Don`t Set Your Option Price Too High
Price It Right For You And The Buyer.
When setting up a Lease Option investment you will need to decide what your Option Price is. Your Option Price is the price that the Tenant Buyer will buy your property from you when they decide to exercise their option sometime in the future. This could be anywhere from 1 to 5 years. Most of my Lease Option investments are for only 3 years.
You will want to set your Option Price based on what you think the property will be worth at the time the option is exercised. I set my option price based on the average appreciations of similar properties in that area for the last 5 years or so.
You will want to make sure that your Option Price is not too high. Here are a few things that could happen if you do.
Let’s say you have a property that is worth $200K in todays market. You decide to Lease option it for $260K in a 3 year agreement. This is considered high in most areas because it is based on an average appreciation of 20% per year (not compounded). In 3 years when your Tenant Buyer tries to buy the property they may not be able to because it is not worth $260K. A couple of things can happen.
- You can sell it to them for less than the Option Price. Let`s be honest. $60K for one Lease Option deal is pretty good. The advantage of having a high Option Price is that you can always lower it to the current rate. If you agreed to a much lower price, let`s say $225K and the appraised value is $235K then you lost $10K of potential profit. But it`s always a good idea to leave some of the equity for the Tenant Buyer and that`s why I chose to start with a lower price. The other thing you could do is hold a second mortgage for the difference in the Option Price and appraisal.
- You could negotiate an extension on the agreement. Extend the Lease Option period another year so that the market price can catch up to the Option Price. The danger with doing this is that the market value could actually go down and the situation could get worse. As part of the extension, you could decide if you want to change the monthly payment because of the inconvenience and consideration.
- The Tenant Buyer could decide not to exercise their option. They get scared because the price did not rise to where it needs to be and they are worried that it could even go down. This is not the ideal situation because I really hope that the Tenant Buyers ends up purchasing the property. I want to help them buy their house. Unfortunately, circumstances change and it is ultimately their decision.
As I mentioned, my first course would be to try and reduce the price so that they are able to make the purchase.