Updated: Apr 24, 2022
What is a Sale leaseback transaction?
Sale leaseback is typically a transaction seen in commercial real estate to free up the capital and invest in other means. Let us see how it works in a residential real estate transactions. In a residential transaction, the property owner or the seller sells the home to the buyer and enters into a lease agreement with the buyer for a certain amount of time. The negotiations are made by the buyer and seller to arrive at a middle ground before the closing of the home. There are a number of components that are taken into account while negotiating and coming to terms before making an agreement.
For example, if the seller is deciding to move into a new construction home after selling their home and the building constructor could not finish their new home on time. Due to the delay in the construction of their new home, the seller may decide to extend their time in the home that they decided to sell.
Components in the lease back agreement
Term of the rental period
The term of the rental period is decided based on a number of factors such as the convenience of buyer and seller, the terms of the mortgage lender of the buyer etc. Some lenders typically allow a rental period of 30-60 days for the seller to stay in the home after the closing. Terms longer than that time period specified by the lender may be considered to have landlord and tenant relationship. Thus, the property does not qualify as the primary home and considered as an investment property. The interest rate, down payment and other terms of the offer vary for primary home and an investment property. The insurance terms and coverage may also vary for the primary home and the landlord home.
The next term that has to be decided while making an agreement is how much the rent is and what basis are they calculated and will they be paid in advance or in arrears. The rental amount is usually calculated according to the market rental rate. The basis of the rent may be calculated as per day basis if the seller decides to stay for few days or per week basis if the seller decides to stay for few weeks, there is also an option to calculate the rent on an hourly basis. These terms are usually decided between the buyer and seller before the close of Escrow.
The next term to be decided is the amount of Security deposit to be made and where to be made. During the regular rental agreements, a security deposit is made by the tenant to the landlord which acts as a security during the rental period. Similarly, the security deposit gives the buyer the confidence to cover the charges in case any damages are done to the property by the seller during the rental term. The security deposit may be held by the escrow company until the contract ends or may be given to the buyer directly.
The next term to be decided is who is going to pay for the utilities and they are usually specified in the rental agreement. Payments are usually directly paid by the seller as they still have their name linked to all the bills rather than reimbursing the buyer.
Maintenance of the Property
As the buyer is the new homeowner of the property, it is important for the seller to follow the terms and expectations of the buyer on the property. Even a minor modification of the property must be informed to the buyer and should be done only after the consent of the buyer. During the lease term, the home is usually expected to be maintained in a good condition and any damages caused by the seller during the renting period is usually waived from the Security deposit made by the seller.
Permission to Enter
The home key, mailbox key, smart lock codes, Garage keys, amenities key etc are handed over to the buyer during or after the close of Escrow as the buyer is the new homeowner of the property and act as a landlord. This doesn't give permission to the buyer to enter the premises at his will as the buyer still needs to give notice to the seller at least 24-48 hours before entering the premises. It also facilitates the buyer to access the home in case of emergencies when the seller is not at home.
The insurance coverage is very important for any home. If a mishap happens during the rental period, the homeowner's insurance owned by the seller are usually not taken into account during the claim as he is not the current owner of the home. As the home is currently owned by the buyer, the insurance company only takes the homeowner's policy of the buyer into account for any claim. The sellers may buy a renter's insurance to protect their personal belongings on the house in case of any mishap.
Pros of Sale leaseback transaction
This option might make the buyer's offer more attractive as the seller might be in a position where he decides to stay back on their home after closing for reasons such as delay in the construction of their new home by the builder, kid's education purpose, medical reasons, delay in getting a new home that fits seller's needs which results in high offer acceptance rate. The buyer might have option to collect the rent in market rate, usually the rental price is charged to cover the home mortgage, HOA, Property tax, insurance and other fees and charged a little extra to ensure good return. These are prorated according to the length of the stay of the sellers.
This option allows the sellers to convert their asset into cash which may be used for personal purposes, business purposes etc. This gives the seller an extra time to renovate their new home that they will eventually move into, more time to find their dream home or avoid the short time relocation cost to move things to a storage and relocate to a temporary housing. If the seller has a below average credit score, he may not be able to do a refinancing transaction. It acts as an alternative method for conventional financing or refinancing. It reduces a lot of stress for the sellers as they won't have to immediately move out of the house after selling.
Cons of Sale leaseback transaction
Buyers may have the possibility of ending up with more responsibility like putting an agreement together, fixing a rent, collecting security deposit, possible eviction if the seller doesn't move out on time and fixing the repairs caused by the seller during move out. Eviction is a complex and time consuming process done to expel someone from the home due to lack of payment of rent. This also disrupts the move in plans of the buyer and causes delay in their move in schedule.
Though the sellers remain in the home for longer period, once the closing is done, the ownership is transferred to the buyers and the sellers have very less control over the modifications that can be done on the home. A written consent of the buyer is needed to make any changes even if it considered being small. There is a possibility of losing their security deposit if any damages are done to the home during their stay. The rental payment amount may not be changed from the amount decided on the contractual sale leaseback agreement. Even if the rental amount lowers due to market fluctuations, the seller is obligated to pay the agreed upon rent stated in the agreement.