How To Sell a House with a Lease Option

As I outlined in my previous article about lease options, the Texas legislature has made it very difficult to sell a house on a “rent-to-own” or lease-purchase basis. The statute – Texas Property Code Chapter 5, Subchapter D, beginning with Section 5.061 – prohibits any executory contract for the sale of residential property if the property already has a mortgage on it, and sets out draconian penalties for any violations of the technical statutory requirements. For these reasons, I have generally advised my clients not to sell their houses with lease options and instead offer owner financing such as a wraparound mortgage.

However, it is possible to sell your Texas house on a lease purchase, and in fact, that may be the best solution for some sellers and buyers. You just want to make sure you keep your transaction “out of the statute,” so you don’t have to jump through all those legislative hoops. And luckily enough, there is a statutory exception that will allow you to sell your house rent-to-own without worrying about having to give all the money back if you don’t follow every single technical requirement for the code.

Landlord-Seller 00 – READ ME Lease Option

This article, titled “Landlord-Seller 00 – READ ME Lease Option,” can be downloaded for $0.01 here or on my downloads page. (I wanted it to be free, but the shopping cart wouldn’t let me.) You can also download any or all of the contract forms you will need to sell your house with a lease option.

These are the documents you will need to sell your house rent-to-own:

Landlord-Seller 01 – Residential Lease Application

Even though you are qualifying your applicants as tenants, you are really qualifying them as buyers. Assuming you want them to buy your house, you are looking for tenants who can afford the eventual mortgage payments and all the other expenses of home ownership, especially if you end up selling them the house with owner financing. So you will want to see verified gross monthly income of at least 3% of the eventual purchase price (or, in other words, three times the estimated “monthly nut” of owning the house).

Landlord-Seller 02 – Residential Lease Agreement

This lease agreement does not mention the option to purchase and vice versa. This is not required by law, but it’s just a good idea to illustrate to your tenant-buyers that the option to purchase is completely separate from the lease, and that paying rent and otherwise being a good tenant is not what entitles them to purchase the house. It’s also worth mentioning that although the option to purchase itself needs to expire within 180 days of the effective date, the lease itself can be longer, so you can offer someone a 12-month lease with a 6-month option to purchase, just so long as they understand (and acknowledge in writing) that the option only lasts 179 days regardless of the length of the lease.

Now, I often get asked if it is legal to give the tenant-buyer a long lease (e.g., 3 years), and provide that the option does not begin until a date 6 months before the end of the lease (e.g., 2 1/2 years into the 3-year lease). The answer is: yes, it is legal, but that transaction will fall under the executory contract statute. Section 5.062(c) of the Texas Property Code says the statute does not apply to a contract

that provides for the delivery of a deed from the seller to the purchaser within 180 days of the date of the final execution of the executory contract.

So you cannot extend the closing date of the actual sale past 180 days in any case without being subject to all the statutory requirements. No thanks.

Landlord-Seller 03 – Option Agreement to Purchase Real Estate

This is obviously the crucial document in the transaction, the document that grants the tenant-buyer the right to buy the property. It is absolutely critical that the option agreement specify that the deed must be executed and recorded on or before 179 days after the effective date of the option, that there are absolutely no renewals or extensions of the option, and that the option consideration is absolutely non-refundable under any circumstances. This document doesn’t have any particular statutory requirements, but I would recommend putting some of the important language in bold all caps and having the optionees initial those paragraphs. This Option Agreement favors the Landlord-Seller very heavily.

Landlord-Seller 04 – Quitclaim Deed

The form of this deed is attached as an exhibit to my form of option agreement to be used whenever the tenant-buyers do not exercise the option to buy the property. Even though the option agreement specifies that it terminates automatically and that recording the option agreement is strictly prohibited and will also terminate the option automatically, it is a good idea to get the non-purchasing tenant-buyers to sign a quitclaim deed so that there is no doubt that they have no legal or equitable interest in the property.

If the tenant-buyers do exercise the option to purchase the property, congratulations! Most don’t. If they do, then you will need to execute a purchase and sale agreement quickly, and you may in fact be selling the house on a wrap or other owner financing now. If so, you will now need some of my seller financing forms, e.g., the wraparound mortgage documents.

Landlord-Seller 05 – Lease Option Bundle

This is a bundle of all of the documents listed above, including the READ ME article.

The purchase price for all downloads includes free updates forever.
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Lease Options in Texas: Caveat Vendor

Most people are familiar with the Latin phrase caveat emptor, which means “buyer beware,” but investors and other homeowners attempting to sell their houses on a “rent to own,” lease option, or lease purchase should learn a new phrase: caveat vendor, or “seller beware.”

The Texas legislature has made it extremely difficult to sell a residential property on a lease option and comply with all the statutory provisions in the Texas Property Code. Chapter 5, Subchapter D of the Code applies to certain “executory contracts for conveyance,” meaning a real estate transaction where title (deed) does not transfer to the buyer immediately. And a 2006 amendment to this subchapter makes it clear that these provisions apply to lease purchase agreements in Texas:

an option to purchase real property that includes or is combined or executed concurrently with a residential lease agreement, together with the lease, is considered an executory contract for conveyance of real property. Tex. Prop. Code § 5.062(a)(2).

So the statute applies to lease options, but there are a number of exceptions and carve-outs that define what lease option sellers must do (and make the statute almost impossible to read).

First of all, the statute does not apply at all to rent to own contracts with a term of 180 days or less, so if your tenant-buyer can exercise the option within 180 days, you don’t have to worry about the statute.

However, if the option term is more than 180 days but less than three years, the landlord-seller must jump through a lot of hoops to comply with the statute.

First and most importantly, § 5.085(a) of the Property Code provides that a “potential seller may not execute an executory contract with a potential purchaser if the seller does not own the property in fee simple free from any liens or other encumbrances.”  That seems to say that a seller cannot lease-option his property if there is a mortgage on it!

But hold the phone, because subsection (b) of 5.085 seems to indicate that there is an exception for purchase money mortgages (a deed of trust securing the payment of money used to buy the house).

Subsection (b) says that you can lease option a house with a mortgage on it if:

1. The mortgage was used to purchase the house; and
2. The seller gives the buyer a written disclosure not less than 3 days before the lease-purchase contract is signed (click here to download a disclosure that complies with the statute); and
3. The lien covers only the property being sold and secures a payment amount that is never greater than the amount owed by the buyer; and
4. the lienholder (lender) does not object to the executory contract and consents to verify the status of the loan on request of the purchaser and to accept payments directly from the purchaser if the seller defaults on the loan; and
5. the contract contains certain specified covenants (click here to download a rent-to-own contract that complies with the statute).

And that’s not all. In addition to all of those requirements, if the tenant-buyer defaults on a payment under the contract, the seller must provide a specific written notice of default to the tenant-buyer and allow the tenant-buyer at least 30 days to cure the default. Click here for a notice of default that complies with the statute.

Finally, section 5.073 of the Property Code prohibits landlord-sellers from including certain terms in the lease-purchase contract (such as the forfeiture of the option fee for a late payment). Click here to download a contract that complies with the statute.

So there’s a lot to do if you’re planning to sell your house on a lease option. If you don’t comply with all of these statutory requirements, you could end up forfeiting every penny that the tenant-buyer pays you, or have to pay treble damages and attorney’s fees, or something else horrible.  

Click here to download the contracts, forms and notices you need to legally sell your house on a lease option in Texas, or contact me to talk more about legally selling your house on a lease option, lease purchase, or rent-to-own program.

How To Write An Investor-Friendly Contract

If you’re a Texas real estate investor, you will have many occasions when you will have to use the TREC form that most realtors use exclusively. My previous article explained how to turn the TREC form into an investor-friendly form. But if there are no brokers involved, or they don’t mind if you and your seller use a different contract form, you should offer to submit the contract form yourself. If you draft the contract, you are in a superior negotiating position, as the other party will have to react to what you propose, rather than the other way around. Drafting your own investor-friendly contract is not as difficult as you might think, and if you follow a few basic principles, you can put together a form that covers all the bases and tips the scales in your favor. You can download an investor-friendly form at the end of this article, or read on and draft your own agreements.

1. Choose an Effective Date

The effective date of the contract does not have to be the date the contract is signed. It can be the date the contract is receipted by the title company, the date the last party signs it, or another date that you choose. Regardless of what date you choose, you should put the effective date in a prominent position at the top of the contract so it’s easy to find later, when you’re calculating deadlines.

2. Identify the Parties

You will want to make sure that the contract spells out who the seller is and that the seller is who actually owns the property. If the property belonged to a deceased family member, you’ll have to get information on the probate process. If the property belongs to a corporation or other entity, you’ll need to be sure you have the right entity listed on the contract. And if the property belongs to an individual who is married, you will want to have the spouse sign the contract too, because under Texas marital property law, there is a good chance the spouse has some interest in the property, even if it was bought before the marriage.

When entering your name as the Buyer, you can add “and/or assigns” if you wish, but it’s not technically necessary, since as a general rule, Texas contracts are freely assignable.

3. Property

You must include a legal description of the property you are selling. Ask the seller for a copy of the deed that conveyed the property to them, and copy it verbatim into the new contract. Make absolutely sure that the legal description is correct or you could have major headaches at closing and even beyond. This section should also include an agreement by both parties concerning the transaction, e.g., “Seller hereby agrees to sell, transfer, assign and convey to Buyer, and Buyer hereby agrees to buy from Seller, that certain parcel of real property located in _____ County, Texas, and further described as follows….” You can also use this section to specify whether or not any personal property will convey with the real estate, and under what conditions.

4. Purchase Price

It goes without saying that the contract should include the purchase price, but sometimes it can be pretty tricky figuring out how to specify the exact number. If you, the investor, are taking over payments on a loan, or planning on doing a short sale, or paying a price per square foot, you might not be able to nail down an exact figure. That’s okay, as long as you specify what portion of the price will be in cash, what portion will be seller financing, etc., and that it is very clear what you are paying and what you are not.

5. Earnest Money

Sellers will obviously ask for as much earnest money as they can. They will usually tell you something about how 1-2% earnest money is “standard in the industry.” Whether or not that’s true, it’s certainly not true that any particular amount of earnest money is required to make the contract enforceable. As an investor, you will always want to put as little earnest money down as possible. It can be as little as $10 and the contract will still be binding. However, just to be safe, you should make a small portion of the earnest money non-refundable. Call it “independent consideration” and specify in the contract that the Seller gets to keep that independent consideration no matter what. It may seem like an archaic formality, but it will erase any doubt that you have a legally valid and enforceable contract.

6. Financing

The contract should specify how you, the investor, will bring funds to the closing table, even if that doesn’t mean you’re paying a dime in cash. If this is a creative deal, you may be paying part of the price in cash, part with seller financing, part with third party financing, assuming a note, and/or doing a short sale! My contract form has a different paragraph for each type of financing and allows you to check off the ones that apply. You can do it that way or just insert the applicable provisions when they come up.

7. Title and Survey

Even though title insurance is expensive, I always strongly recommend by clients get it for each property they buy. The convention in Texas is for the seller to provide the owner’s title policy at their expense, so you should always write the contract that way. Give yourself an inspection period for the title commitment – say 10 days after the effective date for your seller to provide the title commitment, and 10 days after that for you to make your objections. If there is a fairly recent survey, you might just ask the seller to provide a copy, but if there have been any significant changes to the property since the previous survey, you will want a new one. Ask the seller to pay for it. Some won’t, but there’s no harm in asking.

8. Access and Inspection

This section is one of the most important parts of the contract, because it will give you the wiggle room to get out of the deal if you discover something that makes you change your mind about buying the property. Include in the contract a provision that allows you to access the property upon reasonable notice to the seller. You can use this access to conduct inspections, but also to show prospective tenants and buyers, if you’re planning to quick flip the property. Give yourself an “inspection period” that is as long as possible, and put a clause in the contract that you can terminate the agreement for any reason during that inspection period. That way, if you don’t like your financing terms, or you’re not sure you can flip it for a profit, or if you just decide you don’t like the deal anymore, you can terminate and walk away after a free look. Be sure to mention that if you terminate, the Seller agrees to notify the title company and agree to release your earnest money back to you.

9. Closing

You don’t have to pick an actual date (like November 4th) for your closing date. Instead, it can be “a date not more than 30 days after the expiration of the Inspection Period, or such other date mutually agreed upon in writing by both parties.” This section should specify when and where the closing will take place and what each party has to do at the closing. As the buyer, you will only need to show up with the money, but the seller will need to deliver a general warranty deed (conveying the real property to you), a bill of sale (conveying the personal property to you), a title policy (insuring your ownership in the property), and perhaps other documents required by the particular transaction or the title company. You should specify how property taxes will be prorated, if at all, and who will pay which closing costs, and in what percentage.

10. Default

Make absolutely sure you include a default provision specifying that if you walk on the deal, the sole and exclusive remedy for the Seller is to keep your earnest money. Do not agree to a contract where the Seller has the right of specific performance, as the last thing you would ever want is the seller suing you to try to force you to buy a property that you don’t want.

11. Special/Miscellaneous Provisions

Don’t get bogged down by a form; there may be some unique circumstances in your deal that require some special provisions to be written in. You don’t necessarily need a lawyer to write in that you want the carpet to be cleaned within a week before closing. And there are a ton of so-called “boilerplate” provisions that can offer you some extra protection, such as a “merger” clause. This is a provision that makes it clear that what you sign is the complete agreement between the parties and supersedes all “prior or contemporaneous oral or written agreements” between you and the seller concerning the property. This is important because it prevents your Seller from suing you after closing and claiming that you verbally promised to pay him an extra $10,000 within 60 days after closing and that that agreement was part of the agreement you signed. (I won’t get into an academic discussion of the statute of frauds as it pertains to this hypothetical, but in general, real estate contracts have to be in writing to be enforceable, but there are a few exceptions to that rule that you really don’t want to end up in court arguing over.

My standard investor’s contract form is only 3 pages long and it covers all the bases. You can draft your own investor-friendly contract without too much trouble and save yourself thousands of dollars in the process — not just on attorney’s fees for drafting the agreement but avoiding some of the seller-friendly provisions that can cost you a great deal of money “down the line.” Good luck.

 

A Lawyer’s Guide to the TREC Form

If you’re a real estate investor in Texas, you’ve undoubtedly had to submit offers on the standard Texas Real Estate Commission form that real estate agents practically insist on using. Many realtors won’t take you seriously unless you submit your offers on the TREC form. The problem is that the TREC form isn’t necessarily investor-friendly (or even buyer-friendly). But never fear — if you make a few strategic changes to the contract, you can turn a seller-friendly TREC form into a contract you can feel good about signing.

The rest of this article won’t make sense unless you have a blank TREC form in front of you, so go ahead and download it now and print it out.

Section 1: When you are filling in your name or your company’s name as the Buyer, you can put “and/or assigns” if you want to, but it’s not necessary and it might raise your seller’s eyebrows. Contracts in Texas are freely assignable unless they specify otherwise, and there’s nothing in the TREC form to prohibit you from assigning it if you’re just flipping the contract.

Section 2: For the love of all that is holy, be sure the legal description is correct. The best source for an accurate legal descriptiong is the deed that conveyed the property to your seller.

Also, the convention among Texas agents is that appliances such as washer/dryers, refrigerators, dishwashers, etc. do NOT convey along with the house — even though section 2.B says “all equipment and appliances,” it is referring to fixtures that are permanently attached. If you want the appliances and everything else in the house to come along with the house, then you should add a clause to the special provisions (section 11) that says something like, “Notwithstanding anything to the contrary in this contract, the definition of “Property” includes all items of personal property that are located on the premises as of the effective date of this contract.” That way, if the Seller wants something not to convey, the Seller will have to bring it up and list it in the contract.

Section 3: This is important for the entire contract: whenever there is a blank, make sure it is filled in. For example, in section 3, if it is a no-money-down deal, then write “$0.00” in the first blank in section 3 (cash portion of the purchase price).

Section 4: Again, if there is no third-party financing, write “N/A” in the blank. If you are getting third-party financing, pick a number as high as possible for the amount of the loan, and make sure that the contract is subject to financing approval (check the box in Section 4.A.(2)(a)).

Section 5: Most realtors will tell you that one percent or more is “standard” as the amount of earnest money, but you do not have to put down that much as earnest money. Period. In fact, given the fact that there is a provision for the independent right to terminate the contract (section 23), earnest money is not even required at all to make this contract enforceable. Plus, it’s refundable anyway.

Also, you don’t have to get title insurance, and you can use an attorney as your escrow agent if you wish — like, say, Drew Shirley, P.C. (I can help you close escrow with a title company as well.)

Section 6: It is “standard” for the Seller to pay for the owner’s title policy, so you can throw that back at the seller’s agent. However, in subsection B, it allows the seller 20 days to furnish a title commitment, but I think 10 days is plenty of time for the commitment.

If the survey is more than a few years old, you probably want a new one, and you can negotiate who pays for it. You will want to make sure all of the exceptions listed on the title commitment are depicted or noted on the survey, and vice versa.

You will want to write a “title objection letter” to the title company after you receive the title commitment, objecting to some of the standard exceptions to title that appear in the first draft of the commitment. Plus, you will want to review the exception documents to make sure they affect the property you are buying, that they don’t restrict the use of the property in a way that you are intending to use it for, that they haven’t expired, etc.

Section 7.D.: There is no need for you have to identify the repairs you would like the Seller to make as you are signing the contract — you have an inspection period to determine what those are. I would just check box 2 and put “To Be Determined After Inspection” in the blank.

Section 8: If you are dealing with only one broker, you may want to include language to that effect in the special provisions.

Section 11: In addition to what I’ve mentioned already, here’s a good contingency clause to put in the special provisions: “Notwithstanding anything to the contrary in this contract, Buyer shall have the absolute right to terminate this contract, for any reason or no reason at all, by delivering written notice of Buyer’s intention to terminate the contract on or before the date which is thirty (30) days after the effective date of this contract. Upon Buyer’s delivery of such written notice to Seller, Seller shall cause the earnest money to be immediately refunded to Buyer in cash or other immediately available funds, and this contract shall be terminated and shall have no further force or effect, and the parties shall be released from all rights and obligations contained herein, except to the extent such rights or obligations, by the terms of this contract, survive any termination hereof.” That pretty much gives you a free 30 day look.

Section 12: the Seller can pay up to 3% of the purchase price as Buyer’s closing expenses, so go ahead and put 3% of the purchase price in the blank at section 12.A.(1)(b).

Section 15: If you are the Buyer in a TREC form contract, do not, repeat, do NOT sign the contract unless you have crossed out the specific performance remedy for Seller. Specificially, you should cross out a portion of the first sentence of section 15 and replace it with some other language, so that it reads: “If Buyer fails to comply with this contract, Buyer will be in default, and Seller may (a) enforce specific performance, seek such other relief as may be provided by law, or both, or (b), as Seller’s sole and exclusive remedy, terminate this contract and receive the earnest money as liquidated damages, thereby releasing both parties from this contract.” This is the most important change in the contract, and I would not sign this contract unless this change is made. A deal breaker. If you, the Buyer, defaults, then the Seller can keep the earnest money and find a new buyer. He doesn’t get to force us to buy a house we don’t want or can’t afford. Period.

Section 21: If you do not want to accept legal notices in a certain way, then cross out the method you don’t want and do not fill in the blank. (For example, if you do not want to receive valid legal notices by e-mail, then cross out the words “electronic transmission”).

Section 23: Obviously, you want the termination option to be as long as possible, but if you have your special provision about termination, then that provision will control. And like earnest money, $100 may be “standard” as an option fee, but it’s all negotiable.

The TREC form is not a great contract for investors, but if you know what’s in the contract and know where to make a few strategic changes, you can turn it in to a much more buyer-friendly contract without losing the deal. If you have any questions about this article or the TREC form, you should send me an email by clicking here.