Any successful investor will agree that legal control can be as good as ownership. To accomplish your goals, you might not need to own a particular property and in
some circumstances, control of a property can be even better than ownership.
This could be through the use of options; a legal agreement whereby a vendor agrees to sell a property to a purchaser, usually at a pre-agreed price and on pre-agreed terms at some time in the future. (I use the term “pre-agreed price” loosely, as a variation on this theme could be to set a price on a pre-agreed date).
To give an example, I recently took control of a 3-bedroom house whose owner was working and living overseas. Having experienced significant management problems, he wanted to get rid of the property as quickly as possible. I agreed a purchase price with him and now have the option to buy at any time over the next 7 years. In the meantime, I will pay him a monthly payment which is a little less than the current rental value, and if I choose to purchase the property, all of these payments will be credited against the price.
To novice investors, this may sound a little risky. However, an option is legally binding in that the contract is enforceable by law.
When granting an option, a vendor usually requires an upfront payment or “option fee” – a sum agreed by both parties that may or may not be offset by the deposit if the sale takes place in the future. In most cases, the purchaser usually forfeits the fee if they fail to exercise the option within the agreed time frame.
In challenging economic times, this type of strategy has become increasingly popular and can work to not only benefit investors and private vendors, but developers and builders too. As an example, builders and developers sometimes exercise options to tie up land or properties while they work on investigating planning consent. In this scenario, the price agreed under the option may or may not reflect that planning will be granted, depending upon the terms they agree.
Options are a 2-way thing and in some circumstances, it can be advantageous to you, as an investor, to consider granting an option yourself. One scenario may be if you come across a home owner who is facing repossession. You may look to negotiate a “sale and rent back”. In this instance, in return for a quick sale you may secure a low purchase price and allow the vendor to stay on as a tenant if the figures stack up when taking into account the mortgage and other costs. As part of the deal you could also grant the homeowner an option to buy the property back, at a pre-agreed price, within an agreed time frame.
With this example not only can you make a profit if the option is exercised, but it will give the tenant the opportunity to own their home again when times are better financially. This option works to favour both parties.
Another route you might like to consider is granting tenants a “purchase lease option”. With a purchase lease option, the usual scenario is that a tenant rents a property but with an option to buy the property within an agreed time frame at a pre-agreed price. They will pay an option fee up front, often calculated as being between 1% and 3% of the agreed purchase price, and will then pay an additional monthly sum that is over and above the rent. Usually, both the extra monthly payment and the initial option fee will be credited towards the cost of the property, and this will effectively help the tenant save the deposit by dividing the amount needed by the number of months in the option period.
To illustrate this with figures: if an agreed purchase price is £150,000, the parties would consider what deposit is required at the end of the option period. Under current mortgage conditions, (at the time of writing) lenders require an average of 17% but the parties to the agreement might conclude that (hopefully) over the next five years, the mortgage market will unfreeze and 10% deposits will be more the norm. This being the case, the tenant would need £15,000 for the deposit, which over a five-year period would equate to 60 monthly payments of £250.
The advantages of a purchase lease option such as this are many. If the tenant exercises the option the investor has the peace of mind that they will sell at a profit, and if the tenant doesn’t exercise the option, they get to keep the option fee and the extra monthly payments.
It’s also likely that the occupant will be a model tenant as he/she will have a vested interest in keeping up with rent payments and to the terms of the tenancy agreement. What’s more, during the option period the investor will enjoy a significant boost to their cash flow.
And there are advantages for the tenant too. They can buy at a price which, at the time of exercising the option, could be less than the open market value at the time, and will have help to save the deposit.
On the flip side though, if the tenant finds him or herself in financial difficulty or wishes to opt out, the option fee and the extra monthly payments would be lost. And the big risk for the investor is that at the time of exercising the option, property prices exceed the pre-agreed price.
In essence, whatever the agreement, both parties will need to carefully consider the terms before they commit and weigh up the advantages against the disadvantages. All terms must be clearly set out in a binding contract drawn up by a reputable solicitor, and should work to provide a favourable solution for both the investor and the vendor.
Peter Jones B.Sc FRICS
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