The Lease-Option Gambit

Posted by Dave Fratello on Wednesday, August 29th, 2007 at 5:58am.

People lacking the cash for large down payment (increasingly necessary these days) may be tempted by offers of a “lease-option” purchase or “seller financing.”

MBC recently mentioned a Sand Section property, 217 Sea View in El Porto, that is being marketed with both sweeteners. Here’s the pitch, courtesy of an email from the seller several days ago (note: the current price is $1.52m):
1. Monthly lease for 12-18 months (extension to 18 months contingent on no late lease payments).
2. Monthly lease to be $5,300.
3. $530 (10%) of the monthly lease is credited towards the downpayment.
4. Deposit of $17,000, all of which gets credited towards your downpayment in case you exercise the option to purchase.
5. Purchase price to be $1.53 million – appraised 5 weeks ago at $1.58 million (there are currently only 4 properties on the market for less in the "sand section" of Manhattan Beach and one is a tear down.

Advantages to you, the buyer of acquiring a home in this way:

1. Low downpayment – no need to come up with 10-20% downpayment.
2. Monthly lease is almost half of what the monthly mortgage payment would be.
3. No Real Estate taxes.
4. You may sell or sublease the property.
5. Several other advantages depending on agreement.
Let’s boil this down. You agree to a price of $1.5m or so. You pay $17k up front, and another $6k-$9k is credited toward your “down payment” over the next year to 18 months. When it’s time to exercise the option, you’ve got about $25k in the game – 1.5% of the purchase price.

Then what? You need to find a way to pay for the other 98.5%, or you’ll be forced to walk away from your $25k. (The seller doesn’t say so above, but that’s typical.)

MBC is skeptical that you, the hypothetical buyer, will be able to put together all the finances in such a short time. That 12-18 month window is a very quick trigger. If you aren’t able to buy it outright today, why do you think it will be easier next year?

Then there’s the declining-market problem. This relates to price as well as financing.

Whatever price is agreed to now, there’s a good chance that the home will be worth less next year. When you go shopping for loans, the lenders care about a current appraisal, not the contract price you agreed to before. If the value has gone down, you can get a loan, but you’ll need more cash to bridge the difference between your contract price and the appraisal.

But the seller will finance! Even with just 5% down! Yes, and that could be big, but it’s unclear for how long they’d loan you money. No doubt these sellers are sophisticated and can help make a deal work. But don’t kid yourself, they’re not going to play bank for 30 years.

If you must have this home, and you know you’ll be coming into some big money within the next year, going with the lease-option might make sense. It’s a great way to test-drive the home.

What about the home itself? Is it a must-have?

217 Sea View was purchased in Nov. 2004 for $945k, then massively remodeled – converted from a duplex to a 3br/2ba, 1440-sq.-ft. SFR. Everything, top to bottom, inside and out, was redone.

Many of the details are nice – both bathrooms are slick showpieces, and the master bedroom upstairs has a large walk-in closet – not a typical feature in a smaller home.

Alas, the two downstairs bedrooms – just off the entry – are impossibly small. And the small kitchen area was under-done, with mid-range materials and appliances. (What’s with the angled stove?)

There’s little common space and, of course, no yard on this half-lot. Views? You get a peek at the ocean down the alley. Otherwise, in a sadly typical El Porto fashion, most of the windows look out on the walls of neighboring houses.

Evidently there was already one taker, but the buyer didn’t “qualify.” Credit the sellers for being creative and aggressive in their marketing; they're trolling all the waters.
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