Leaseback On a House: Pros & Cons Explained
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Summary:
In a leaseback on a house, also known as a sale-leaseback transaction, a seller sells their house but stays on as a tenant. In exchange, the seller makes lease payments to the new owner for an agreed-upon leaseback period. There are pros and cons to this arrangement (whether short-term or long-term), so both buyers and sellers should be clear about their expectations going in.
Anyone who has ever bought or sold a home knows that things don’t always go exactly as planned. Oftentimes this is because the person selling the place needs a little more time to move out, and a sale-leaseback can be a convenient way to bridge that gap. But that’s not the only time a leaseback arrangement makes sense for both parties involved in the agreement.
Read on to learn the ins and outs of sale-leasebacks, the different types of leaseback agreements, and the pros and cons of a sale-leaseback transaction for the buyer and seller.
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What is a leaseback on a house?
A sale-leaseback agreement on a piece of residential real estate is a transaction in which a homeowner sells their home but immediately signs a lease to continue living there as a renter. The buyer of the property then becomes the landlord for a specified time period rather than the owner-occupant.
When sellers and purchasers agree to a sale-leaseback transaction, the seller is able to gain access to needed capital from the home without having to move out right away, if at all. In turn, buyers have now purchased a piece of real property, and the tax advantages that come with it, in addition to making money from rent with the same asset.
“A leaseback agreement can be a win-win for buyers and sellers. Buyers gain the advantage of instant rental income and potential tax benefits, while sellers benefit from a seamless transition,” says Gagan Saini, director of acquisitions at JiT Home Buyers.
A leaseback agreement can be a win-win for buyers and sellers. Buyers gain the advantage of instant rental income and potential tax benefits, while sellers benefit from a seamless transition. - Gagan SainiClick to Tweet
Types of sale-leaseback transactions
In many cases, a sale-leaseback is utilized when sellers need more time to move into their new home but still want to close on the deal before leaving the premises. There are several instances when this might happen. For example:
- The seller has bought another place but can’t move in until the previous owners vacate
- The seller’s new home is still under construction
- They haven’t found a new house to buy and need more time to look
In those scenarios, the lease term is usually for a short period of time.
But sometimes, a residential sale-leaseback transaction results in the seller becoming a long-term tenant. This could be because the current owner wants to get out from under the debt load of a mortgage but still wants to remain in the home for a long period of time.
It’s also possible that:
- The property taxes are too high to manage
- The previous owner no longer wants the responsibility of homeownership
- They need the cash flow (by accessing the equity in the home) for other purposes
In this scenario, an individual investor or an investment company might buy the property purely as an investment with no intention of ever living there.
It’s important to be aware that in some areas a sale-leaseback transaction is only good for a leasing term of less than 60 days. That means investors would need to apply for a mortgage for an investment property rather than a property where the buyer intends to be the owner-occupant. There may be stricter requirements to qualify for the loan, which your real estate agent should be able to explain to you.
NOTE: A residential sale-leaseback differs from a commercial real estate leaseback transaction in that a commercial property is most often characterized by a very long-term lease agreement rather than the more common short-term leaseback period for a residential property.
Pros and cons of a sale-leaseback
A sale-leaseback has benefits for both parties. But it’s also important to keep in mind that a real estate transaction, especially a complicated sale-leaseback, has the potential for some bumps in the road.
“There are potential risks, like tenant-related issues or changes in market conditions,” says Saini. “It’s necessary for both parties to carefully negotiate and draft the terms of the leaseback agreement to ensure a smooth transition.”
Benefits for sellers
More time to move: For short-term sale-leasebacks, the previous owner has a little more time (and less stress) navigating the move if they don’t have to vacate right away.
No need to move: For long-term sale-leasebacks, the seller can get out from under the responsibilities of homeownership without having to find a new place to live. This could be an alternative to a reverse mortgage, for example.
Money in the bank: The seller can access the cash equity in the home before needing to pack up and move out. Or for long-term tenants, the money can be used for other goals like retirement savings or consolidating debt.
Potential to save money: If the previous owner doesn’t have a permanent home to move into right after the sale, they might have to pay for storage space or rent another place. A leaseback allows them to save on those expenses.
Risks for sellers
You don’t own the home: By giving up ownership rights and becoming a renter, you now have to abide by the buyer/landlord rules and pay rent. Plus, you no longer have the right to make any major changes without the landlord’s permission.
May cost more: Most of the time, the new owner is going to want enough rent to at least cover their monthly mortgage payment. And, since you probably sold the home for more than you paid for it, and property taxes likely went up as well, chances are your rent payments will be more than you paid when you owned the place.
Could lose your deposit: If you’re renting, you are responsible for keeping the home in, basically, the same condition as when you took possession. (Or, in a sale-leaseback transaction, when you ceased to be the owner and instead became the renter). That means if you cause any damage to the home, you may end up forfeiting your deposit.
Benefits for buyers
Instant tenants: If you are the owner of an investment home, you may have a hard time finding a reliable person or family to rent the place. A sale-leaseback gives you instant access to tenants, at least for a short period of time.
Built-in income: Because you have automatic tenants in a sale-leaseback transaction, it follows that you have automatic, presumably reliable, access to steady rental cash flow. Obviously, this is a more significant benefit for long-term leases.
“The buyer benefits from a leaseback agreement because they are able to acquire a property with a built-in tenant. This can provide them with a steady stream of rental income, which can be particularly attractive if they are looking for a passive income stream,” adds Adie Kriegstein, licensed real estate salesperson at Compass Real Estate.
Better chance of an accepted offer: In a competitive market, home shoppers who are open to the idea of a sale-leaseback may have a better chance of having their offer accepted than a buyer who has no flexibility on when the seller moves out. It could make or break the whole deal, and you might even get a better price.
Risks for buyers
Can’t move in right away: You agree to delay your move-in date with a sale-leaseback, but it can still be inconvenient (or even expensive) depending on your current living situation.
You’re now a landlord: This may seem obvious, but if you’ve never had a renter, you might not realize the specific responsibilities that come with the position. You have to collect the rent, make repairs, and deal with other issues that come with homeownership and renting.
Risk of tenant mistreating the home: You would think the previous owners would treat the home well even though they don’t own it anymore, but you really never know. Tenants may mistreat the home, break things, or leave it a mess. If you’re buying and renting out, getting a deposit is a good idea.
Risk of tenant delaying their move: Even if you have a contract in place, your tenants may not move out when they should. At the least, it could be an inconvenience. At worst, you may have to resort to legal efforts to remove the occupant. This could be expensive, time-consuming, and tricky because laws tend to protect a renter over a landlord.
Plus, if you’re doing a long-term leaseback, you may have to deal with evicting a renter who is not living up to the terms of the leasing contract. Maybe they are not paying rent or causing damage to the property.
Pro Tip
If your main reason for utilizing a sale-leaseback transaction is to access the equity in your home, consider other options such as a home equity loan, home equity line of credit, or a home equity investment.
If you’re considering a home equity investment, read more about home equity sharing and compare your options.
Negotiating sale-leaseback agreements
Regardless of whether the sale-leaseback is going to be a long- or short-term lease agreement, it’s important to get the details of the arrangement in writing before the real estate closing. This protects both the seller and the buyer of the real estate asset. Here are some common conditions to cover when drawing up a residential lease.
Length of the lease agreement
No matter if the sale-leaseback option is for a short- or long-term lease, the buyer and seller need to agree on the length of the arrangement. It’s important for the seller to know when they must vacate the premises so the new owner can take full possession of the property. Or, if the lease is for a long-term arrangement, the parties may agree to a one-year lease with renewal options, for example.
Monthly rent
Even if the seller doesn’t remain in the home for very long, they’ll usually pay some rent for the duration of their stay. In general, the buyer would want to get at least enough money to cover the monthly mortgage payment, so they’re not operating at a loss. The mortgage payment, in addition to the principal, typically includes real estate taxes, homeowners insurance, interest, and (sometimes) mortgage insurance as well.
In some cases, this could actually mean that the previous owner pays more in rent than they paid for a mortgage when they owned the house. However, if it’s just for a short period of time, it may be considered a small price to pay. You get the convenience of not having to move out in a hurry and/or put your belongings in storage, stay in a hotel, or find a short-term rental property.
Pro Tip
For sale-leaseback agreements that involve the seller maintaining occupancy for less than 30 days, you may be able to use a “seller-in-possession” (SIP) agreement. It’s is a shorter version of a standard rental agreement and is essentially an addendum to the purchase contract, but covers the same bases.
Security deposit
If someone rents a property, a deposit is customary but not required. If the buyer wants a security deposit, it will be up to both the seller and buyer to decide how much it should be. They will also decide if the money will be held in escrow or given directly to the buyer/landlord until the final walk-through when the tenant moves out.
Home insurance
The buyer should have insurance on the home prior to the closing, but the seller should also have coverage for their personal belongings. Depending on the length of the sale-leaseback agreement, the new owner may also need landlord insurance.
Utility payments
The leasing agreement should also include provisions stating who is responsible for payment of the utilities, such as gas, water, and electricity. Sometimes landlords will cover utility expenses for tenants or sometimes the tenants are responsible. But either way, it should be spelled out in the contract.
Home repairs/maintenance
Finally, It’s also important for both parties to agree on who is responsible for any repairs or maintenance needed on the property. For instance, if the water heater needs to be replaced or the furnace is due for service, you need to state in writing who has to pay.
Key takeaways
- A sale-leaseback on a residential real estate asset is a transaction in which someone sells the property and then immediately signs a lease to become the tenant.
- Sale-leasebacks are often for short periods of time when the previous owner needs more time to move out of the home, but there are long-term sale leasebacks too.
- While there are benefits to both the seller and the buyer, it’s important to be aware of the risks that also come with leaseback agreements.
- It’s critical to have a written agreement stating monthly rent and other requirements and responsibilities to protect both parties in a leaseback transaction.
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