Recent Publications By:
BRAD N. SOMMER, ESQ.
WHAT DID I JUST SIGN??
Lease w/ option to purchase
Installment land contract
The Lease with Option to Purchase Agreement has become a popular tool for real estate investors to attract Tenants, because it offers Tenants the opportunity to lease a property with an option to buy it at the end of the lease term.
For a Tenant, this arrangement is far more enticing than simply paying rent and walk away empty handed when the terms of the lease expire. For the Landlord, you have a Tenant who will presumably take better care of the property, and if Tenant go into default, he/or she may be evicted based on the lease portion of the agreement.
Unfortunately, the name of a document is not always clear. Ambiguous and vague language can confuse the Landlord as having offered an Installment Land Contract despite the Landlord’s true intent to offer a Lease with Option to Purchase Agreement.
Property X is being offered to a Tenant with a rental payment of $500 a month and an Option to Purchase for $50,000. The Agreement provides for a $5,000 upfront “option” fee and a direct rent credit for the entire $500 per month, both of which are applied to the purchase price. Thereafter, if all payments are made, at the end of the term the tenant may purchase Property X for $1.00.
In this example, in exchange for the Tenant’s long-term commitment to Property X, he/she is granted an option to purchase the property at the end of the lease for essentially no additional consideration. It is a win/win situation. The Landlord will turn a profit on their investment, and the Tenant is now a home owner where their credit probably would have otherwise prevented the same.
However, in the event the tenant defaults under the terms of the lease, a complicated jurisdictional problem can result, transforming a simple Landlord/Tenant dispute into a property equity action. The problem lies in how the agreement is drafted and interpreted by the Court, and often time, the Lease with Option to Purchase is considered an Installment Land Contract and/or a Residential Mortgage.
According to the Pennsylvania Code, an Installment Land Contract is “a lease of real property where the lessee pays or agrees to pay as compensation for use a sum substantially equivalent to or in excess of the aggregate value of the real property involved and it is agreed that the lease will become, or for no other consideration has the option to become, the owner of the real property upon full compliance.”
Moreover, if the agreement constitutes an Installment Land Contract, the PA Department of Banking has determined that this contract constitutes a “security document,” meaning that it is secured on the property resulting in an equitable (ownership) interest.
Such a transaction may also qualify as a Residential Mortgage if there exists: 1) An obligation to pay an original principle amount of $50,000 or less, 2) Evidenced by a security document, 3) Secured by a lien upon Real Property in PA, and 4) Contains two or fewer residential units. 41 P.S. 101,101(f).
So what does all this mean??
It means that the agreement that you thought was constructed as a Lease with Option to Purchase may actually be treated an Installment Land Contract and/or a Residential Mortgage, and your Tenant’s ownership interest in the property may not be distinguished by the local Magistrate with a Landlord/Tenant eviction action.
Pennsylvania Court decisions support this reality, finding that suits based in contract which concern or are connected with title and/or equitable interest in realty are excluded from the jurisdiction of the district magistrate justices, including claims for rent. Accordingly, the Magistrate Award for Damages/Possession may be found to be void for lacking jurisdiction. This means that the eviction secured may also be deemed unlawful and actionable – so be careful what you represent to the Court and what steps you take!
While a breach of a properly drafted Lease with Option to Purchase may be appropriately filed before a Magistrate, disputes under agreement which falls under the definition of an Installment Land Contract or Residential Mortgage are only actionable before the Court of Common Pleas as an Equity Action for Ejectment or Foreclosure.
A properly drafted agreement is all it takes to avoid costly litigation and legal exposure. Whether you are a new to real estate investment or have been in the game for years, it may be in your best interest to have your documents drafted or reviewed by an attorney experienced in this area of practice.