Lease option to increase liquidity of property investment

Lease option is a form of financing strategy.

As the name suggests, it consists of two parts: the lease and the option. The first part is where the tenant-buyer leases the property from the landlord-seller for a fixed period of time while the latter is allowing the tenant-buyer an option, not an obligation, to buy the property at an agreed price upon signing of the lease option agreement. The definition of a lease is not less than three years.

It may sound like our Government’s initiative of the “rent-to-own” scheme, but it is not the same. The main distinction is that in the rent-to-own scheme, the tenant-buyer is obliged to purchase the property where the rental paid are meant to contribute to the purchase price while lease option is merely an option to purchase.

Another difference is that the option comes with a price tag in exchange for the landlord-seller’s consideration to commit to the option granted.

As the nation is focusing on the issue of affordable housing, there are three hard facts from the market sentiment today.

1. The buyer facing difficulty to secure a financing loan but desires to buy the property;

2. The buyer who has bought a property but unable to service the monthly instalments; and

3. The seller who wish to sell the property but is unable to sell.

How does lease option provide a feasible way to ease these unfavourable agenda of the day?

The basic conceptual of lease option is to ease the tenant-buyer who faces the financial credit hardship that can be resolved during the option period. Similarly, it is applicable where tenant-buyer lacks the fund for the down payment. Here, the lease option comes in handy where the tenant-buyer may secure the purchase of the property of his/her preference while resolving its financial fluidity and simultaneously saving for the down payment during the tenure of the lease.

Another incentive for the tenant-buyer is that he/she may be relocating to a new area and may need to sell his/her previous property before qualifying for the purchase of this property. The tenant-buyer may also utilise the lease tenure to familiarise the area while making certain improvements to the property which will firm up the intention to exercise the option.

Where liquidity is a national issue, one who has happily purchased a property may find himself/herself not able to finance the monthly loan repayment and intends to dispose of the property eventually. In such a scenario, he/she may work out a lease option with the potential buyer where the potential buyer continues to service the instalments while he/she pays rental which is lower than the instalments sum to the potential buyer if he/she is occupying the premise.

The excess between the instalment sums and rental shall be the consideration to keep the option to purchase open and possibly towards the payment of the purchase price deductible upon signing of the sale and purchase agreement. This may buy sufficient time for both parties to make arrangement of the financial fluidity and also to the convenience of the parties. In other words, a win-win situation.

One may be curious, what incentives does a landlord-seller enjoy in a lease option agreement? A landlord-seller may not dispose of the property immediately and get immediate return of investment, the rental from the lease may not be sufficient to cover the monthly instalments and the landlord-seller is locked to one tenant-buyer as long as the lease period.

Undeniably, there are scenarios where one meets trouble selling the property. This may be due to various reasons such as the lack of long-term maintenance and the refusal of the seller to value-add the property, rejection from the bank to finance the purchase of the property, or for the mere reason to avoid paying a high rate of real property gains tax if selling within the prescribed five years.

The lease option may provide a way out for these scenarios where the landlord-seller may lease the property to any interested tenant-buyer at a lower rental, allowing the tenant-buyer to conduct certain improvement or refurbishment to the place to value-add the whole premise, and thereafter at the option of the tenant-buyer, to purchase the property with the approved financing from the bank.

In such a scenario, besides savings on the real property gains tax, the seller is secured with a potential buyer for a property he/she wishes to dispose of and even when the tenant-buyer is not exercising the option, he/she has gained from the rental and value-added services to the property. Not to mention, the landlord-seller may further save from real estate agent fees should the tenant-buyer exercise the option.

As with all sale and purchase contract, the lease option contract is also based on a willing landlord-seller and willing tenant-buyer to enter into such an arrangement. Lease option may sound fresh to those who first heard of it but it is practised in many other jurisdictions.

Nonetheless, it may not be foolproof, but it is manageable with sufficient legal tools which also serves the flexibility purpose for both parties. Nothing is risk free, and when an investment is risk free, it will be termed as “insurance” instead.

Chris Tan is the founder and managing partner of Chur Associates. - By The Star

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