I have had several questions of late about doing lease options in Texas. Many have heard that it can't be done. Always check your source!
So here is the breakdown and it's OK to pursue:
Lease-purchases have always been a favorite tool of residential real estate investors. They are one of the "Big Three" – alongside contracts for deed and lease-options – all of which are creative devices for getting less than fully-qualified buyers into a home. These contracts have been traditionally popular in Texas for two reasons: first, it was easy to get tenant/buyers into the home by offering a low down payment; and second, it was easy for sellers to evict them through the forcible detainer process if they defaulted (and still keep the down payment).
In a typical lease-purchase (or "rent to own"), a portion of each monthly rent payment is (allegedly) set aside and credited toward the tenant/buyer´s down payment. It is common (but not universal) for a lease-purchase to provide that after a certain amount is paid in, the tenant is able either (1) to convert the transaction from a lease to an owner-financed sales transaction in which the tenant gets a warranty deed and gives back a note and deed of trust to the seller; or (2) the seller agrees that the tenant/buyer may show the accumulated down payment on a loan application to a third-party lender and thereby qualify for "take out" financing.
Lease-purchases, lease-options, and contracts for deed present serious burdens and risks to sellers under Texas Property Code 5.061 et seq. relating to "executory contracts" – i.e., contracts that remain essentially unfinished for a period of longer than 180 days. Sec. 5.061 provides that numerous initial and ongoing requirements must be observed if an executory contract is going to be properly implemented, and the burden (as well as all the risk of violation) is entirely on the seller to meet these. More on these requirement and penalties below.
The Dark History of Executory Contracts
In the past, unscrupulous sellers abused executory contracts by disregarding the buyer´s equitable rights and misrepresenting to Justices of the Peace that such buyers were ordinary tenants subject to ordinary leases (which was manifestly untrue). Sellers were then able to obtain evictions for minor or technical defaults, often confiscating large down payments in the process. The seller was then free to move on to his next "victim" and obtain another down payment. The legislature rightly acted to stop such abuse.
What exactly is an "Executory Contract"
An executory contract is any transaction that defers some action by either party that pertains to ownership or possession of real property into the future. Think of it this way: an "executed" contract is one that is fully performed today. It is done, finished. An "executory" contract, on the other hand, leaves something dangling. Usually the dangling item is the most important item of all, namely, who owns title to the property while the contract is pending and when does the buyer get the deed?
A seller improperly engaging in an executory contract incurs not only penalties under the Property Code (e.g., the return by the seller of all payments made by the buyer, including the down payment and monthly payments) but also liability under the Deceptive Trade Practices – Consumer Protection Act ("DTPA"), which can involve treble damages plus attorney´s fees. Even in minor transactions, small numbers can turn into big ones as a result. Note that the Property Code includes no seller defenses – even if the whole arrangement was the buyer´s idea in the first place.
Because of the burdensome requirements and penalties of Prop. Code Sec. 5.061, a landlord/seller may be tempted to re-write a traditional lease-purchase in an attempt to call it something else or make it appear as if it is something else. The important point to remember is this: if it´s an "executory contract," then Sec. 5.061 applies – regardless of the title or wording of the document. Judges tend to look to substance over form (the "if it quacks like a duck" theory).
Lease-Purchase-Option Hybrids
A complication that occurs with many lease-purchases (aside from the obvious fact that they are executory contracts) is that they may provide that once a sufficient down payment is paid in the tenant/buyer will have an option to purchase the property at a certain price. Result? The lease-purchase has become tangled up with a lease-option – and becomes become a hybrid "lease-purchase-option."
What if the lease-purchase provides that payments will continue over a number of years until the property is paid for? Then it may not be a lease-purchase at all. It may more properly be described as a contract for deed.
Two points are worth noting. The first is that each of these devices – lease-purchases, lease-options, and contracts for deed – can, if only slightly modified, become hybridized with something else, sinking the transaction deeper into the executory contract hole. The second point is that regardless of the ultimate form such hybrid contracts take, they remain executory contracts for purposes of the rules and penalties of Prop. Code Sec. 5.061 et seq.
The Six-Month Lease-Purchase-Option ("Stacking")
Lease-purchases may theoretically be used if the term is 180 days or less, although this is such a short period of time most buyers will not be able to accumulate much of a down payment. So what about the possibility of "stacking" contracts for a short period – say, 179 days to be safe – allowing the lease-purchase to expire but providing that it then automatically renews for an additional 179 day period? This would appear to a loophole in the statute.
The risk, of course, is that a disgruntled buyer who wants to get out his contract might talk to a real estate lawyer who then files a lawsuit. The judge in the case may choose to look at the totality of the facts and decide that it was the intent of the parties from the beginning to enter into a long-term arrangement – i.e., longer than 180 days in the aggregate – and that the contract is therefore an executory contract. This could be a disastrous outcome for the seller given the absence of any real defenses along with the statutory penalties involved.
Will an investor be "caught" if he goes forward with a lease-purchase that utilizes a stacking technique? Maybe, maybe not. There are no "executory contract" police. Again, it all comes down to whether or not the buyer becomes dissatisfied with the deal and decides to challenge it with a lawsuit.
DAVID J. WILLIS ATTORNEY http://www.LoneStarLandLaw.com
I have had several questions of late about doing lease options in Texas. Many have heard that it can't be done. Always check your source!
So here is the breakdown and it's OK to pursue:
Lease-purchases have always been a favorite tool of residential real estate investors. They are one of the "Big Three" – alongside contracts for deed and lease-options – all of which are creative devices for getting less than fully-qualified buyers into a home. These contracts have been traditionally popular in Texas for two reasons: first, it was easy to get tenant/buyers into the home by offering a low down payment; and second, it was easy for sellers to evict them through the forcible detainer process if they defaulted (and still keep the down payment).
In a typical lease-purchase (or "rent to own"), a portion of each monthly rent payment is (allegedly) set aside and credited toward the tenant/buyer´s down payment. It is common (but not universal) for a lease-purchase to provide that after a certain amount is paid in, the tenant is able either (1) to convert the transaction from a lease to an owner-financed sales transaction in which the tenant gets a warranty deed and gives back a note and deed of trust to the seller; or (2) the seller agrees that the tenant/buyer may show the accumulated down payment on a loan application to a third-party lender and thereby qualify for "take out" financing.
Lease-purchases, lease-options, and contracts for deed present serious burdens and risks to sellers under Texas Property Code 5.061 et seq. relating to "executory contracts" – i.e., contracts that remain essentially unfinished for a period of longer than 180 days. Sec. 5.061 provides that numerous initial and ongoing requirements must be observed if an executory contract is going to be properly implemented, and the burden (as well as all the risk of violation) is entirely on the seller to meet these. More on these requirement and penalties below.
The Dark History of Executory Contracts
In the past, unscrupulous sellers abused executory contracts by disregarding the buyer´s equitable rights and misrepresenting to Justices of the Peace that such buyers were ordinary tenants subject to ordinary leases (which was manifestly untrue). Sellers were then able to obtain evictions for minor or technical defaults, often confiscating large down payments in the process. The seller was then free to move on to his next "victim" and obtain another down payment. The legislature rightly acted to stop such abuse.
What exactly is an "Executory Contract"
An executory contract is any transaction that defers some action by either party that pertains to ownership or possession of real property into the future. Think of it this way: an "executed" contract is one that is fully performed today. It is done, finished. An "executory" contract, on the other hand, leaves something dangling. Usually the dangling item is the most important item of all, namely, who owns title to the property while the contract is pending and when does the buyer get the deed?
A seller improperly engaging in an executory contract incurs not only penalties under the Property Code (e.g., the return by the seller of all payments made by the buyer, including the down payment and monthly payments) but also liability under the Deceptive Trade Practices – Consumer Protection Act ("DTPA"), which can involve treble damages plus attorney´s fees. Even in minor transactions, small numbers can turn into big ones as a result. Note that the Property Code includes no seller defenses – even if the whole arrangement was the buyer´s idea in the first place.
Because of the burdensome requirements and penalties of Prop. Code Sec. 5.061, a landlord/seller may be tempted to re-write a traditional lease-purchase in an attempt to call it something else or make it appear as if it is something else. The important point to remember is this: if it´s an "executory contract," then Sec. 5.061 applies – regardless of the title or wording of the document. Judges tend to look to substance over form (the "if it quacks like a duck" theory).
Lease-Purchase-Option Hybrids
A complication that occurs with many lease-purchases (aside from the obvious fact that they are executory contracts) is that they may provide that once a sufficient down payment is paid in the tenant/buyer will have an option to purchase the property at a certain price. Result? The lease-purchase has become tangled up with a lease-option – and becomes become a hybrid "lease-purchase-option."
What if the lease-purchase provides that payments will continue over a number of years until the property is paid for? Then it may not be a lease-purchase at all. It may more properly be described as a contract for deed.
Two points are worth noting. The first is that each of these devices – lease-purchases, lease-options, and contracts for deed – can, if only slightly modified, become hybridized with something else, sinking the transaction deeper into the executory contract hole. The second point is that regardless of the ultimate form such hybrid contracts take, they remain executory contracts for purposes of the rules and penalties of Prop. Code Sec. 5.061 et seq.
The Six-Month Lease-Purchase-Option ("Stacking")
Lease-purchases may theoretically be used if the term is 180 days or less, although this is such a short period of time most buyers will not be able to accumulate much of a down payment. So what about the possibility of "stacking" contracts for a short period – say, 179 days to be safe – allowing the lease-purchase to expire but providing that it then automatically renews for an additional 179 day period? This would appear to a loophole in the statute.
The risk, of course, is that a disgruntled buyer who wants to get out his contract might talk to a real estate lawyer who then files a lawsuit. The judge in the case may choose to look at the totality of the facts and decide that it was the intent of the parties from the beginning to enter into a long-term arrangement – i.e., longer than 180 days in the aggregate – and that the contract is therefore an executory contract. This could be a disastrous outcome for the seller given the absence of any real defenses along with the statutory penalties involved.
Will an investor be "caught" if he goes forward with a lease-purchase that utilizes a stacking technique? Maybe, maybe not. There are no "executory contract" police. Again, it all comes down to whether or not the buyer becomes dissatisfied with the deal and decides to challenge it with a lawsuit.
DAVID J. WILLIS ATTORNEY
http://www.LoneStarLandLaw.com