Real estate investors have options. Lots of them. There are options on what property to buy, how much to pay and whether or not to hold or flip a future investment. For investors with several properties in their portfolio, at some point the investor will lease with option to purchase real estatesell a home originally held for long term appreciation.

Sometimes though an investor is asked to sell a property to a buyer on a lease-purchase arrangement. A lease purchase agreement is a way for buyers who need a little help to buy a home and provides a property owner with more options. Lease purchase agreements work, but only if set up properly.

A lease purchase agreement is a contract that allows buyers to rent a property for a specified time then finance the property with a traditional mortgage. Typical lease purchase agreements are for a one to two year period. For example, a tenant agrees to rent the property for $2,000 per month and at the end of two years buy the property for $200,000.

Many such agreements allow the property owner to set aside a certain amount of that $2,000 rent to be held in reserves and used as a down payment when the two year period expires. For instance, the owner holds back $500 each month which will grow to $12,000. The tenants apply for a loan at a bank and use the $12,000 as part of their down payment and closing costs.

The common mistake with such an arrangement is the amount held back compared to the rent. Whatever amount is withheld, the remaining balance must be equal to the current market rent for the area. In this example, the rent for similar properties should be $1,500, not an inflated $2,000. When a lender reviews a lease purchase agreement, the lender will credit the $12,000 only if that amount can be verified as over and above market rent.  If not, the lender won’t give the tenants any credit at all and could be viewed as the property owner giving the tenants $12,000 to buy the house, which the owner can’t do.

It’s relatively easy to establish a market rent by viewing and storing other rental properties in the area or if there’s a question, hire an appraiser to make the determination for you. If not documented properly, the lease agreement won’t work. You still keep the house, but the tenants can’t buy the home.