Purchase Lease Options & Costs Explained
Q – What has 3 parts to it, can cost as little as a £1 and could give you a monthly income?
A – A Purchase Lease Option!
As a tool in the property investors toolkit , Purchase Lease Options are awesome when the situation is right. They can be as simple or as complicated as you chose to make them.
The less complicated they are, the easier they are to understand and cheaper to produce. They only work in the right circumstances. Whether the circumstances are right will only be discovered by listening carefully to what the owner really needs.
In this ultimate guide we will provide you with the answers to the common questions often asked, including cost!
What is a Purchase Lease Option?
A Purchase Lease Option (PLO) is a contract between a property owner and another party that gives the other party the right, but not the obligation, to buy the property within a specified period of time.
The other party (which could be a business of individual) can generate an income from the property without the need to pay a deposit or get a mortgage at the outset.
What documents does a Purchase Lease Option usually include?
There are usually 1-2-3 separate agreements as follows…
This will give you the right to buy the property later if you wish to do so & also sets out the purchase cost and payments during the option period.
This is typically a Management Agreement which sets out how the property will be used, managed and outlines the parties’ responsibilities.
This will authorise you to sign necessary documents in relation to the property transaction. It is very narrowly drafted and can only be used to enforce the terms of the agreement.
What are the main terms of the Option Agreement?
The owner of the property and the buyer will usually agree 4 key terms which will be included in the “Heads of Terms” document for the lawyers to draft into a fully detailed binding contract.
The 4 key terms are as follows…
The purchase price that will be paid should you decide to buy the property.
After which, if you have not exercised the option to buy, the property will be handed back. This is sometimes called the “long stop date”. The longer it is the more likely the property will increase in value.
That the buyer will pay during the term of the option agreement. This might be to cover the mortgage, although could include more. A bit like a guaranteed rent.
Which is the “consideration” the buyer pays to the owner. This can be as little as £1.
What are the benefits of using a PLO from the buyer’s perspective?
- You can take on a property without getting a mortgage (great if you have poor credit or expect to be in a much better financial position at a later date).
- No need to save up (or tap up the bank of mum and dad) for a deposit.
- No stamp duty to pay until you actually buy the property.
- If you already own your home, you could use a purchase lease option to move into a larger property (which you might not be able to afford if you were buying), whilst renting out your own home.
- If the property increases in value above the agreed purchase price, by the time you decide to buy (within the option period), you benefit from the increase depending upon the terms agreed with the owner.
- You can use this as a way of taking control of a property, adding value and flipping it to retain the uplift beyond the agreed purchase price. Great for those unloved homes which the owner is struggling to sell.
An example of a Purchase Lease Option?
As part of your marketing, you come across a fed-up landlord who has had enough of the private rental sector. The owner does not need the money from the sale and it’s already on a Buy to Let mortgage. These are perfect conditions for a PLO.
You get to know the owner. You have carried out your due diligence and the property is currently worth £150,000. It will rent for about £800 per month. The mortgage is £300 Per month.
You agree the following Heads of Terms:
- Purchase price of £155,000
- Purchase within 7 years
- Monthly payments of £450
- £1 for the option fee
After maintenance of say £80 per month + £450 to the owner you get £270 per month. Let’s assume that 7 years later you decide to buy the property and it is valued at £180,000.
There are a number of ways in which you can exit the PLO. You can either:
- Exercise the option and buy the property.
- Assign the option to someone else who will buy the property.
- Let the option expire and hand control of the property back to the owner.
SCENARIO ONE – Exercise the option and buy
Over that period if you were the buyer you will have made (assuming you get the prefect tenant who stays throughout):
- 84 months x £270 = £22,680 income, before tax
You would take out a mortgage based on the purchase price of £155,000 creating equity of £25,000.
As the owner over that period, even in the event of voids, you would have received: –
- 84 x £150 (£450-£300) =£12,600
- So, an extra £17,600 on top of what the property was originally worth when the PLO was entered into
Had the owner sold the property initially, he or she would have received £150,000. If put into a bank account earning 0.5% interest, this would generate £750 per year or £5,250 in total over the 7-year period, far less than the returns under a PLO. A win/win for both the owner and the buyer.
SCENARIO TWO – Assign the option
As a buyer you could decide to sell the option agreement to another buyer for say, £5,000. You would also get the rental income up until that point and the new buyer would pay the owner £155,000.
The owner receives the same as in scenario one above.
SCENARIO THREE – Give it back
You could decide to give the property back. Let’s say that the price has not increased. You have still made £22,680 over a 7-year period, all for £1 plus legal fees.
The owner will have made £12,600 income and will have the property back. The property owner can then decide whether to sell up or continue renting or even agree to a further PLO.
Why would an owner agree to a Purchase Lease Option?
It all depends on the circumstances. If the owner can sell at market price and needs the money now, then a Purchase Lease Option is not suitable.
An owner might agree to this style of arrangement for several reasons:
- They have no real need for the money now and would prefer to earn a better rate of interest than if the money is sat in the bank. With the prospect of negative rates on the horizon, this becomes even more attractive!
- For property portfolio owners, they can earn income, whilst staggering the sales, thus using their Capital Gains Tax allowance each year.
- It could be due to negative equity. This type of arrangement allows the buyer to move on quickly without having to find the money to pay off the mortgage.
How do you find Purchase Lease Option deals?
That essentially comes down to marketing. You are trying to find properties in negative equity or existing landlords, couples going through divorce, repossessions etc.
You could try leafleting areas, putting adds in social media, attend networking meeting, put advertisements in the paper. Look on-line; there are lots of resources and lots of books to read about sourcing property.
Once you find a property, you will want to try and agree an exclusivity period to enable you to carry out your due diligence on the property and negotiate, before asking your lawyers to prepare the Purchase Lease Option documents. This is often referred to as an “Exclusivity Agreements” or “Lockout Agreements”.
We can provide you, free of charge, an exclusivity agreement as part of our services, which you can use whilst putting your deal together.
Can Purchase Lease Options go wrong?
Yes. You should always consider the risks. These might include:
- The owner refusing to sell. This could lead to costly litigation.
- Lots of unexpected maintenance eating into your profit.
- Tenants refusing to pay rent. It was taking on average 9 months before Covid-19 to evict a tenant. The situation is far worse now, during which time you would be obliged to pay the owner the agreed monthly payment.
- An owner failing to pay the mortgage. As a result, the property is repossessed?
- The owner decides to re-mortgage without telling you!
- The owner is made bankrupt in which case the trustee in bankruptcy may wish to sell the asset.
Can the risk of things going wrong be reduced?
Yes. No investment is risk free, but you can mitigate the risk. For example, you could consider the following:
- Make sure that there is a restriction registered against the title of the property so that it cannot be sold with you being notified.
- You can always consider getting landlord insurance in case of non-rental payment, but this will eat into your profit.
- With the consent of the owner, you can write to the lender, and get permission to speak to them about the mortgage account. Alternatively, you can ask to see mortgage statements to make sure monthly payments are being made.
- You should make sure that the Purchase Lease documents are drafted by lawyers. This will make sure that each party understands their responsibilities. Furthermore, if the property owner gets independent legal advice, the courts are much less likely to say the owner did not understand the terms of the agreement, should the owner refuse to sell the property on the agreed terms later.
- Make sure you do your due diligence on the owner. Are they in debt? Is there a risk of bankruptcy?
How long does it take to produce a Purchase Lease Option?
This depends on several factors, often outside of our control, such as:
- Searches (if required) – can often take up to 5 weeks or longer.
- Negotiations. If they are all agreed, great. If not, this could cause delay.
- The other side’s lawyers and how reactive they are.
If the terms are already agreed, then the actual documents can be drafted within a week. If searches are needed (which we would recommend if you are serious about buying), then once these are available the contracts can be signed. Alternatively, to get signed contracts quickly, they could be signed subject to searches being satisfactory.
So, there you have it, between 1-5 weeks.
How much does a Purchase Lease Option cost?
Charges vary from firm to firm. We like to be transparent about the costs involved. If we are acting for the seller and are advising on the documents drafted by the buyer, our costs will be £500 + VAT.
If we are acting for the Buyer, so long as it is not complicated, we charge £750 + VAT for the option agreement and £250 + VAT for the management Agreement. This also includes the Power of Attorney.
If the Option Agreement is complicated, the cost could increase to £1250 + VAT.
As part of our services, we can provide you free of charge, with a lockout agreement, whilst you negotiate the heads of terms in addition to a Heads of Terms template.
We also recommend Local Search, Drainage Search & Environmental Search. Should these searches highlight the need for any furher searches these will be additional. If the searches above are required, we charge £300 + VAT which includes the actual cost of the searches and a report on title.
For a detailed breakdown of the searches and costs see below:
Land Registry Fee (to file restriction)
Land Registry Search Fee (per title)
|ID check (per person)||£4.00||£0.80||Mandatory|
Bank Transfer Charge
|Local Search, Drainage Search, Environmental Search||
How can Kumari Hart Solicitors help with your Purchase Lease Option?
We can help you with your investment by advising and drafting your Purchase Lease Option Agreements. If you are the buyer and already have a solicitor, we can still act for the owner. Simply pass on our details to the owner and ask them to make their own enquiries. Independence is essential.
As part of our service, we will also provide you with the Head of Terms template and an exclusivity agreement to help you seal that deal.
We understand the importance of speed and the mind-set of property investors. We are also open from 8am to 8pm during the week and from 9am to midday at the weekends.
If you have any questions about Purchase Lease Options, please contact us now by using the “Make a free enquiry” below. To make life easier for you, we are open from 8am – 8pm during the week and from 9am to midday at weekends.
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