Disclosures and tenant agreements for a lease with an option to purchase contain many of the same terms and conditions as standard rental agreements but there are differences. These are important differences that both the landlord/owner and the tenant/buyer need to understand. One thing that should not surprise the owner is that some tenants almost nonchalantly enter into a lease option agreement if they aren’t fully aware that it is legally binding. While this might quickly place a paying tenant in the property, it can raise the risk that the tenant does not complete the purchase.
Whenever you are entering into a lease contract, remember that the agreements must be written in accordance with all state landlord-tenant lease laws in addition to following the state’s real estate commission’s rules, which typically require attaching specific disclosure forms.
A Lease Option is an Agreement to Purchase
Both the owner and the seller are better off when they enter into the disclosures and tenant agreements with an attitude and understanding that the main purpose is for the tenant to complete the purchase before the end of the option period. You don’t want to get two or three years down the road (the option period) to discover there is a misunderstanding.
I’m not an attorney but it’s easy to understand that from a legal point of view the owner/landlord is held to a higher expectation of understanding the disclosures and tenant agreements than the tenant/buyer. The logic here is that the landlord is a business person who understands the importance of legal contracts. Also, the owner/landlord is the person writing or having an attorney write the agreements. These are good reasons for owners to take a course on the subject. My course contains all of the information you need including how to select successful tenants and how to make sure they understand they are entering an agreement to purchase the house.
A few ways you can encourage approaching the agreement as a purchase is by suggesting the tenant take a detailed tour of the house. People treating it as just another rental tend towards a brief 10-minute tour to check out the size of the bedrooms. What you can do is encourage them to look over the yard and the neighborhood before making a commitment. Another way is by suggesting a professional home inspection since that is an early step in the purchase process.
Lease Agreements and Option Contracts are Separate Agreements
Knowledgeable lease option investors keep the lease and option contracts as two separate documents. They are also careful with the terminology and phrasing of the documents.
The reason is so that courts don’t misinterpret a combined lease and option contract to grant a tenant ‘equity’ (ownership) in the property without completing the purchase. If the tenant defaults on the contracts, having a separate rental agreement also makes it simpler to remove a tenant that has stopped making rent payments.
In the disclosures and tenant agreements, you avoid words like “credit,” “seller,” and “buyer.” Instead, use the standard terms “security deposit,” “landlord,” and “tenant”. Generally, the lease agreement does not cross-reference the option to purchase contract.
Be clear in the purchase option document that the “potential buyer” receives no equity in the property until the purchase is fully completed. Getting this part wrong is where you run the risk of a court interpreting your lease option contract as converting the nonrefundable option fee into equity for the potential buyer.
Basic Disclosures and Tenant Agreements
Landlords and property managers are required to follow federal, state, and local laws to inform tenants of policies, facts, and rules regarding the property. This includes providing government pamphlets such as the EPA’s “Protect Your Family From Lead In Your Home” (properties constructed before 1978).
There is a distinction between disclosures and tenant agreements although in some states the disclosures can be part of the agreement document. Still, you often must have the tenant initial clauses in the agreement acknowledging the disclosures. Common disclosures include:
- Security deposit details such as where it is held, if and how much is nonrefundable, and the conditions that make it nonrefundable.
- Tenant rights regarding condition of the rental at move-in and move-out. Including the tenants’ right to be present when the landlord inspects the property at either the time of move-in or move-out.
- Existence or nonexistence of safety features such as smoke detectors and carbon dioxide detectors.
- Outstanding code violations.
- Any shared utilities with other tenants such as shared electricity for halls and outside lighting or a shared hot water boiler.
- Disclosure of health hazards including lead paint, mold, or radon.
- Any flooding history the rental unit might have.
- Disclosure of a statewide sexual offender database.
- Any previous presence of an illegal drug lab that could leave hazardous chemicals behind.
- Any tobacco, smoking, or pet policy.
This is not a comprehensive list of everything that goes into disclosures and tenant agreements. Rather, it is only an indication of what these documents need to contain.
Maintenance and Repair Responsibilities Are Different
Maintenance and repair responsibilities are substantially different when there is an option to purchase. As the owner/landlord, this is a major benefit to reduce or eliminate your expenses. The tenant will soon become the new owner and it makes sense for him/her to begin taking on ownership responsibilities. Investing their time and money into maintenance and repairs is also a motivator for the end buyer to complete the purchase option. Additionally, it’s well established that most end buyers in a lease option take better care of the property they will soon own.
However, because the end buyer doesn’t yet actually own the property, there should be dollar limits to how much repairs cost him/her. Major expenses like a new roof or shoring up a sagging foundation should still be the responsibility of the current owner. Otherwise, the end buyer will not complete the option to purchase.
Don’t take these as all-inclusive of state and local requirements for disclosures and tenant agreements. My students and I have fine-tuned the sandwich lease investing technique over many years. The right disclosure and tenant agreements enable you to take control of the property for a couple of hundred dollars. You then put an option buyer in place that takes on most of the homeownership responsibilities until they make the purchase and take full ownership responsibility. The Sandwich Lease Option lets you make a big profit for a small investment.
By Wendy Patton
For more than 30 years, I’ve used the Sandwich Lease Option System to earn myself and my students millions of dollars. From my experience, I know there is plenty of room and opportunity in the real estate investment market for everyone wanting to participate to find profitable deals. It’s because of that fact and my personal success that I share the Sandwich Lease Option System with others.
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