Lease Option Agreement: What is it?
What is a Lease Option Agreement and how do you go about getting one? Read our trusty guide on everything you need to know.
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The UK property market is ripe with opportunities for savvy entrepreneurs and investors alike. However, the starting capital needed to get a foot in the door is astronomical for the most part. As a result, the market has seen the popularity of lease option agreements skyrocket in recent years. This mechanism can provide you with a much lower entry barrier and the opportunity to invest in the property market.
What is a lease option agreement?
A lease option agreement is a property contract that allows you to take control and profit from a property. With the option to purchase that home for a predetermined price in the future. To enter into this type of contract, you'll agree to pay a monthly lease to the owner.
As well as an upfront fee for the contract. It sounds confusing, but it's easier to understand when you breakdown the contract into two separate parts:
- Property Lease: You reach an agreement with the owner to lease the property for a monthly fee, which in turn gives you the right to rent out the property and profit from the rental income.
- Option Clause: This is the second part of the contract, which refers to a price you and the owner agreed on at which you can buy the property in the future. Both parties will also agree on a term, which can be for any length of time. However, you aren't obligated to buy the property when the period runs its course since the agreement only gives you the 'option' to buy.
There are four structural parts of the Option Clause that we've touched on but will help if we break it down further:
- Property Price: The price you have the option of buying the property at in the future.
- Agreement Term: The length of the lease option agreement (also known as the option period).
- Monthly Lease: The monthly payment you'll make to the property owner.
- Upfront Payment: An upfront payment you'll make for the lease option agreement.
Note that the upfront payment can be for any monetary amount you agree on with the owner. It's essential that there is an upfront payment so that the contract is legally binding. Without this step in the process, the owner could refuse your right to purchase the property in the future, and you wouldn't have a solid position to dispute it in court.
What are the benefits?
Data from Uswitch shows that on average first-time buyers in the UK will need between £10,000 and £20,000 deposit to get a home. That's a considerable amount of money, especially if you have a family and other expenses. A lease option agreement offers you a way around having to put down such a significant amount of cash.
As the buyer in this situation, there are plenty of benefits, provided that you enter into an agreement that's been appropriately structured. If you've worked out a reasonable lease cost and manage to rent the property for more each month, you can pocket the profit and make a steady income. Here's a breakdown of the main benefits:
- Low Entry Barrier: Little to no upfront cash requirement.
- No need for a mortgage.
- You benefit from any increase in the property's value during the option term. On the other hand, if the property's value doesn't rise, you can always opt not to execute your option rights.
- You can sell the option agreement to a third party.
- The agreement stops the owner from selling to anyone else during the option period.
So, if you're interested in entering the property market but feel like you're priced out by the high deposits required to take out a mortgage, a lease option agreement could be your ticket to a new investment opportunity. Since property prices continue to rise, recently hitting a record average of £270,000 across the UK, the property you choose will likely see a significant price increase, especially if you set the option term for 10 to 15 years.
Note, however, that most agreements will be for much shorter periods, as you're unlikely to find someone with negative equity that has recently entered into their mortgage contract.
What makes a good lease option agreement deal?
To make a profit from these agreements, you will need to look for a negative equity property. These are getting harder to come by in the UK as housing prices keep rising every year. Negative equity refers to a property that's worth less than its mortgage. This often makes it hard for owners to sell or remortgage since they can incur a huge loss.
Your lease option agreement offer could provide a win-win situation for both parties, where you offer a lease that covers their mortgage payments whilst you make a profit by charging tenants higher rent.
Where to find a deal
As we've mentioned before, you need to ensure that you've found the right deal for your lease option investment to work. You won't achieve much if, for example, you pay the owner £600 per month as part of the lease agreement, but then you find that you can only rent the property for £550 per month. In that case, you're actually losing money. So before entering into talks and negotiations, ensure that you are aware of what to look for and what type of property makes an excellent opportunity.
Now in terms of actually entering into an agreement, you're only going to find a deal if you put yourself out there. You could contact homeowners in an area that has a high rate of negative equity, you can advertise your offer online, or you can find opportunities through estate agents.
Note that you'll need to be completely informed and educated on the topic since, at times, you'll be trying to sell this solution to property owners that have no prior experience or knowledge. You won't come across as professional if you can't provide all the information and risks involved.
What should you consider?
As we can see, there are plenty of benefits to lease options agreements in the UK. If you don't have a considerable amount of starting cash, they are a fantastic tool that enables you to profit from the property market.
Now, before you go ahead and commit yourself to a contract, there are some points that you should consider. Knowing common pitfalls is the best way to avoid committing the same mistakes and ensure that you will profit from these types of deals.
You will need the owner to continue cooperating with you throughout the option contract. Since they've entered into a lease option agreement, their finances might be in a difficult position. This exposes you to various risks, such as:
- The owner stops paying their mortgage, resulting in the property being repossessed.
- The owner declines your right to buy the property once the option period is over, which can lead to a lengthy and costly legal case.
- The property isn't well maintained, thus eating into your rental profits.
In addition to this, you'll also have to deal with getting the correct type of insurance, opposition from the mortgage lender, and meeting mortgage requirements.
Depending on the contract, you might be liable to cover the upkeep of the property. Therefore, if the house is already in bad condition when you enter into the agreement, you might end up forking out a considerable amount to replace essential items. Figures from Simply Business state that landlords should prepare to pay up to £3,134 per year on maintenance. Having a figure in mind will help you budget better when considering the earning potential of a property.
Why aren't more people opting for lease option agreements?
These agreements are often talked about and are extremely popular online. There's plenty of information on the market, a lot of which can be overwhelming. The reason why everyone isn't jumping straight into lease option agreements is that it takes time, persistence and skill to land a good deal.
If, after reading through our helpful overview, you decide that this is the right way forward, you'll quickly realise how much research and networking needs to be done to find a deal on your own.
Why would a property owner opt for a lease option agreement?
If a property owner is looking to enter into this type of contract, chances are, their choices are limited. Not many people are in this position, which is why it can be challenging to find a good deal.For the most part, you will encounter negative equity property owners who owe more than they can get from selling their property. They will likely look for a lease option agreement if they are required to move since selling their property will mean that they lose a large chunk of their investment, and remortgaging isn't really an option.
What to include in the agreement?
The agreement should include both parts. The first specifies the lease cost, the option period, and the upfront fee. The second states the predetermined price at which you can purchase the property at the end of the option term.To avoid any unwelcome surprises, you might want to include a third document. One that stipulates certain restrictions and clauses that protect you if something goes wrong. This can occur when the owner doesn't make mortgage payments or the property's condition is poor. Note that if your demands are too high, there's a chance the owner might back out of the deal. So, ensure that you're being reasonable and cooperating fairly with the homeowner.
What you should be asking before committing
As with any financial decision, you should never rush to a conclusion without proper consideration and research. If possible, get in touch with a professional advisor to discuss your options. If, after all this, you are still certain a lease option agreement is for you, here are a few questions you should be asking before signing on the dotted line.
Can you conduct a home inspection?
Ask the owner if you can inspect the property beforehand. If possible, take a professional with you to assess the condition and identify any future problems. If you are liable for the maintenance of the property, you might find that a poorly kept home will eat into your monthly profits.
What's the housing situation like in the area?
Get a good idea of the housing market in the area, including the historical value of the area, how much property prices have risen in recent years, and what sort of potential the property will have. If you agree on a purchase price of £100,000 with an option term of 10 years, and at the end of that term, the property is worth £150,000, you've got access to instant equity.
Are you liable for maintenance?
Understanding who is responsible for what is essential. Ideally, the owner will agree to cover maintenance costs. Still, since this type of deal favours you over the owner, they won't likely agree to cover expenses.
What to do once you've found a fantastic deal?
If you've done your research and put together an agreement with good structure- congratulations! Before moving ahead, you should go through UK Government regulations for landlords to ensure that you comply with all the latest laws. Now, you need to ensure that you can find tenants to provide you with a monthly rental income to cover the lease payments to the owner.
Since you'll be looking to keep costs down to maximise the efficiency of your lease option agreement, Oasis Living is the perfect lettings and property management company to ensure your option period runs smoothly. The company utilises tech to help landlords keep costs down and the renting process hassle-free. They will work to find the right tenants for your property, whilst its experienced property management team will ensure that you can focus on landing more fantastic lease option agreements.
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