Purchase Options

An “option” is a contract where a property owner (optionor) grants an option to purchase to a prospective buyer. In exchange for consideration, this buyer (optionee) has the exclusive right, but not the obligation, to buy the property within a certain time. The optionor is not permitted to sell the property to someone else during the option period. The optionee pays for this exclusive right and has effectively purchased time to consider buying the property. The consideration paid for the option may or may not be applied to the purchase price, depending on the terms of the agreement. The option fee is nonrefundable and if the optionee does not exercise the option, the money is not returned.
Along with many other terms and warranties, an option contract includes the time period for the option, price for the option, manner in which the option is to be exercised and the property purchase price (or manner in which price shall be determined). The purchase price can be fixed at the time the documents are executed or established by independent appraisal at the time the option is exercised. The option can also be drafted as a right of first refusal, wherein the optionee has an option to purchase on the same terms as a bona fide third party.
Options for Residential Buyers

An option may be used by residential buyers who need time to decide whether or not to buy for many reasons. They may be new to the area and are still deciding on what neighborhood they like. Or buyers may be anticipating job changes and want to wait for more certainty before committing to a home purchase.  Or they might be expecting financial gain that they need in order to purchase the home sometime in the future. Another reason to do an option is that they have recently gone through a foreclosure or short sale and need time in order to recover in terms of finances and credit rating.

Options for Investors
An option may be used by investors to gain an equitable interest in the property while speculating on value and securing potential future buyers. The investor has the potential to purchase a property and can work to find a buyer without having to commit to a purchase until that buyer is committed to making the purchase.

Lease with Option

Frequently an option is accompanied with a lease agreement that grants possession and use of the property to the optionee. The option period gives the tenant (optionee and prospective buyer) time to get finances in order for the purchase. Having a tenant who holds an option utilizing the property under a lease often means that tenant is committed to the property and perhaps likely to exercise the option.

Documents for a Lease Option

When creating the transaction, it is important to execute the lease, an option and a purchase agreement. These documents affect the rights and obligations of the parties. Utilizing a lease is beneficial because it signifies that the landlord-tenant laws apply and provides a means to evict the tenant in the event of default. It is important to make sure that the security deposit is distinct from the option fee. If the optionor retains a fee that is later found to be a security deposit, this many expose the optionor and landlord to liability and damages equal to three times the amount wrongfully withheld. Including cross default provisions that indicate a breach of one document amounts to the breach of another will help simplify the situation in the event of default.

Lease Option Benefits to Seller
  • Option fee is earned and tenant/prospective buyer already received valid consideration and is nonrefundable.
  • Might be able to secure a higher price than a traditional sale.
  • Have a tenant in the property with a potential interest in buying the property who will take good care of the property.
Lease Option Benefits to Buyer
  • Gives the tenants/prospective purchasers time to get financials in order to be able to purchase the property.
  • Gives tenants/prospective purchasers an opportunity to “try out” the neighborhood and community before committing to a purchase.
  • Tenant/prospective purchaser is not obligated to buy and can walk away after the lease is done.
Lease Option Risks to Seller
  • Seller is obligated to sell if tenant/prospective buyer exercises option.
  • Uncertainty because tenant/prospective buyer may or may not ultimately buy.
  • If landlord/seller has mortgage on property, lease purchase may trigger due on sale clause.
Lease Option Risks to Buyer
  • If landlord/seller has mortgage on property, lease purchase may trigger due on sale clause.
  • Seller may encumber property before the tenant/prospective buyer purchases it: mortgages, liens and judgments may attach.
  • Seller may file bankruptcy and be unable to transfer the property.
  • If Seller passes, the buyer may have to wait for estate to be probated.
  • Seller may sell to someone else during option period and if the option is not recorded, another buyer would have no notice of your property interest unless a memorandum was recorded. The new buyer may take title to the property free and clear, cutting off the original Buyer’s rights.