Lease option investing

Lease option investing

What are they?

Lease option investing is a concept that has been popularised in the United States that allows people to rent a property and purchase an otion to buy the house at a point in time in the future for a pre agreed price. These kinds of products have been specifically designed for people who are saving deposits and want to get on the housing ladder that can't quite affors to. In adition in times of rising house prices such arrangements can be viewed as investments in their own right.

How do they work?

Lets look at an example. Assuming I want to buy a house for $300,000 but am waiting for a bonus from work to fund the purchase, I could set up a lease option contrat where I would rent the property off the owner for lets say $2,000 per month. In addition I could buy an option to buy the house at any point over the next 3 years. For this option the current owner might make me pay say $10,000. If in a years time i opt to by the house I will have to pay $290,000 ($300,00 less my $10,000 option premium). If i decide not to purchase the property the owner would get to keep my premium of $10,000.

Many people have taken out lease option investments with a view toward just making money, not as a way to purchase a new home. During times of rising house prices, often by the time the option to buy was coming to an end the house value may have appreciated more than the original premium. In the example above lets assume that just before the 3 year option is up, I decide to buy the house, however the market has moved in my favour and the property is now worth $360,000. I am now in a position that I can buy a house worth $360,000 for just $290,000 (I have already paid $10,000 as the initial option premium. Therefore I could buy the property and sell it immeadiatly and make an easy £70,000 ($360,000 less $290,000).

The above example is simplified and in reality the option price is usually linke to inflation or some other rate. That said the opportunity to profit from such deals still exists. Another key benefit from the investors perspective (the one selling the option and house is that the rent they charge to the option buyer can be significantly higher than the market rate. In addition the possibility always exists that the option holder will decide not to go ahead with the purchase, allowing the home owner to pocket the option value, with nothing to give in return.

Assuming you are entering a lease option, not from an investment perspective but as a future home owner, another key benefit is that they allow buyers to potentially benefit from cheaper financing assuming the property appreciates in value from when they buy the option to when they buy and finance the house. This assumes that they can get cheaper finance due to their loan to values (LTV) ration being lower, and therefore lower risk to the mortgage providor.