High property prices, low salaries and widespread debt make that first rung of the property ladder a distant dream for many in the UK. But a new form of property agreement called a lease option could be a light at the end of the tunnel for cash-strapped first time buyers.
The concept of the option is well-known in the financial world, and can be applied to shares, land or property. Having an option gives the holder the right to buy or sell something at an agreed price after an agreed period. The holder usually pays a premium to be granted this right, but is not obliged to exercise it.
Lease options on property are already popular in the US and other overseas markets. New UK companies such 1stLOCation, run by The Lease Option Company, and Property Lease-Option UK are now offering them up in a bid to attract both hard-up buyers and landlords in search of reliable tenants.
So how does it work? A lease option agreement involves a tenant being given the option to buy a property at an agreed price at the end of a given rental period, usually three to six years. The renter-buyer pays a consideration up front, but at 2-3% of the market value of the property this is preferable to putting up a full deposit of 5-20% straight away.
Take first-time buyers Fran and Fred as an example. They are looking to rent a flat worth £180,000 in January 2007. Under a lease option agreement the owner offers them the right to buy the flat for £200,000 in January 2010, for a consideration of £3,600.
They agree to the lease option, Fran and Fred can sleep easy while other property prices move further and further out of their grasp. They get to test out their property by living in it before they decide to buy, and if soaring prices bring the value of their flat up to £230,000 by January 2010 then they’ve clearly got themselves a good deal.
Agreeing a price in advance makes it easier for buyers to plan financially and save for a full deposit. A longer lease and the prospect of ownership provide security and reduce the amount of ‘dead’ rent money going down the drain. Of course, if you’re the itchy-footed type, with frequently changing circumstances, then being tied into a long lease may not appeal.
Another bonus for the renter-buyer is avoiding the nasty business of buying property on the open market. A deal agreed in advance, on a property you’re already occupying means no complicated chains or moving costs.
Lease options don’t just have to be for first-time-buyers. They can provide a place to live at a guaranteed price and time to sell your existing property. This is useful if your property is slow to sell but you need to relocate quickly.
A lease option is not completely risk free though. It only saves buyers money while prices are rising. If the value of Fran and Fred’s flat ends up declining over those three years, they’re left with a difficult choice: Pay over-the-odds for the property, or forfeit the option to buy and start again from scratch.
Benefits for landlords
Lease option agreements can appeal to sellers too. They are best suited to buy-to-let landlords who own a number of properties they may wish to sell in a few years time. Sellers who need an immediate sale to buy another home (i.e. those in a chain) are better off sticking to the open market.
Unreliable tenants who don’t care for a property are a landlord’s worst nightmare. Think wine-stained carpets, blocked sinks and car tyres in the garden. Those on longer leases in properties they’re looking to own are unlikely to fall into this category. Longer rental periods also allow landlords to avoid costly gaps between tenancies when a property lies empty.
The lease option offers some protection against the value of a property going down. However, the seller has the inverse risk to the buyer. If house prices rocket during the rental period then a property could end up being sold for much less than it could make on the open market.
Like any contract, the exact terms of a lease option can vary. One variation offered by the company Rent-2-Buy, offers tenants a six-year lease and gives them full responsibility for maintenance and repairs. Tenants are then given a 6% share of any increased value on an annual basis, effectively saving for a deposit as they rent. Signing an ‘Option to Purchase’ at the onset of the tenancy gives tenants the right to buy between the end of the third and sixth year, at a price knocked down by up to 36% of the growth in value (6% per year for six years).
In a Rent-2-Buy agreement, a property worth £100,000 could rise in value to £150,000 in three years. The renter-buyer could earn an 18% rebate on the £50,000 value rise, and therefore be offered purchase of the property for a tempting £141,000.
Rent-2-Buy contract does give the landlord the right to sell early and cancel the tenant’s option, but this tends to be in exceptional circumstances and tenants are financially compensated. Equally, if the tenant’s situation changes any time after the first six months of renting, they can give one month’s notice and forfeit their option to buy. With the landlord’s agreement, they can also pass on their tenancy and option to another tenant.
As with any property purchase, a lease option carries some risk for buyers and sellers alike. But with perks on both side of the deal, this new form of tenancy could prove a refreshing alternative to traditional property agreements in the UK.