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Lease with an Option to Purchase: Top Four Challenges to Consider

When a business owner examines available space options for their business, they may consider a property marketed for both lease and sale. Many times, a business owner decides to purchase the property instead of leasing after realizing that rental payments can go towards paying down a mortgage. They could actually own the property instead of paying rent for 10 + years. They then begin examining the costs involved in the purchase. These include a down payment, attorney’s fees, engineering inspections, title search, insurance and other due diligence expenses. At this point the business owner may have second thoughts and consider the option of leasing.

The third scenario is entering into a property lease with an option to purchase at a specified point in time. A landlord who would prefer a sale, but is having difficulty finding a buyer, will often offer this arrangement in an effort to make the property more attractive to a prospective buyer or tenant. This sounds great in theory; however, when put into practice, the tenant and owner of the property may have very different ideas. The tenant expects some portion or all of the rent will be applied to the purchase price. The owner is not as flexible about this concept as the tenant anticipates. The owner also expects the tenant to pay a higher price because of their level of interest in the building.

Top four challenges when entering into a lease with an option to purchase agreement

1.     Determining how much, if any, of the rent shall be applied to the purchase price.

2.     Agreeing on a purchase price and time frame for the purchase option to be exercised.

3.     If rent is applied to the purchase price, the buyer and seller may need to seek advice from a tax consultant; in some cases, tax returns may have to be amended.

4.     Over time, the interest rate and purchase price may fluctuate significantly changing the tenant’s ability to afford and/or qualify for the mortgage.

The parties can negotiate to have the purchase option occur at any point in time that they agree upon. Also, standard legal language can be added to the purchase option in order to establish a fair market value at the time the option is exercised. This can be accomplished by having the seller or buyer submit a suggested purchase price. If not accepted, the refusal can trigger both parties to obtain appraisals. This enables a compromise to be reached establishing a purchase price based on the current market. While leasing with an option to purchase may be suitable for many, it’s important to consider the aforementioned challenges before making a decision.

Jeanne Sabo Rothenberg, CCIM
Vice President
NAI DiLeo-Bram & Co.
Cell: (908) 377-9004
http://www.commercialrebroker.com/
jrothenberg@naidb.com