A Primer on Residential Leases With Options to Purchase
| Publication year | 2005 |
| Pages | 75 |
2005, February, Pg. 75. A Primer on Residential Leases With Options to Purchase
Vol. 34, No. 2, Pg. 75
The Colorado Lawyer
February 2005
Vol. 34, No. 2 [Page 75]
February 2005
Vol. 34, No. 2 [Page 75]
Specialty Law Columns
Real Estate Law Newsletter
A Primer on Residential Leases With Options to Purchase
by Michael J. Katz
Real Estate Law Newsletter
A Primer on Residential Leases With Options to Purchase
by Michael J. Katz
This column is sponsored by the CBA Real Estate Law Section
Articles in this column cover a broad range of real estate
land use, and related topics, and focus on the practical
aspects of matters of interest to real estate lawyers
Column Editors:
Steve Sommers, Denver, Brownstein Hyatt & Farber PC -
(303) 223-1100, ssommers@bhf-law.com; Pat Barney, Steamboat
Springs, TIC - (970) 879-2561, barneyp@ticus.com
About The Author:
This month's article was written by Michael J. Katz,
Aurora, Managing Member with Corporon, Eyler & Katz, LLC
- (303) 768-8004, bizlaw@ ix.netcom.com.
The lease with option to purchase offers a tenant the
opportunity to buy his or her leased property without
immediately signing a purchase contract. This article
provides a framework for drafting the operative documents for
such an arrangement in the context of a residential lease.
The permutations in the world of leases with options to
purchase are considerable. Such transactions involve personal
and real property issues in both commercial and consumer
arenas. In a residential lease setting, the parties can agree
to transfer title through a variety of methods, including a
right of first refusal, a stand-alone option not dependent on
the lease, and a contract for deed.
This article briefly considers alterative methods of
acquiring title in the context of residential property. It
reviews the basics necessary in drafting a residential lease
with option to purchase ("Lease with Option"). The
article also provides sample language that can be
incorporated into a Lease with Option.
The Basics of
Residential Leases
Residential Leases
In its most basic form, an option to purchase property grants
the optionee the power to compel the optionor to sell the
subject property under the terms and conditions specified by
the option.1 A purchase option that is coupled with a
residential lease contains three categories of agreements:
the lease, option, and purchase agreement.
In preparing the terms of the lease, the practitioner will
start with a basic residential lease. Because the lease is to
be coupled with an option to purchase, each of the lease
covenants should be examined to determine whether
modification would be required. For example, a determination
should be made of the fate of the security deposit on
exercise of the option. Likewise, it should be determined
whether the lease will terminate before or after exercise of
the option but before the closing. It is important for the
terms of the option to include specification of the
conditions precedent that a tenant must satisfy to exercise
the option and then the manner of exercising the option. The
several terms of a standard option will vary because of the
lease or the status of the lease - for example, where an
option is not exercisable upon default under the lease.
In addition, the terms of the purchase will memorialize the
agreement of the parties as to the specifics of the purchase
transaction. Likewise, the terms of the purchase may be
impacted by the terms of the lease or performance under the
lease, such as the acceptability of the condition of the
premises. Each of the categories of agreements is dependent
on the others and must be considered in light of the others.
Alternate Methods
Of Transfer
Of Transfer
Practitioners often are asked to offer advice to a client who
wishes to participate in a Lease with Option. Before
proceeding with a Lease with Option, practitioners should
first consider alternative structures to such a transaction.
Lease with Option Versus Right of First Refusal
In Kroehnke v. Zimmerman, the Colorado Supreme Court stated:
"The privilege of first refusal merely requires the
owner, when and if he desires to sell the property, to offer
it to the lessee. . . ."2 Thus, the landlord would make
a unilateral promise to the tenant to first offer the
property to the tenant if, and only if, he or she decides to
sell. The right can be drafted to provide a first opportunity
to purchase, which is frequently referred to as a right of
first offer. Alternatively, it can grant the tenant the first
right to match the terms of a third-party offer, which is
commonly known as a right of first refusal.
A right of first offer or right of first refusal gives the
tenant little peace of mind in a residential setting, because
the decision to sell is that of the landlord. For similar
reasons, landlords dislike rights of first offer and first
refusal because they are burdensome. Third-party buyers are
less likely to go through the pain and suffering of making an
offer if the tenant can trump the offer. The Lease with
Option is the appropriate vehicle if the tenant is seeking to
compel the landlord to sell the subject property under known
terms and conditions.
Lease with Option Versus Stand-Alone Option
A "stand-alone" option exists where the option is
not dependent either on the lease or landlord-tenant
relationship. If the option is not coupled with a lease, a
tenant's breach of any covenant of the lease will not
affect any terms of the option. For example, a termination of
the lease on breach would not affect the stand-alone option,
but would continue under its original terms.
Alternatively, a Lease with Option typically requires the
tenant to perform under the lease to exercise the option; a
breach of the lease will have a stated effect on the
opportunity to exercise the option. Therefore, a landlord
will typically want the extra protection afforded by the
Lease with Option.
Lease with Option Versus Contract for Deed
Although not used frequently, the parties to a lease may want
to consider a contract for deed.3 Under a contract for deed,
legal title passes to the vendee, if at all, on the
occurrence of a future event,4 usually the delivery of the
final installment payment of the purchase price.
The contract for deed differs from the Lease with Option in
many important ways. Under the contract for deed, the parties
execute a contract for purchase and operate under its terms
until its breach or the completion of all contingencies.
Under Colorado common law and on execution of the contract
for deed, " . . . both possession and equitable title
are in the purchaser, with the seller retaining bare legal
title. . . ."5 Breach by the vendee/tenant resulting
from violation of the covenants may require the vendor/
landlord to regain title by the expensive and time-consuming
process of a judicial foreclosure.6 Further, the granting of
a contract for deed may violate the due-on-sale clause of a
deed of trust filed against the property.7
Under a Lease with Option, title does not pass until the
closing of the contract to purchase. Until exercise of the
option, the tenant has a mere executory right. Breach of the
lease before exercise of the option permits the landlord to
evict the tenant through operation of the Colorado forcible
entry and detainer ("FED") statute.8 A lease for a
period of less than three years is not as likely to violate
the due-on-sale provision of a deed of trust.9
Additionally, a line of Colorado cases has held that
executing a Lease with Option does not result in
"equitable conversion" - that is, the conversion of
the vendor's interest into personalty and the
vendee's interest into real estate. Thus, the
optionor/landlord's right, title, and interest in the
real property are preserved.10 As a result, contracts for
deed are infrequently used, primarily because of the
potential to trigger the due-on-sale clause in a deed of
trust and the time and expense necessary to pursue a judicial
foreclosure upon default.
Legal Status of a Lease With Option
In Houtchens v. United Bank of Colorado,11 the Colorado Court
of Appeals confirmed, "A purchase option in a lease is
an irrevocable unilateral[12] offer by the optionor/landlord
to sell the leased property to the optionee/tenant for a
definite consideration."13 To protect the
optionor/landlord (not the tenant), the Lease with Option
must be reduced to writing.
The Lease with Option typically provides that the
vendor/landlord must keep the option open for its entire
stated term, unless the option is terminated by the uncured
breach of a covenant of the agreement.14 Until exercised, the
landlord retains legal and equitable title under a Lease with
Option, and the tenant enjoys mere possessory rights.15
However, the option language may be enforced by the tenant
through specific performance.16
Under certain circumstances, the granting of a Lease with
Option may violate the terms of a recorded deed of trust.17
Once exercised, the option is replaced with a contract to
purchase and, when recorded,18 a Lease with Option ripens
into a lien and not a mere cloud on the title.19 A detailed
discussion of the tax implications of a Lease with Option is
beyond the scope of this article.20
Anatomy of a Lease
With Option
With Option
A Lease with Option is appropriate when the tenant seeks the
exclusive right to purchase the property subject only to the
tenant's performance under the lease, compliance with the
option exercise terms, and payment of the purchase price. An
effective Lease with Option clearly and concisely sets forth
the intent of the parties as to the terms of the lease,
option, and purchase.
The practitioner may generate a lease in which the option and
purchase language are provisions of the lease. As an...
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