Lease Option

One of the most popular techniques pitched by cable TV real estate gurus and seminar sponsors -- "rent to own" or "lease option" contracts -- is coming under increasing scrutiny by state legislators and regulators.



One state, Texas, has clamped tough new restrictions on lease-option offerings through a new law that took effect yesterday. In Florida, the state attorney general, Charlie Crist, is investigating consumer complaints about lease-options offered by a network of rental property companies operating along the Gulf coast. Crist says, "We are looking into it very aggressively. It has all the indicators of an unfair and deceptive trade practice."



Stripped to its essentials, the lease-option or rent-to- own concept is simple: Would-be home buyers who lack downpayment cash, have imperfect credit histories or high debt-to-income ratios, get to occupy the house they want for a set period -- usually 12 to 24 months -- in exchange for monthly rent payments. A portion of their monthly rent goes toward an eventual downpayment. They must also pay the landlord-property seller an "option fee" ranging from a nominal amount up front to hundreds or thousands of dollars. The option fee typically is either non-refundable or only partially refundable under limited circumstances. Sometime during the lease-option period, the tenants are expected to apply for mortgage financing and purchase the house at a pre-set price.



The landlord, meanwhile, gets a number of benefits from the deal: First, the tenants are highly motivated to pay their rents, which sometimes are above going market levels. The lease-option language typically lumps extra responsibilities on the tenants for property maintenance and upkeep, relieving the landlord of some customary expenses. Finally, the landlord gets to pocket the option fee money with little or no requirement to refund the money under most circumstances.



Problems with lease options arise when investors intentionally target consumers who are relatively unsophisticated about real estate or contract law, and who have little real likelihood of ever qualifying to purchase the property. In those cases, the promoters are essentially in the rental business and convince unsuspecting tenants to pay them fees and premium rents, plus pick up most routine property maintenance costs.



In Florida, consumers complained to the attorney general that the lease-option promoter included clauses in rental contracts that permitted them to be evicted -- and their option fees forfeited -- for the most minor problems, such as missing a rent payment deadline by one day or failing to keep the house broom clean. Other problems surfaced in Texas, where promoters allegedly offered lease-options to lower income tenants on properties with serious title issues. In some cases, according to Robert Doggett, an Austin-based housing law advocate who helped write the new statewide legal restrictions legislation, promoters "acquired' houses from owners facing imminent foreclosure by taking over their payments to lenders. But the lenders still held legal title, plus the right to call the underlying mortgage at any time, and could take back the real estate whenever they chose.



In other cases in Texas, promoters allegedly offered properties for lease-option in illegal or unrecorded subdivisions where no one could obtain clear title. The new Texas legislation forces promoters to comply with a long list of new restrictions on title, lease provisions and existing financing. The net effect, said Doggett, will be "to close down what had become a racket here. You had all these Mom and Pop investors, who took seminars and learned to do lease- options as a way to make a million bucks without doing a lot of work."



The victims "were almost always first-time buyers who had no idea that the contract and lease they signed contained clauses that made it almost impossible for them to actually exercise the option" and acquire legal title to the house.



Doggett says he has been contacted by state legislators from North Carolina, California and other states in recent weeks. "They all want to know what we're doing down here," he said, "because they see problems where they are" and expect more this year as softening real estate markets encourage more investors to seek to dispose of rental houses with negative cash-flows.



What are the minimum standards that would-be purchasers -- and investors -- should look for in lease-option contracts? For starters, people with serious credit problems should not participate at all, unless they feel they can raise their credit scores within the 12 to 24 month lease period. Second, the rent level and house price should be fair. Consumers should expect to pay a little more per month to help with the eventual downpayment. But they should not sign up for an excessively high rent nor should they agree to buy the unit at a price that doesn't reflect the likelihood of appreciation slowdowns -- even lower prices -- as the local market cools over the coming year or two.



Finally, lease option promoters must be willing to demonstrate with hard proof up front that they have clear legal title to the property they are offering for sale. Buyers should also read the contractual language carefully to make certain they cannot be evicted or forced to lose their option fees for the most trivial violations of the lease terms.



The key to lease options, says John Schaub, a Sarasota, Florida-based investor and author who has used them for more than three decades, is "they've got to treat people fairly." Contracts should provide for at least partial refunds of option fees in emergency situations such as a divorce, death, or employment relocation beyond the control of the tenant-purchaser. Promoters should also take pains to qualify their lease option customers to weed out people who are never likely to purchase the house.



"If you are in the rental business, then collect rents," said Schaub. "If you are in the lease-option business, then make sure your tenants have real prospects of becoming your buyers."



ps by pr: Colorado is looking into the same restrictions.

by Kenneth R. Harney