By Anthony J Cordato of Cordato Partners
Buying as you are renting a house or home unit allows tenant to hold an option to purchase while renting the residential property.
It has been used in commercial leases for many years.
In a recent decision: Le v Tran  NSWSC 632, the Supreme Court of NSW has upheld the validity of a combined option to purchase and a residential tenancy, as a vendor finance transaction.
In this article, we review the decision and the form that an option to purchase should take when combined with residential leases, to make a rent to buy transaction.
What form should Options to Purchase take in rent to buy transaction?
Options to Purchase provide a pathway for residential tenants and residential property investors to control a house or home unit, initially without taking out a bank loan or paying a traditional deposit.
Over an agreed term, the tenant or investor, can either accumulate a deposit and obtain a bank loan to take title to the property, or sell the option at a profit, or relinquish the option.
This is the form that the rent to buy transaction should take:
– An option to purchase (a call option) and a residential lease are entered into at the same time. That is why the transaction is commonly known as a Lease Option.
– The residential lease is entered into at market rent, in the standard form prescribed by the Residential Tenancies Law.
– The option to purchase (a separate document) specifies the option fee payable and how it is to be paid, the fixed purchase price payable and the option expiry date.
– The amount of the option fee payable and the option expiry date are set by reference to the projected loan availability at the end of the option term. For example, if the tenant will qualify for a loan of 90% of the price, then the option term will need to be sufficient for option fees to be paid amounting to 10% of the price. As a fall-back, often there is provision to extend the term if the loan qualification becomes more difficult during the term. The term of the residential lease mirrors the option term.
– The option fee is paid by instalments. Part of the option fee is paid on the entry of the option. The rest of the option fee is paid during the term, by instalments, usually when the rent is paid. For example, the rent might be $400 per week and the option fee might be $200 per week. And so, the total weekly payment might be $600 per week. The rider is that the weekly payments of $600 per week need to be affordable to the tenant or investor, as if assessed in terms of responsible lending guidelines.
– The price is a fixed price which is set when the option is granted.
– The price represents ‘full market value’ of the property. The price will be higher than the cash price, because payment terms are offered. How much higher depends on prospects for capital growth and the term.
– The option to purchase can be exercised at any time.
Do the courts recognise Lease Options as valid?
In Le v Tran, Associate Justice Harrison of the Supreme Court of New South Wales upheld a Lease Option which took the above form.
The house was a standard 3 bedroom house. The other facts were somewhat unusual – the option fees payable were lump sums on certain dates; and the court’s task was to determine the validity of the termination of the Lease Option, as opposed to enforcing a Lease Option.
And so the decision, which centred upon the tenant/grantee’s default, the termination of the option and the lease, and an orders for possession and payment of arrears of rent and option fees, is not relevant for our purposes.
However, relevantly for our purposes, the court upheld the validity of the Lease Option documentation. These were the observations made by her Honour:
– The option agreement provided that Ms Tran would be granted an option to purchase the property for the price and in accordance with the terms of the Contract for Sale attached to the option agreement in return for an option fee, comprised of an upfront option fee and ongoing instalments. The option fee was to be credited against the purchase price of the property. … Although the option agreement appears to be expensive, the benefit it conferred on Ms Tran is that she had the right to purchase the property and the payments made by her were credited to the sale price. [paragraph 69]
– The residential tenancy agreement is a standard form agreement in accordance with the Residential Tenancies Regulation 2010 (NSW) Schedule 1 clause 4. …. the term of the agreement is two years. The rent is $550 per week. A rental bond of $550 was required. [paragraph 71]
Sandwich Lease Options
There is an interesting twist to this decision, which is that the grantor of the option, Mr Le, was not the registered owner of the property.
Mr Le had taken an option to purchase the property from the owner, Ms Phan. Mr Le’s option was to purchase the property at a fixed price.
To pay the option fee, Mr Le agreed to pay Ms Phan’s loan instalments, as they fell due, together the land rates and water rates. He also paid for the home insurance.
Mr Le was given a residential lease of the property, with the right to sub-lease.
He was appointed the attorney of the owner to deal with the property.
This form of option is known as an ‘Assumptive Option’.
When they are used together, an Assumptive Option and an Option for Purchase, they are known as a ‘Sandwich Lease Option”,
Their attraction lies in the fact that someone in Mr Tran’s position can put together a Sandwich Lease Option to control the property without needing to expend any of their own money – figuratively, they can ‘buy a house for $1″!
Why is no financial outlay necessary? The reason is that payments made by the tenant/grantee of the Option to Purchase exceed the payments made to the property owner under the Assumptive Option. Note that the payments in question are a mixture of option fees and rent.
The methodology of setting up a Sandwich Lease Option is beyond the scope of this article.