very green investor in CA; first L/O and I need advice

I’m searching for a contract for my first L/O. I purchased the property for 180, 000 but have refinanced and taken a second. I owe close to 350,000. It is zoned SFR, but has a large guest house that is also rented. The tenant in the main house has agreed to a purchase price of 400,000. Option consideration is 10,000. The current rent will increase to 1800 per month, with 250 credited toward purchase. I’ll continue to collect rent from the guest house (650 per month) during the 5 years that she has to exercise the option.
I live in CA, have never done anything like this before, and I want to be sure to do it right. Please provide any suggestions and advice.

You’re the owner of the property, correct? My first question is why, oh why, did you give someone five years?! Too much time, and not at all advantageous for you to do so. If it isn’t too late, I would definitely rethink that.

Thanks for the reply. Reading the other posts, I felt that 5 years was probably too long. May be able to negotiate that. I do own the property and have made numerous upgrades. I thought that the longer period would allow me to take advantage of tax depreciation, etc.
Another question – I have an equity line on the property. Should I try to pay it off early or refinance to get a better rate? The first is low because it’s an interest only for 3 more years (another reason to limit the time on the L/O, I suppose). The second is variable and currently around 9.5%.

I would have given them 2 years, 3 years max. You did a good thing by getting 10K for option consideration, but 5 years is too long. The house could be worth signifigantly more than $400,000 by then, especially in CA which has higher than average appreciation.

Another tip is that I hope that the rent is paying your mortgage plus some cash flow. If they are paying $1,800, that doesn’t sound like enough to cover a mortgage of $350,000 (unless you have an adjustable rate mortgage, in that case what will the payments be in 5 years?). Taxes will probably also go up in the next 5 years and will increase the mortgage you are paying. It sounds like you are paying an extra few hundred dollars per month out of your pocket, this may be tough to do for 5 years.

A good amount to charge for rent on a lease option is to estimate what the mortgage payments are going to be when they exercise the option (i.e. buy the house). They are ultimately going to have to make that payment when they are paying the mortgage, so you might as well get that amount.

I hope my comments were helpful, if you haven’t done the deal yet you’ll be able to consider these points.


Thanks Jeff,
Your comments are very helpful. The additional income from the guest house puts me far beyond the mortgage payments. This is a pretty rural area of CA, so appreciation has happened, but not so dramatically as other areas. Taxes are still low and we are in a very down market. I foresee a slump of at least three years.
Still, I’ve been considering the benefits of a 3 year, vs. 5 year option. Still wondering about the tax benefits of the additional two years of rent vs. capital gains, etc.