Planning a Rental Home Sale with Lease-Purchase

Entering 2018, the new tax bill and growing economy are expected to bring buyers, particularly first-time homebuyers back to the market. While some Millennials are still living at home, many are renting, and many others who just haven’t had a lot of enthusiasm for buying are on the fence as well.

The glass half empty view for rental property owners could be that they expect to lose some tenants and possibly have more competition to get new tenants in at rents that cashflow well. Those are valid concerns, but the glass is also half full.

With things getting better, perhaps you want to think about rolling up and putting your rental home profits into better neighborhoods or higher priced homes. The tax bill didn’t change the 1031 Tax Deferred Exchange, so you can do so without capital gains concerns.

If this idea is enticing, do you have tenants who like or love the home they’re renting from you? For many, particularly first-time homebuyers, they are getting into the mood to buy, but they still need to either improve their credit or save more for a down payment. If they really like the home, perhaps you should give them another option as opposed to looking for a home to buy and moving. If they’re interested, you can structure a lease-purchase (rent-to-buy) deal to give them the time to save their down payment and if necessary work on their credit score.

This gives you some advantages:

  • You can schedule the sale of the home in the future; often these are three to five-year lease purchase deals.
  • You should be able to negotiate a non-refundable option fee up-front, often these can be between $1,000 and $3,000. It can be structured to apply to their down payment and gives them some “skin in the game.”
  • You can continue with their current lease amount, and even structure in some increases in advance.
  • Many lease-purchase agreements also have negotiated repair clauses such that the tenants take over minor repairs or improvements. They want to own it, so they may decide to upgrade a water heater for more hot water and lower costs of operation.
  • At the time of signing, they agree to a stated purchase price that can be based on expected appreciation.

There are benefits to them as well. They now have a guaranteed option to purchase on or before the expiration of the contract, and they can begin to plan on improving the home to better meet their needs.

Of course, they have the option to buy, not the obligation to do so. They can go the full term and then move if they want. They can also move out sometime before the full term with normal early termination terms, or some of these deals allow their initial option fee to be liquidated damages for a broken lease; it’s up to you.

Another advantage to you as an investor is requiring substantial notice if they intend to exercise their option to purchase, as they may decide to do so early. You need the time to find a replacement property and meet the timeline requirements of a 1031 Exchange. Should they leave at the end of the lease and not buy, you can simply install another tenant and/or put the home up for sale if you want.

Of course, check your state’s laws concerning lease-purchase, and it’s best to work with a real estate attorney to draft a proper contract to protect your interests.

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