Understanding Lease Option Contracts

With a housing shortage and rising costs to purchase homes, parties are looking for alternative methods to buy and sale homes. One of the most common alternatives is the “lease-option”. Today, we take a look at some of the common mistakes of the lease-option transaction.

As always, if you have any questions about your real estate, business, estate planning, or any other legal issue, please let us know by e-mailing managing shareholder Keith Dunnagan at kbdunnagan@bpelaw.com.

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Understanding Lease Option Contracts
By: D. Keith Dunnagan, Esq.

In the standard residential real estate transaction, a seller lists their home for sale and a buyer makes an offer to purchase. A standard transaction that results in a short-term relationship between the buyer and seller than hopefully culminates in a closed sale. However, with the short supply and increasing prices of homes, more and more people are being priced out of the market and the would be buyers are looking for alternative methods to buy a home.

One of the most common alternative transaction methods is the use of the “Lease Option”. A potential win-win for a buyer and a seller. The seller who may not be able to sell immediately obtains a rent paying tenant who enters into an agreement that may result in the tenant buying the property in the future (usually 3 – 5 years). The tenant moves into a home that they may purchase in the future and contractually agree to a price or price determining method that gives the tenant a superior right to eventually buy the property consistent with the terms the parties had already agreed upon.

While the structure of the transaction can be a benefit for both parties, done improperly it will almost always lead to litigation. With a little bit of knowledge and thought common mistakes like the ones identified below can be avoided.

When contemplating the lease option there are some things that the parties should contemplate. Naturally, the terms of the lease are important. The bedrock of the structure is the landlord-tenant relationship and the parties must be sure to carefully build the lease with terms that both parties can accept. One mistake that we often see is when the Option gives the buyer 3 years to exercise a purchase right while the lease only creates a one year tenancy. Such a term is likely to result in litigation if after one year the landlord wants to seek a different tenant. The option period should be tied to the lease period so that there is no confusion as to when the option may be exercised. It is perfectly reasonable to make the option period shorter than the lease term.

Default clauses are important. What happens if the buyer is in rent default and then wants to enforce an option and the price of the property has dramatically increased? Make sure that the contract addresses the issue. It is not uncommon for a contract to contain a clause that states that if the tenant defaults on rent payment or late on two or more rent payments in a twelve-month period then the option lapses. The idea is that defaulting parties should lose certain benefits.

Identify the method of exercising an option right and make sure terms are defined. If the buyer is supposed to exercise within a certain period, say within one year, then make sure there is a clause that requires the time for performance. Its one thing to say that the party must exercise in one year, but quite another to put a performance timeframe on that the exercise. If a party exercises the option to purchase by what time after exercise do they have to close. Make sure that is identified.

In preparing a lease option agree to the sale terms ahead of time and reduce to them to writing and attach that writing to the lease option contract. The most common lease option dispute we see arises when the parties agree to a lease option, but have not agreed to the terms of a sale or even a form sale contract which will substantially govern the transaction. In that case, often times no consideration for the option is given. If no consideration for the option is given and no written terms exist enforcement may be difficult because the terms are not agreed too.

Finally, if you are the buyer, discuss whether or not consideration will be paid for the option. Contracts generally require some form of consideration (exchange of value) to create a binding agreement. Lack of consideration makes it easy for the courts to say no contract existed. However, if the buyer can show some form of payment for the option to buy, the enforceability increases dramatically.

Most importantly, these types of transactions, while common and can provide significant benefits for parties must be crafted carefully. There are hidden pitfalls that if not addressed can increase the likelihood of future litigation. Make sure you seek proper counsel and prepare your documents in a manner that is consistent with the terms agreed. A good contract can solve a lot of problems in the future or at minimum give a court guidance on the terms the parties agreed upon.

If you have a question about lease options or are looking to enter a lease option, the attorneys at BPE Law Group have decades of experience in both crafting and litigating lease option contracts. Our attorneys are here to help you navigate the complexities of this transaction and structure your agreement in a way that makes sense for you.


The attorneys of BPE Law Group, PC. have been advising our clients on real estate, business and estate planning issues for over 20 years and have assisted numerous clients in business and real estate matters and have represented and advised brokers on their professional obligations as well as consumers on their rights. If you have questions concerning legal matters, give us a call at (916) 966-2260 or e-mail Keith at kbdunnagan@bpelaw.com. Our flat fee consult for new clients may get you the answers you need for the questions you have.

The information presented in this Article is not to be taken as legal advice. Every person’s situation is different. If you are facing a legal issue of any kind, get competent legal advice in your State immediately so that you can determine your best options.