The contract is typically between two parties: the tenant (also called the lessee or tenant-buyer), and the landlord (lessor), who owns or has the right to lease or dispose of the property.
The tenant-buyer often is expecting that the property will appreciate in value, particularly if the agreed-upon purchase price is equal to or higher than the fair market value at the time of the inception of the option.
Perhaps even more important, often the tenant-buyer has credit or other financial issues preventing him/her from immediately purchasing.
Often, the monthly lease payment is equal to or slightly above the fair market rent of the property.
So, for example, if fair market rent for that unit would be $1,000, the seller might charge $1,100 with $200 of that being credited toward the purchase price.
The risks include the seller's inability to transfer clear title when the investor seeks to exercise the option.
In that case, the investor will have made improvements (sometimes substantial) to a property he/she doesn't own and may not be able to acquire.
Retail buyers typically cannot get financing or have too much to choose from to bother with physically distressed properties.
These include items typically found in leases: maintenance, utilities, taxes, pets, how many occupants, insurance, ability to make modifications to the property, and so on.
At the end of the contract, the tenant has the option to purchase the property outright.
Excess credit may also be applied towards the eventual purchase of the property, or towards the down payment for a mortgage (CAUTION, the buyer and seller can agree to whatever they want, but when the buyer goes to get permanent financing the bank has guidelines to what can be applied towards the down payment or the purchase.
Buyers In the event of non-payment, it may be possible for the seller to remove the tenants through eviction, which is likely to be cheaper than foreclosure on a mortgaged property.
Sellers can often avoid paying a Realtor fee by using a lease-option agreement (as they have already found the buyer themselves).
If the buyer defaults and the contracts are drafted properly then there is an automatic tenant landlord relationship.
For example, sometimes lease-options are offered to tenants who cannot realistically expect to ever exercise the option to purchase.
Sometimes the lease-option period is for such a brief amount of time (6 months, for example) that the tenant-buyer has little chance to repair his/her credit, save money for a down payment, or address whatever other problems exist.