Tell Me My Options: Drafting an Option to Purchase the Property

Rent As Offset of Purchase Price

Often when an option to purchase is granted to a tenant, a portion of the rental amount that is payable by the tenant will be used as an offset from the purchase price, in the event the option to purchase is exercised by the tenant. In order to make this arrangement more equitable to the landlord, the overall rental that is payable by the tenant may be increased, with the increased rental being used as an offset against the purchase price if the option is exercised and, in the event the option is not exercised, with that amount being forfeited to the landlord. In this manner, the landlord has actually received something of value for granting the option and providing a right to the tenant, while at the same time, a tenant who does exercise the option will receive full value for the monies paid at the time it exercises the option.

Closing Costs and Obligations

In connection with the option to purchase the property, all of the same issues that are addressed in a contract to purchase will be present in drafting the option to purchase. As a result, issues such as the condition of title, the manner in which title will be taken by the purchaser/tenant, elements to be included in the survey, closing costs and fees, as well as closing dates and locations should be addressed in the option to purchase provision. It is generally a good idea to affix the contract to purchase the property to the lease document as an exhibit so that once the option to purchase is exercised, there are no disputed issues between the parties as to how the transaction will be handled. Further, a current survey and title commitment for the property should be affixed to the lease document as exhibits, and the landlord should represent to the tenant that the condition of title for the property at the time of closing will be the same as shown on the survey and the title commitment, subject to nonmaterial encumbrances that do not affect the value or use of the property. While addressing all of these issues at the inception of the lease may increase the time and cost to the landlord and the tenant for the negotiation of the lease, it should save considerable time, money and effort at the time the option is exercised, by resolving these contract issues and avoiding potential litigation costs to resolve such issues.

Intervening Issues

Finally, the option to purchase the property should address issues that may arise during the pendency of the term of the lease that may affect either the value of the option to purchase and/or the value of the property. For instance, if an encumbrance on title (eg, a mechanic's lien) has attached to the property, then the value of the property would need to be adjusted to take into account this diminished value of the property. While contrary to the typical contract situation, wherein the purchaser has the right to terminate the contract in the event of an encumbrance that diminishes the value of the property, simply having the right not to exercise the option to purchase will generally not be a satisfactory remedy for a tenant. As a result, the parties will need to establish what the remedies will be for the tenant, in the event the value of the property is affected by some factor other than normal market forces. Similarly, if intervening actions occur that affect the tenant's rights under the lease (eg, a default of the lease by the tenant) and as a result the tenant's rights under the lease are terminated, the option to purchase the property should likewise be terminated at the time the lease is terminated. While courts may interpret the termination of the lease as a termination of all rights under the lease, including the option to purchase, it should be made clear in the lease document that a termination of the lease will result in a termination of the option to purchase, as well. In addition, the parties may want to stipulate that the option to purchase the property may not be exercised while the tenant is in default of its lease obligations, whether or not the lease is terminated as a result thereof.

Final Thoughts

While an option to purchase the property can be a powerful exit strategy for a tenant in a lease transaction, the terms of that option to purchase need to be well established and thought through at the time of the drafting of the lease document. Otherwise, the parties may be surprised to learn what their relative rights are at the time the tenant seeks to exercise its option to purchase the property. By carefully drafting the option to purchase provision, including addressing therein the issues set forth above, the landlord and the tenant will be able to document accurately the agreement between the parties and successfully create an exit strategy for the tenant that was intended by the parties.

When considering a new lease for a single use property, generally the tenant of the property will want to consider its “exit” strategies at the time of the initial negotiation of the lease. Potential “exit” strategies may include: assignment of the lease, early termination rights and options to purchase the property. The last on the list of these “exit” strategies, options to purchase the property, often creates substantial business issues for the landlord and tenant, as well as drafting issues for their legal representatives. As a result, certain conceptual issues, set forth and discussed below, should be addressed when drafting an option to purchase the property.

Purchase Price

An option to purchase is really a one-sided right; if the terms are favorable for the tenant at the time of exercise, the option will be exercised, and if the terms are not favorable at the applicable time for exercise, the option will not be exercised. As a result, from the tenant's perspective, the purchase price should be established in an absolute dollar amount, in order to allow the tenant to evaluate the value of the option. By contrast, the landlord would want the option expressed in terms of “market rate” at the time the option is exercised. While this “market rate” approach does provide the tenant with the right to purchase the property before any other person or entity, it does not provide the tenant with a sum certain to plan for the acquisition of the property. Therefore, the landlord and tenant should carefully consider what the option purchase price will be and include that specified amount in the lease document. In the event the lease contains multiple options to purchase the property that are exercisable at various points during the term of the lease, the option prices could be indexed up to reflect the rising costs, in order to take into account rising costs in the real estate market.

Rent As Offset of Purchase Price

Often when an option to purchase is granted to a tenant, a portion of the rental amount that is payable by the tenant will be used as an offset from the purchase price, in the event the option to purchase is exercised by the tenant. In order to make this arrangement more equitable to the landlord, the overall rental that is payable by the tenant may be increased, with the increased rental being used as an offset against the purchase price if the option is exercised and, in the event the option is not exercised, with that amount being forfeited to the landlord. In this manner, the landlord has actually received something of value for granting the option and providing a right to the tenant, while at the same time, a tenant who does exercise the option will receive full value for the monies paid at the time it exercises the option.

Closing Costs and Obligations

In connection with the option to purchase the property, all of the same issues that are addressed in a contract to purchase will be present in drafting the option to purchase. As a result, issues such as the condition of title, the manner in which title will be taken by the purchaser/tenant, elements to be included in the survey, closing costs and fees, as well as closing dates and locations should be addressed in the option to purchase provision. It is generally a good idea to affix the contract to purchase the property to the lease document as an exhibit so that once the option to purchase is exercised, there are no disputed issues between the parties as to how the transaction will be handled. Further, a current survey and title commitment for the property should be affixed to the lease document as exhibits, and the landlord should represent to the tenant that the condition of title for the property at the time of closing will be the same as shown on the survey and the title commitment, subject to nonmaterial encumbrances that do not affect the value or use of the property. While addressing all of these issues at the inception of the lease may increase the time and cost to the landlord and the tenant for the negotiation of the lease, it should save considerable time, money and effort at the time the option is exercised, by resolving these contract issues and avoiding potential litigation costs to resolve such issues.

Intervening Issues

Finally, the option to purchase the property should address issues that may arise during the pendency of the term of the lease that may affect either the value of the option to purchase and/or the value of the property. For instance, if an encumbrance on title (eg, a mechanic's lien) has attached to the property, then the value of the property would need to be adjusted to take into account this diminished value of the property. While contrary to the typical contract situation, wherein the purchaser has the right to terminate the contract in the event of an encumbrance that diminishes the value of the property, simply having the right not to exercise the option to purchase will generally not be a satisfactory remedy for a tenant. As a result, the parties will need to establish what the remedies will be for the tenant, in the event the value of the property is affected by some factor other than normal market forces. Similarly, if intervening actions occur that affect the tenant's rights under the lease (eg, a default of the lease by the tenant) and as a result the tenant's rights under the lease are terminated, the option to purchase the property should likewise be terminated at the time the lease is terminated. While courts may interpret the termination of the lease as a termination of all rights under the lease, including the option to purchase, it should be made clear in the lease document that a termination of the lease will result in a termination of the option to purchase, as well. In addition, the parties may want to stipulate that the option to purchase the property may not be exercised while the tenant is in default of its lease obligations, whether or not the lease is terminated as a result thereof.

Final Thoughts

While an option to purchase the property can be a powerful exit strategy for a tenant in a lease transaction, the terms of that option to purchase need to be well established and thought through at the time of the drafting of the lease document. Otherwise, the parties may be surprised to learn what their relative rights are at the time the tenant seeks to exercise its option to purchase the property. By carefully drafting the option to purchase provision, including addressing therein the issues set forth above, the landlord and the tenant will be able to document accurately the agreement between the parties and successfully create an exit strategy for the tenant that was intended by the parties.