How to successfully navigate a leaseback agreement
There’s a fairly unanimous conclusion that buying or selling a home can be a stressful process. When you add in trying to time both buying and selling—and potentially juggling two mortgages—the stress levels rise exponentially. One option to buy sellers a little bit of time is a leaseback transaction. Data from the REALTORS® Confidence Index Survey shows that 20% of sellers moved out of their homes after a leaseback period. Comprising close to a quarter of sellers, it’s a popular option to try and offset inopportune timing.
So, what’s a leaseback and how does it work?
A leaseback, also referred to as a rent back, is a transaction where the seller sells their property and then leases it back from the new owner. Typically, this occurs when the seller hasn’t found a new home yet and needs more time before vacating the property. But leaseback agreements can come in handy in a variety of situations. Let’s take a look…
Benefits for the seller
While typically sellers are the ones who would request a leaseback in the first place, a leaseback agreement can give sellers peace of mind during a potentially stressful situation.
If you haven’t found your new home yet, a leaseback can give you the opportunity to spend more time searching or save you from having to move twice. And if you’re building a new home to move into, it’s not unusual to run into construction delays and need extra time in the home you’re selling. Another scenario where a leaseback could come in handy is if you have school-aged children and receive an offer on your home before the end of the school year. The option to rent back and finish out the school year could be greatly appreciated.
A leaseback ensures you’ll also be able to use the proceeds from the sale of your current home at the closing of your new home. While the money you made from the sale can take a while to appear in your bank account, if you were closing in close proximity to the sale of your home, you might not be able to use that money right away. A leaseback allows for plenty of time for the money to get to your account. So much so, it might be burning a hole in your bank account waiting until you’re ready to place an offer.
What you’ll need to consider
It may feel a little strange being a tenant in your own home, especially if you’ve lived there for a long period of time. You forgo the ability to make permanent changes and other freedoms that come with the power of owning. But seeing as this is a short-term solution and that you’ll be busy searching for (or building) your new home, it’s highly unlikely you’d be planning to make major changes to your current home.
Besides the strange feeling of renting what used to be yours, you’ll want to keep in mind that your rent charge could be higher than what your mortgage payment used to look like, and that in the case of any damages, you might not get your security deposit back.
Benefits for the buyer
Even though leaseback agreements are typically drawn up to accommodate the seller, there can be benefits for the buyer as well.
Elevate your offer
If you or your agent uncover that the seller of the property that you’re interested in hasn’t found their new home yet, offering a leaseback option could help your offer stand out in a competitive market. This will of course depend on how soon you need to be out of your current home. But if you don’t need to move in right away, that stipulation could mean everything to a seller who’s anxious they haven’t found a new place yet.
A boost to your bank account
Another benefit is of course the rent you’d be collecting. Some extra money could be a nice boost as you settle into your new mortgage payment, although that’s as long as it covers your full monthly payment. And with rates on the rise, it could be beneficial to lock in your rate as soon as possible, even if you won’t technically be moving for a bit.
If you’re buying a vacation home or investment property, a leaseback works particularly well. In this case you might’ve been interested in renting out your property in the first place, so now you will have found your first tenants. And a lot of vacation property rentals thrive off of positive reviews. Ask the seller to write a review when they move out and you won’t have to worry about being a no-review listing. Seeing that the first renters used to live in the house, they’ll probably leave a positive review!
What you’ll need to consider
Besides ensuring that the rent you collect covers your mortgage payment, you’ll also want to factor in whether it will cost you to continue living in your current space. If you were going to be paying your mortgage or rent for a couple of months anyway, collecting rent from your new property is great. But say you’re moving into a place where your mortgage payment is going to be lower than your rent and you now have to keep paying those higher rent payments.
It’s important to remember you’ll be taking on landlord responsibilities as well. If a repair needs to be made, you’re on the hook to both pay for the repair and deal with fixing or scheduling the maintenance required.
You also run the risk that your newly purchased property isn’t in the same condition as it was at the time of your closing. Which brings us to…
Navigating the agreement
When entering a leaseback, you’ll need to ensure that you account for all the necessary details. Here’s a general outline of what the seller and buyer need to agree upon:
- Seller move-out date
- Rent amount
- Who is paying for utilities and insurance
- Amount of security deposit
- Maintenance of property
- Buyers’ access to property
What you’ll definitely need to confirm? The duration of the terms. Generally, a leaseback period cannot surpass 60 days. If you’re looking into a long-term rental agreement, you’ll need to speak with your lender because you’ll likely need to be approved as an investor instead of an owner-occupant, which tends to require a higher down payment and credit score.
Calculating the rent
Typically, the buyer is going to want to make sure they will be recouping the cost of their monthly mortgage payment, including the principal, interest, mortgage insurance, home insurance and real estate taxes. But there are some instances where the buyer may agree to cover, say the insurance, as part of their offer, or may agree upon a monthly rent that’s lower than what their mortgage payment will look like in an effort to accommodate the seller and boost their offer. Some buyers even offer a leaseback option with no rent charge at all for a certain amount of time. It all depends on circumstances.
The rent charge can also be prorated depending on how long the seller is going to stay on the premises. A daily rate can be determined if the timeframe is going to be less than a month.
Why working with an agent is your best bet
An agent can help you complete a foolproof contract that makes sure every detail has been accounted for. Here are the aspects that will generally be covered in a legal document to protect the buyer:
- When the seller will vacate the property, as well as rights and responsibilities of both the buyer and seller (including costs of insurance, right to sublet, when the buyer is able to enter the property to make repairs, etc.)
- A security deposit that’s held in escrow
- Lease amount
- Late charges
- Verification of the property’s condition, usually including a walk-through before closing and a final walk-through at the end of the leaseback period
Your agent will be able to help you address all of these aspects and make sure that your ownership rights are protected. They’re also familiar with various stipulations that can change the way your contract will need to be written up.
For instance, different states have different laws. In California, there are two interesting provisions pertaining to renting a property. First, any leasebacks of over 30 days require a full residential lease, and second, the only way to evict a tenant is for the landlord to file a lawsuit. Just an example of the little circumstances that could end up making a big difference. Working with an expert will ensure you’re covered across the board.