Definition
A lease option is a type of contract used in both residential and commercial real estate. In a lease-option, a property owner and tenant agree that, at the end of a specified rental period for a given property, the renter has the option of purchasing the property.
Lease Option
What is ‘Lease Option ‘
An agreement that gives a renter the choice to purchase a property during or at the end of the rental period. As long as the lease option period is in effect, the landlord/seller may not offer the property for sale to anyone else.
When the term expires, the renter must either exercise or forfeit the purchase option. A lease option gives a renter/potential buyer more flexibility than a lease-purchase agreement, which requires the renter to purchase the property at the end of the rental period.
Explaining ‘Lease Option ‘
The property owner may charge the renter a premium for the option to purchase the property, perhaps in the form of higher (above market value) monthly rental payments. The property owner may opt to apply some of the higher rental fee toward the purchase price if the renter exercises the option.
Any premium will likely be forfeited if the option is not exercised. The term of the option may be any period on which the property owner/landlord and potential purchaser/renter agree, but is commonly one to three years. The lease-option property’s purchase price may be determined either at the outset of the agreement or at its conclusion.
Further Reading
- Lease terms, option pricing and the financial characteristics of property – www.jstor.org [PDF]
- Capital market imperfections and the incentive to lease – www.sciencedirect.com [PDF]
- Valuing lease contracts a real-options approach – www.sciencedirect.com [PDF]
- Risk management in supply chain: a real option approach – www.emerald.com [PDF]
- The pricing of embedded options in real estate lease contracts – aresjournals.org [PDF]
- Valuing long-term leases: The option to redevelop – link.springer.com [PDF]
- The case for using options to evaluate salvage values in financial leases – www.jstor.org [PDF]
- Valuing lease contracts under incomplete information: A real-options approach – www.tandfonline.com [PDF]
- Survival of the fittest? Financial and economic distress and restructuring outcomes in Chapter 11 – papers.ssrn.com [PDF]
