Lease-To-Own Purchase Or How To Profit From Spain's Market Downturn

Raymundo Larraín Nesbitt - Lawbird Legal Services
5th of November 2009

Introduction

It has become Spain’s favourite sport to second guess on when the real estate market will finally pick up again. Reputed experts, both national and foreign, are jumping in giving all sort of contradicting timelines for the economical recovery i.e. 2011, 2014 and the most pessimistic ones on 2017. Although it may be fun to indulge in this sport on whether it will be an “L”,“U”,“W” or X-shaped recovery the gist is that it remains a fairly futile exercise as everyone, both experts and laymen alike, are basically clueless on where the market will be heading next.

As appealing an amusement as may be, nonetheless I believe it may be impractical and rather sterile for most buyers who are now sitting on the sidelines waiting for events to unfold, as in hindsight very few people do actually call the market bottom correctly and most miss out on the opportunity to pick a bargain in the dip. These potential buyers who are now sitting on the fence musing over how much lower house prices can get may in fact already, unbeknownst to them, profit from today’s market turmoil. A rent-to-own contract does exactly that. It is an interesting alternative worth looking into in times of uncertainty, such as these, on where house prices will be heading next.

A lease purchase simply removes all the associated angst on whether one should still be holding out or else be moving in for the kill. The truth of the matter is that no one has a clue on when the market will finally hit rock bottom. And even then it may be lingering on a valley for a while until it picks up again. So it may be worthwhile reviewing this lease to buy option jumping in today at tomorrow’s prices TM.

What is a Lease–To-Own Contract?

This type of contract, “contrato de alquiler con opción a compra”, allows you to lease a property, whether off plan or resale, with an option to buy it within a deadline normally spanning 2-5 years. The main advantage being that the full let is actually discounted from the final purchase price. So if you finally do opt into buying the property within the deadline, the paid rent (rental premium) will be deducted in full from the pre-agreed sales figure.

This contract has multiple advantages for both grantor and grantee in the context of a deflationary environment such as the current one. The advantages under normal circumstances far outweigh the potential disadvantages. It is worth noting that the below listed advantages are almost certain to take place under normal circumstances; however, the disadvantages may or may not take place which is why I label them as potential.

Advantages

For the option holder:

Foremost is the flexibility it allows you. You can actually withdraw from the contract as if it were a normal Tenancy Agreement should you spot a better opportunity within the next years, forfeiting the lease of course. At no time are you forced to buy the property at the end of the deadline, it will be your choice. This lack of commitment actually enables you to be on the prowl looking out for other opportunities without being bogged down.
You may freely agree on the time frame to exercise the purchase option tailoring to suit your needs. Normally they span 2-5 years but can agree to be made longer.
The pre-agreed price of the property stipulated within the contract is normally well below the current market prices so as to provide a reasonable incentive to prospective buyers. This offsets normally the risk of property prices decreasing even further in the near future (next couple of years) as the pre-agreed sales price has already factored this in.
As written above, the rent premium is deducted in full from the sales price, so it is not forfeited as it would normally be the case in a Tenancy Agreement.
In some contracts you may assign the option to buy. This allows for even greater flexibility as the buyer can sell on the right.
Unlike the UK, there is no option fee to be paid on exercising the option right.
For off plan you can actually claim back the VAT you are overpaying for the lease which will be set at 16%. Buying off plan freehold property has currently set a VAT of 7% (which is due to be raised to 8% as from July 2010). You are entitled to claim back the difference only if you exercise the option to buy from the developer. It is advisable there is a clause worded on this point.
You are actually living in the property that will be yours in a near future without being riddled now with the associated stress of applying for a mortgage loan. Although you may not qualify for a mortgage loan now you may in a few years’ time when the credit market ease’s up again.
If the property is within a Community of Owners you may come to know of internal problems of which you may have been previously unaware that may ultimately affect your buying decision. You may possibly never come to knowledge of these quirks unless you’ve actually taken the trouble of letting the property. Not least is worthwhile mentioning that you will not be expected to pay the Community fees, these will be taken care of by the landlord.
The applicable laws will normally be Spain’s Tenancy Act (Law 29/1994), the Spanish Civil Code and the Private Contract of course. Tenancy laws in Spain are historically biased towards tenants so it’s always good to be protected by them being a tenant. It may be advisable to lodge this contract before the Land Registry.

For the option grantor:

The advantages are really self-evident. Foremost you actually have a tenant who is genuinely interested in buying the property not just in renting it avoiding time wasters altogether. An option to buy actually increases the pool of genuine potential buyers as it makes it easier for them to commit now.
The let can help offset any mortgage repayments, community fees or expenses in general thus avoiding slipping into arrears.
Having a tenant inside should normallyensure the property will be looked after properly avoiding it sitting empty which may lead to break-ins or in the worst cases even being vandalised.
On very long-term options it is normal to implement additionally an option fee. If you’re tenant defaults you can always pocket it besides the let’s deposit and the rental premium.

Potential Disadvantages

For the option holder:

You are actually letting a property. You must ensure you will be able to meet the let on time otherwise you will be jeopardising the contract. Bear in mind the currency exchange rate fluctuation if you’re source of income comes from abroad i.e. sterling pounds or dollars against the euro.
As it’s a let, the rent premium may be revised annually by your landlord in line with inflation. Spanish Tenancy Agreements are normally referred to the Consumer Price Index (IPC in Spanish).
For very long-term options, exceeding normally 3 years, an additional deposit (option fee) may be requested by the landlord besides the normal 1 or 2 months’ deposit for letting out the property. This may not appeal to everyone of course but it is done as prove of a serious commitment on behalf of the potential buyer.
The main disadvantage is that these contracts last typically 2-5 years and in the interim the landlord’s financial circumstances may change. i.e. if the property has a mortgage loan taken against it and the landlord defaults, it may lead to a repossession procedure. You would still have a right to let the property if it’s repossessed, as the lender must respect a long term tenant, albeit you may no longer have the option to exercise the purchase of the property in the same conditions as you agreed to initially. You would actually have to raise the funds now and pay off the outstanding mortgage on the property if you wish to buy it off from the bank. Not to mention that if you additionally paid an option fee you would likely forfeit it in the event of a foreclosure.
Buyers prefer long-term options to build up equity and in the interim keep an eye on where the property market is heading. Short-term options appeal to vendors but on doing they will be reducing the pool of potential buyers as few buyers will be interested. It’s a tug of war on which a consensus, balancing both opposed interests, must be sought.
Another problem is that you are committing yourself on a pre-agreed price that in a few years time, despite the hefty worded in discount, may still be above the current market price. Obviously it makes no sense to execute the option if you are buying a property above the current market value. It would then be a case of a lost opportunity really as at no time are you forced to buy the property but you will of course forfeit in full the paid rental (opportunity cost) over the years negating the main advantage of following this option.

For the option grantor:

From the grantor’s perspective it’s that you are actually letting your property with a potential view to selling it on at some point in the future. Letting entails the risk of the tenant defaulting becoming a non-paying tenant in which case a formal eviction procedure would have to be followed before the law courts. This can however be mitigated to a great extent requesting for long term options (those exceeding 2 or 3 years) a deposit (option fee) from the option holder as a token of good will or else you can always include an arbitration clause in lieu of having to resort to the civil courts which brings down significantly the timescale on having the tenant removed.
The opportunity cost. On signing this agreement you will be held legally bound for whatever timeline you’ve agreed upon. This is particularly annoying in the event of a cash-buyer suddenly knocking at your door... Although it may sound unrealistic given today’s grim market, should the market pick up again sharply this is bound to happen and must be carefully considered. By accepting a rental-to-buy contract you are implicitly gambling the market will remain depressed for the next years.
It goes without saying you will have to carry out a thorough screening procedure on potential candidates weeding out unsuitable profiles. Fortunately you can now rely on FIM’s database which can greatly assist you eliminating professional non-paying tenants that abuse Spain’s legal system.

In Conclusion

Rent-to-buy schemes may not be everyone’s cup of tea albeit it is a very interesting option to pursue if you’re serious and committed on buying a property below the market value (BMV) taking advantage of today’s uncertainty. On following it, you will simultaneously retain a certain degree of freedom should either your personal circumstances or the market’s change. Buying property is always a serious decision for most people and this type of contract actually allows you the flexibility to live in it without forcing you into buying it.

When the market takes off again in .... (take your pick) years time, these contracts will no longer be as widely available as they are today both on off plan and resale property. It is precisely the current financial turmoil which drives landlords and developers onto offering this type of contract that may benefit both them and the option holder.

Those who are determined on buying cheap property which has already a pre-agreed significant discount in relation to today’s prices, may already profit from the current market uncertainty removing all the associated stress -and potential lost opportunity cost- of second guessing where today’s market will be heading next. Might as well leave all this guessing-work to the experts throwing darts, however fun it may be, and just play your cards safely. Mind you, these “confounded” experts do seem to always get it right...in hindsight.

And to close this article I cannot but recommend you hiring a registered Spanish lawyer to either draft this contract or else to review an existing one so as to avoid rash decisions that may lead you to future losses.

Please note the information provided in this article is of general interest only and is not to be construed or intended as substitute for professional legal advice.

Related legal services offered by Lawbird:

Tenant Eviction for a Spanish Property
Drafting of Tenancy Agreements

Lawbird Legal Services is a law firm with broad experience in Litigation, Corporate and Spanish Property Law.

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The article Lease-To-Own Purchase Or How To Profit From Spain's Market Downturn was originally published on belegal.com.