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Understanding the Lease Purchase Agreement is Vital to Safe Transaction - 2008-06-15
Last week we looked at lease-purchase agreements, and saw why they are becoming increasingly popular in metro Atlanta. You might say they represent a short term solution to the very real problem of a very slow selling market in our area.

The owner gets a prospective purchaser who starts paying rent immediately, while the buyer gets a house he may or may not want to buy in the next two or three years. Often, a portion of the rent may apply toward the eventual purchase price.

Here are some typical questions that are asked about the subject of lease-purchase arrangements:

Q: You said that lease-purchase agreements often require the buyer to pay a "down payment" or a "non-refundable fee." Why can't the renter get this back, and how much is this amount?

A: While every part of these contracts is negotiable between the parties, the seller typically seeks a non-refundable fee from the buyer as an indication of the buyer's sincerity. The higher this amount, the greater the confidence the seller has that the buyer will eventually buy the house.

In exchange, it would seem appropriate that a buyer who makes a significant down payment with no expectation of refund could negotiate for a contractually specified price that would allow a bargain purchase anytime over the next three years.

Q: How would things be different under a lease-option agreement?

A: The word "option" means that the buyer has no legal obligation to purchase the house, but has a protected opportunity to do so if he chooses. The option may specify the terms and conditions of the available purchase, but if and when the option expires, the opportunity is usually gone.

Q: Is the price always set up front?

A: It certainly can be. But many lease purchase agreements include price adjustment mechanisms which cause the specified price to adjust with inflation or move up by a set dollar or percentage amount with each month that passes.

I have also participated in a lease-option agreement where the parties agreed to each have the house appraised when the buyer decided to exercise the option. The contract stated that, so long as the two appraisals were within 10 percent of each other, the purchase price would be set as the average of the two.

Fortunately, the buyers appraisal came in slightly higher than mine, so both of us were happy with the sale price.

Q: Is this sort of arrangement fair to both parties?

A: It depends on the goals and the plans of both parties. In other words, as long as both parties go into a lease-purchase agreement with their eyes wide open and are fully knowledgeable about their responsibilities under the contract, then we can assume it is fair if both parties agree to it.

However, I must say that these agreements can be quite complex, calling for serious financial consequences if one party fails to perform or another party decides to live elsewhere. This is why it is so important for both buyer and seller in a lease-purchase to have their attorney fully explain the contract.

Q: Do real estate agents usually offer to negotiate lease-purchase contracts?

A: Typically not. Because most real estate professionals are compensated by commissions from sales, they are often discouraged from pursuing lease-purchases in which the sales commission may not be generated for another three years, if at all.

In addition, know that agents are not lawyers. While most real estate agents have had training in how to assist buyers and sellers fill out forms in typical sales situations, they are not qualified to draft complex lease-purchase agreements, nor to offer advice regarding them.

Q: What percentage of lease-purchase agreements eventually result in a real estate purchase?

A: That figure would vary dramatically with the motivation of the owner of the property.

If an owner only wanted to fill his vacant house and offered an option as a way of attracting a renter, and he truly did not want to give up ownership, I suspect that the likelihood of an eventual sale would be less than one in ten.

In contrast, if the owner was truly motivated to sell and was willing to offer generous inducements to a renter while that renter improved his credit and built up a downpayment, then the chances might be as high as one in two.

Remember that in the world of real estate, three years is a long time, and people's lives are constantly changing. The same is true for their real estate needs.

Investors I talked to around Atlanta say that about one in three agreements eventually turns into a sale, and that it's hard to do much better than that.

Q: If I enter into a lease-purchase agreement, shouldn't I have an inspection of the property in the weeks before I finalize the purchase?

A: While you are certainly entitled to have an inspection anytime you choose, you may or may not be legally entitled to use the results of that inspection as grounds for refusing to purchase. Again, it's all in the contract details.

Most lease-purchase agreements are based on the assumption that a sale will occur, so they often require the buyer to have their inspection before they occupy the property. In addition, such contracts typically ask the buyer to be responsible for repairs during the pre-purchase occupancy.

In contrast, a lease-option agreement typically assumes that a sale will not take place, but that it might if the renter wants to buy. That scenario most often treats the sale as a more typical home purchase, with an inspection of the property occurring just before the closing.

This is another reason that it is vitally important for both parties to fully understand their obligations under the written agreement.
 
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