Lease/Option Formulas
When a seller and buyer cannot agree on today's price, a lease with an option to purchase can bridge time, use, and value.
By Darryl McCullough4 min read
FIRST PUBLISHED MAY 2018; EDITED FOR WEB READABILITY.
We found a parcel of land that fit our buyer client's commercial plan, but buyer and seller could not agree on today's price. The seller believed the location and its growth would support the asking price later. The buyer liked the future but could not justify that price at the time.
During the negotiations, the seller learned about the buyer's financial strength and integrity. That relationship led to a transaction in which the seller advanced construction funds for a new facility. Buyer and seller entered a long-term lease, and the buyer received an option to purchase over a period of years.
Once his business was proven up, my buyer exercised his option.
The seller received a solid net income stream for years, kept pride of ownership over that period, and ultimately received his full asking price through the exercised option. The buyer took advantage of an excellent location, expanded the business, and, at that time, obtained bank financing well over 100 percent of the option price based on the appraisals completed when the option was exercised.
The option: the owner keeps title while the option is open
TODAY
Your building · still yours
you keep the title, the rent, and the keys
THE PARTIES AGREE
An option to purchase
price, term, and conditions are written down
DURING THE OPTION TERM, ONE OF TWO THINGS HAPPENS
IF THE OPTION HOLDER BUYS
the owner receives the agreed purchase price
on the terms written into the option
IF THE OPTION IS NOT EXERCISED
the owner keeps the building
and the remaining rights and obligations follow the written agreement
illustrative structure
We took the same formula to another location in another city, with similar success.
Leasing real estate with an option to purchase can create several other opportunities for sellers and buyers. The buyer can receive many of the benefits of ownership, including appreciation, without needing the full purchase financing at the beginning.
Split the land and building
Another possible solution to a price-point challenge is to sell the improvements and lease the land, with an option to purchase the land later. The priority of the lease, including whether it is subordinated, becomes part of meeting the seller's and buyer's needs.
Head-lease the vacant space, with an option to buy
Every jurisdiction has multi-tenant and single-tenant buildings with low or challenged occupancy. A well-structured head lease with an option to buy can cover an entire building.
The existing owner may receive rent that helps relieve negative cash flow, funds needed structural or leasehold improvements, or relief from management. The experienced buyer may receive upside cash flow from releasing the space and the ability to buy later at a favorable price after repositioning the property and proving the income. The parties can also negotiate additional security for the existing owner.
THE HEAD LEASE · WHAT CHANGES FOR THE OWNER
The building stays yours. The operating role moves.
Home land-lease with an option to buy
This form of home ownership is common in many North American jurisdictions and less understood in others. It can contribute to attainable housing by lowering the resident's initial cost of acquiring the home. It can also give a passive land owner a sound return through a land lease for a defined period. The actual economics depend on the land, lease, financing, and local law.