spread between either of them as their profit.
The lease/option strategy is a great way to leverage your real
estate investments since it requires very little cash. The lease / option
is more of a financing alternative than a financing strategy since you do
not own the property. The basic lease / option strategy involves two legal
documents namely, a lease agreement and an option.
The lease gives you
the right to possess the property, or, as an investor, to have someone
else occupy it. In case you can obtain a lease on a property at a rent
below market norms, you can profit by subleasing it at market level
rent.
An option is on the
other hand, the right to buy a property. It is a unilateral or one-way
agreement wherein the seller obliges himself to sell you the property, but
you are not obliged to buy. By obtaining the right to buy, you gain
complete control over the property and you can market the property and
even sell it for a profit. The longer you can control the property in an
appreciating market, the more value you successfully create for yourself.
Thus by combining a lease and an option, you create a lease /
option.
What are the
various Financing Alternatives?
The two most important
objectives of the real estate investor are cash flow and appreciation. You
don't necessarily need to own a property to make cash flow or to benefit
from appreciation. A lease entitles you to possession, which in turn
allows you to create a cash flow. An option gives you the right to buy at
a set price, which in turn allows you to benefit from future
appreciation.
Does a Lease
imply The Right to Possession?
Yes. Under a lease
agreement, the lessor or landlord gives the lessee or tenant the right to
possess and enjoy the property, which is the most important benefit of
real estate ownership. The lessee is normally not responsible for property
taxes or major repairs. Once you have the right to obtain possession of
the property, you stand to profit by subletting or assigning your right to
possession.
What is a
Sublease?
A sublease is a lease
by a tenant to another person called a subtenant, of a part of the
premises held by the tenant under a lease. The sublease can either be for
part of the premises or part of the time period. For instance, if the
tenant has a three-year lease agreement with the landlord, he can either
sublease the rental unit for two years, or else sublease part of the unit
for three years.
What is an Assignment?
An assignment is a
transfer of the whole of any property or any estate or right therein to
another. As with a sublease, the master tenant is again not relieved from
liability as part of obligations, if any, under the lease. However, the
assignee of a lease is in contract with the landlord, and hence the
landlord can collect from the assignee or the master tenant for nonpayment
of rent. Assignment and subletting are always permissible as long as there
is no explicit provision in the lease forbidding the tenant from doing so.
As a tenant / investor, it is imperative that there is no anti-assignment
or anti-subletting clause in your lease with the owner of the property
before you engage in the same.
Do Options
imply The 'Right' to Buy?
A real estate sales
contract is a good example of a bilateral or two-way agreement as per
which the seller agrees to sell, and the purchaser agrees to buy. Compare
this agreement with an option which is a unilateral one in which the
seller is obliged to sell, but the purchaser is not obliged to buy in any
manner what so ever. On the other hand, if the purchaser on a bilateral
contract refuses to buy, he can be held liable for damages.
A bilateral contract
with contingency is hence similar to an option. Many contracts contain
contingencies, which, if not met, can result in the termination of the
contract. Essentially, a bilateral contract with a contingency in favor of
the purchaser converts a bilateral contract into an option in the sense
that it gives the purchaser a way to opt out if he decides not to purchase
the property. Though the two are not legally the same, an option and a
bilateral purchase contract with a contingency does yield the same
practical result. The receiver of the option called the optionee usually
pays the giver of the option or the optionor some non-refundable option
consideration, in the form of, money or other valuables for the right to
buy. If the option is exercised, the relationship between the optionor and
optionee turns into a binding, bilateral agreement between seller and
buyer. In most cases, the option consideration is credited back towards
the purchase price of the property and if the option is not exercised, the
optionee forfeits his option money.
An option can be used
to gain control of a property without actually owning it in the following
ways:
o A speculator who is aware of a proposed development can acquire
options on farmland and then sell his options to developers.
o In
order to take advantage of appreciation in a hot real estate market, an
investor can use a long-term option to purchase property.
o In order to induce timely rental payments, a
landlord can offer the tenant an option to purchase. There are several
hundreds of ways that an option can be structured and every detail is open
for negotiation between the optionor (seller) and optionee
(buyer).
Can an
Option Be Sold or Exercised?
Yes. An option,
similar to a real estate purchase agreement, is usually a personal right
that is assignable. In case you were able to obtain an option to purchase
at favorable terms, you could sell your option. The assignee of the option
would then have the same right to exercise the option to purchase the
property. As with a lease, an option is freely assignable in the absence
of an express provision in the option agreement stating
otherwise.
What are the
Alternatives to Selling an Option?
Rather than selling your option, you may
wish to exercise the option yourself, and then sell the property to a
third party buyer in a double closing.
