If you are going to sign a lease/option contract with a prospective tenant buyer, you should go through the normal screening process used in any seller financed deal. That means credit reports, background checks, pay stubs, reference checks and any other due diligence that gives you an accurate profile of your prospective buyer. After all, you really want them to perform on the lease and exercise the option.
Be firm, be fair: Some investors take advantage of the fact that they are not outright selling the property to a tenant buyer. They put clauses in the option document that make it near impossible for the buyer to exercise the option or even want to exercise the option. That is not fair!! Keep the lease portion 12-24 months in length, consider crediting some portion of the payment towards the option price, and make the option terms reasonable. A two year lease option with a balloon in 24 months is only destined to fail.
Work on the Exit Strategy Now: If you’ve done your due diligence and have a qualified tenant in place, start working on their credit with them right away. You can help them get to a mortgage faster by working with them from the start as opposed to when they are a year into the option. Banks are slow to move right now and getting a property to finance out is going to take time and effort. Might as well start now. Even if they don’t exercise the option, the process of helping to restore credit is a good thing, and will only save you time the next time you work with a lease option buyer. If you are planning to hold onto the contract, maintain good records of payment history so that if you do decide to sell the contract you have payment history during the lease period and after they have exercised their option.
I recommend and stress these action steps so if you are providing seller-financing, you have to only deal with an eviction process during the lease period for those that don’t perform. For those that do perform, you will create positive payment history which can lead to several positive exit strategies that benefit you and the buyer!
{ 6 comments… read them below or add one }
Before you “consider crediting some portion of the payment towards the option price” as suggested in the article, you must talk to your attorney about how that is handled in your State. In some States that alone can mean you’d need to foreclosure (not evict) to get the property back if they tenant-buyer decides to fight you.
excellent point James. Thanks for adding that!
You’re welcome. As of April 5, 2011, here in Colorado the Colorado Real Estate Commission now requires via an official position statement that attorneys (not agents) prepare all Lease Option, Lease Purchase and Installment Land Contract agreements because of the subtleties that have far reaching implications.
Here is their official position statement:
http://www.dora.state.co.us/real-estate/rulemaking/CREC/PS/CP_39.pdf
Hope that helps others here investing or even buying/selling creatively in Colorado.
Kevin –
Great article. I really appreciate that you tackled the topic from the standpoint of “actually” trying to get a seller note or lease option to close. So many times you hear about these transactions being set up and the people doing the explaining talk about how you don’t want them to close. How this is advantageous to the owner. It’s nice to read an article where strategies to actually get them to close are being deployed. Lease option contracts have such a low average closing rate to begin with, so tips for helping them close is great topic.
This is a great article for new landlords, agents and other people who are into seller financing. I think the “Be fair” should come first “Be firm”. Give your sellers a reasonable terms and options so you can firmly execute your part in the contract.
Very few owners own their property outright. Most owners have some type of loan on the house which makes that lender the true owner. If this house is not paid for free and clear, you could pay the seller monthly mortgage payments for years when the seller’s lender shows up and kicks you out.