Glossary of Lease Purchase Terms

Overview of Lease Purchase Vocabulary and Terms: Introduction These terms are somewhat recognizable, with the exception of the words Optionee/Optionor, Consideration, Option Consideration Monies, Strike Price, Assign, Lease Option and Instalment Land Contract. Option means choice. The Tenant has the CHOICE at the end of the lease to: 1. Give the Owner the keys back and vacate the property 2. Arrange their lender financing and settle the transaction. The tenants have an OPTION or CHOICE to buy or not to buy. Some vocabulary: • Lessee/Optionee: Tenant leasing property who holds the option, does not have to purchase;but has a right to purchase that can not be taken away. • Lessor/Optionor: Owner possessing legal title of leased property giving an option to purchase to a tenant (Lessor/Optionee). • Capital Growth Value Appreciation Rate: Properties appreciate, depreciate or stay the same. Landlord and Tenant agree on a rate of growth and what statistics demonstrate that growth. • It is important to be fair. For a win-win arrangement, we recommend a fair rate in the vicinity of 4% to 8% depending on what part of the country you are residing. • The Capitalization Rate: The Cap Rate is calculated as follows: Cap Rate = (Net Operating Income / Market Value) x 100 Cap Rate = (NOI / MV) x 100 • Click here for a discussion on cap rate, NOI, Gross and Net Income Multipliers • Option: The unilateral (one-way) right or privilege to do something, for example, the right to renew a lease or the right to purchase a property at a certain price. The optionee is the holder of the option; the optionor is the owner of the property usually. The optionor is bound by the option, but the optionee is not. Remember: the optionee has the choice! • Consideration: Anything of value given to induce entering into a contract is called consideration. it may be money, personal services, a product, or a privilege. Consideration is required in all contracts; consideration must be present for a contract to be valid. • Contract: An agreement between 2 or more persons which is which has intention to be enforceable at law; for there to be a simple contract, there must be agreement between the parties as to the: • 1. terms of their bargain, • 2. intention to relate legal relations, • 3. consideration and • 4. capacity to contract. • A contract maybe entered into a special form known as a deed; • to be enforceable regarding real estate, the contract must be in writing. • Option Consideration Monies: Monies given from lessee/optionee as non-refundable option consideration; will be subtracted from the agreed upon Strike Price to determine the price to be entered on the Sale and Purchase Agreement. • Note: If the option is not legally exercised, the option consideration monies are not refundable, but the lessee’s monetary interest is assignable to a new tenant-lessee, subject to the lessor-vendor’s approval. So there is risk to the tenant in that the option money paid to the landlord is not refundable, but the interest in the property can be sold (assigned for a fee) to the another tenant-buyer with the approval of the owner. • Strike Price: Say the agreed upon Strike Price is $200,000 in the first 12 months of the lease option contract. There has been a total of $10,000 in consideration monies paid. The Sales Price is now $190,000. • Assign: To make over a right or interest to another (e.g., to assign a lease or a debt or a chose in action). The tenant-buyer in a lease option agreement is not entitled to a refund of option consideration, but tenant may advertise for a SALE of their interest in the contract, and tenant may ASSIGN their INTEREST in the property for a FEE. This assignment is subject to the approval of the owner. • Performance Credit: This is a paper credit where the landlord helps the tenant receive a credit which is subtracted from the future purchase price. No money changes hands. If and when the tenant wishes to buy, and the lease option contract permits the tenant to buy, all performance credits that have been earned are subtracted from the Strike Price, resulting in the Sales Price. There are different types of performance credits: for example, paying rent on time credits, keeping property tidy credits, improving property credits. If the tenant changes their mind and does not exercise their option, all credits are forfeited. This is how the tenant and the landlord create a “win-win” partnership with the rental property. The risks and rewards are shared between both parties. • Lease With an Option to Purchase: An agreement by which the lessee (tenant) has the unilateral (one-way) option to purchase the leased premises from the lessor (landlord). • Some lease-option agreements provide for a portion of the rent to be applied towards the purchase price. The price may be fixed at the beginning of the agreement or be determined by another formula, such as a valuation at another time in the future. • A Simple Lease Option example: • Note: This is an oversimplification and is not complete. • It is, in the simplest language, a partnership agreement between the landlord and the tenant. • Tenant-Lessee leases property with an option to purchase. • Tenant must pay $1200 per month (for example) in rent for the first 12 months. • Rent is increased at 5% each year (for example) for the next 12 months, and so on. • The term is for 12 months (for example), with rights to extend 4 more times at 12 months each. • The tenant may buy the property (but is not forced to buy) for a certain price during each of these 5 rental 12 month periods. • The increased yearly Strike Price is agreed upon by both parties at the inception of the contract. • The landlord may require the property be rented for a minimum of 24 -36 months before the tenant can exercise their option to purchase. • The landlord may require that the option money paid and performance credit earned add up to a certain minimum amount or a certain percentage of the strike price. • The purchase price will increase at a capital appreciation rate of 5% (for example) per year. • For each month a performance credit is offered to be earned by the tenant from the landlord. • Caveat: A notice to refrain from some action, such as a vendor acknowledging an option given to a lessee and agreeing not to sell or encumber (place new financing) during the option period. • Instalment Land Contract (ILC): The instalment land contract is an agreement wherein the buyer makes payments in a manner similar to a mortgage. The buyer has “equitable title”. However, the seller holds legal title to the property until the contract is paid off. The buyer has equitable title, and, with all intents and purposes, is the owner of the property. Also known as “contract for deed” or “contract of sale.”