At the February, 2011 AZREIA meeting, I was repeatedly asked about Lease/Options and Contracts for Conveyance.  Unlike the traditional purchase contract, the Lease/Option and Contract for Conveyance provide for the transfer of possession immediately, while the transfer of title is intended to occur at a date usually years down the road.

             Given the current economic climate – buyers with no credit, and banks unwilling to lend – many investors are looking to secure not only a tenant, but obtain the added benefits of having a prospective purchaser in their home.  A person interested in buying the home will often put down more money at the beginning of the transaction and will take better care of the home.

             However, if these contracts are not drafted properly, the parties may face unintended consequences such as expensive litigation and the inability to regain possession of the property quickly.  Before you can understand the issues, you must first understand the documents: 1) a Lease/Option is a lease with separate option to purchase –  the occupant’s right to possession is controlled by the lease agreement, and the tenant’s right to purchase is controlled by an purchase option; 2) a Contract for Conveyance is a sales contract where the Occupant pays a down payment and a monthly amount, some or all of which is being applied towards the purchase price, which when paid, the Seller transfers title to the Buyer.

             To highlight these issues, I have prepared a two-part series on the benefits and drawbacks of the Lease/Option and the Contract for Conveyance.  This first article will explore the Lease/Option.  The second article, which will be published in the May newsletter, will explore the Contract for Conveyance.

             Lease/Option.  The lease with an option to purchase at a future date has been a long-standing favorite of investors.  Here the parties sign a lease which controls the use and occupancy of the premises, and a separate purchase option giving the right, but not the obligation, to the tenant to purchase the real property in the future.

             Investor Benefits of the Lease/Option.  When these documents are properly drafted, the investor retains a very high level of control over the use of the property.   The tenant also feels more invested in the property because the tenant has paid a substantial amount for the right to purchase the property in the future.

            Primary Advantage. Quickly retaking possession of the property.  The lease creates a landlord/tenant relationship between the parties.   In Arizona the ability to evict persons from real property is tied to the requirement that the parties have a landlord/tenant relationship.  The lease between the parties creates the landlord/tenant relationship and governs the terms of the tenancy.  Under the lease, if the tenant fails to pay the rent, the landlord can serve a five day notice for non-payment of rent and pursue an eviction to terminate the tenant’s right to possession.  (Please note – if the Option fee is very large, many judges will be hesitant to evict the tenant in the belief that the tenant must have some equitable interest in the property.) Upon the judge signing the eviction judgment, the lease is terminated, and as a consequence, the option is no longer valid.  No forfeiture, foreclosure or quiet title action is required.  In short, if you have a significant concern that your tenant will fail to pay rent, you may want to consider using a lease with separate option.  It provides a fast method by which you can obtain possession from a defaulting tenant, generally two or more months faster than obtaining possession after a breach of the Contract for Conveyance.

             Primary Disadvantage. Maintenance of the property.  When the parties are under a landlord/tenant relationship the parties are bound the Arizona Residential Landlord Tenant Act (“ARLTA”).  While the ARLTA allows the landlord of a single family residence to shift much of the maintenance responsibilities to the tenant, repairs necessary to comply with health and safety issues generally remain the Landlord’s responsibility. (A.R.S. §33-1324(C)).  While there are ways to address this, it is still a concern that must be addressed.

             When the option matures, if the tenant has not breached the lease, the tenant can  then exercise the option and enter into a standard purchase contract which must be closed through escrow within a set time period.  The option fee should not to be applied to the purchase price, it is not a refundable deposit under the lease, it belongs to the landlord upon payment and it is not refundable.

             Be careful when drafting these documents – if drafted poorly, the landlord may lose its ability (advantage) to evict the tenant.

 Information contained in this article is for informational purposes only and should not be considered legal advice. You should always contact an attorney for legal advice and not rely on information published here.