Lease-Options: A Guide for Sellers
Redbird Conveyancing Limited
house sales, real estate lawyers, real estate solicitors
A GUIDE TO OPTIONS:
‘LEASE-OPTION’ OR ‘MANAGED OPTION’ AGREEMENTS
As mortgage lending has become increasingly difficult to obtain and housing prices have dropped, option agreements have become an attractive alternative to an immediate sale for many sellers and buyers. It is important, however, to understand how an option works and what your legal rights are under the option agreement.
What Is An Option?
An Option is an agreement between a seller and a buyer by which the seller gives the buyer the right to purchase a property in the future at a certain price.
How Is An Option Different From A Contract for Sale?
An option is a binding contract, but it is not a contract for sale. The parties to an option agree that the buyer has the right to buy the property in the future at a certain price. The option does not force the buyer to buy. The option merely prevents you from selling to anyone else for the period of the option. If the buyer fails to exercise the option by the end of the option period, you are free to sell to someone else.
Why Are Options Attractive?
Options are attractive because they represent a firm expression of interest by the buyer. Most options provide the seller with either some money now or relief from managing a burdensome property, plus the promise of a sale in the future.
Options are attractive to buyers because they lock in a price for a period of time, the buyer has the opportunity to alter or improve the property so they can get a larger mortgage on it when lending becomes more widely available, and the buyer may be able to take some cash flow out of the property now if they can rent it at a higher value. Many option-buyers are professional property investors or lettings professionals who know how to manage properties to get the most out of them and already have tenants waiting for properties. It is important for you the seller to understand the buyer’s background and make sure they are competent property professionals before you enter into any contractual relationship with them.
What Money Is Payable to the Seller?
Like any property contract, options are supported by consideration. Consideration is something of value which changes hands between the buyer and seller. In the case of options, the consideration is usually money, but it can be interest in another property (in the case of house swaps). For a basic option, the up-front consideration may be very small (£1.00 to a few hundred pounds), but usually with the promise of more to come. This is where the ‘lease-option’ or ‘managed options’ come in.
What Is A ‘Lease-Option’ or ‘Managed Option’ Agreement?
A ‘lease-option’ is a bit of a misnomer, because no lease is actually created. What the seller gives to the buyer in a ‘lease-option’ is the ability to manage the property during the option period (a ‘managed option’). The seller may receive a small monthly fee, or the seller may merely be relieved of the burden of managing a property that they no longer want to manage and cannot sell in the current market.
Under a ‘lease-option’ or ‘managed option’ agreement, the seller steps out of the role of landlord and lets the buyer step into this role. There is a formal Management Agreement between seller and buyer that gives the buyer all the rights the seller would normally have in the property. For example, the buyer is able to enter into tenancy agreements, collect rent, and seek repossession of the property if the tenant fails to pay the rent. The buyer may also take over repayments of any mortgage or secured loan on the property, although you should be careful to review the terms and conditions of your mortgage to ensure that this does not violate your agreement with your lender.
In most cases, the Management Agreement will be supported by a Power of Attorney. The seller gives the buyer a Power of Attorney so that the buyer has the legal right to act in the seller’s stead in dealing with any third party in relation to the property. This includes tenants, mortgage lenders, letting agents, utility companies, insurance companies and other third parties the buyer would need to deal with in order to manage the property the way a landlord would. The Power of Attorney gives the buyer broad rights over the property, even though the buyer doesn’t actually own the property yet. It is important for sellers to carefully read the Power of Attorney and ensure that they are comfortable giving these rights to the buyer.
Why Do I Need All Of These Documents?
Many sellers find the amount of legal documentation associated with the ‘lease-option’ or ‘managed option’ agreement overwhelming and frustrating. What is important to understand is that you are creating a long term relationship with your buyer and that unless the boundaries of that relationship are tightly defined, in writing, it is likely that a dispute will arise in the future. As the legal owner of the property (and it is important to understand that you remain the legal owner of the property during the option), the risk is on you if the terms of the option and management of the property are not well-defined.
What Are The Risks of a ‘Lease-Option’ or ‘Managed Option’ Agreement?
The biggest and most important risk is entering into an agreement where you don’t understand your rights and responsibilities. Accordingly, it is tremendously important that you have legal advice before signing a ‘lease-option’ or ‘managed option’ agreement.
The second risk that sellers often ask about is the death of one of the parties. If you die during the period of the option, the option will be generally binding on your estate, so the sale can still go through to your buyer. If the buyer dies, however, you could not force a sale to the buyer’s estate and it is highly unlikely that the estate would want to pursue the option, so it is a good idea for the buyer to put a life insurance policy in place in your favour to pay out on the option in the event of the buyer’s death. With or without an insurance policy, in the event of the buyer’s death, the property is likely to revert to you.
Bankruptcy is also a risk. If you are made bankrupt during the period of the option, your bankruptcy trustee or receiver may disclaim the option. This means that the buyer would not be able to purchase the property and would have to stop managing it. The receiver would take over the management of the property and probably try to sell it. However, if there is a good cash flow out of the property and the market continues to be depressed (that is, the receiver could not easily sell it or sell it for much profit), then the receiver may leave the option in place and allow you and the buyer to complete on the option in the future, either during your bankruptcy or thereafter. You may not see any profit from the sale if you are still in bankruptcy when it goes through (that is, the receiver may take the proceeds of sale). There is also a risk that your buyer may go bankrupt during the option. If this happens it is likely that the buyer’s bankruptcy receiver would disclaim the option and the management of the property would revert to you.
Finally, you should consider what happens if the buyer does something with the property you would not approve of, or if you have a falling out with the buyer. A ‘lease-option’ or ‘managed option’ agreement is a long-term contract between you and the buyer, sometimes for a few years and sometimes for decades. It is important that you research and get to know your buyer to ensure this is someone you would be happy to deal with over many years. You also need to appreciate that the buyer is likely to manage the property in a way that realises the most cash flow out of the property. This may mean turning the property into a house in multiple occupation, student lets or some other structure that creates a high rental yield. The buyer may make alterations to the property to allow for such conversion, may make applications to the planning authorities without your knowledge, and may install tenants that you don’t like. Because you are giving up control of the property, you need to have a relationship of trust and confidence with your buyer, and understand that there are consequences to letting someone else manage your property that you may not anticipate and might not like.
Redbird Conveyancing is here to help sellers understand the sometimes murky and confusing world of option agreements. If you have been offered an option agreement by a buyer, or are considering advertising your property under an option, please give us a call on 01706 281 016, ask for Pam or Alison, and we would be happy to assist you!
Redbird Conveyancing Limited
Office 5, Market Chambers, Market Place,
Ramsbottom BL0 9HT
01706 281 016
©Pamela R. O’Brien 2012. All rights reserved. The information in this article is provided for general purposes only and is not a substitute for specific legal advice. No legal relationship is created between the writer and readers of this article.
, property conveyancing
, real estate lawyers
, real estate solicitors