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What is an Option to Purchase in Texas Real Estate Law?

TEXAS COURT DEFINITION OF “OPTION TO PURCHASE”

Under Texas court decisions, an option to purchase is a land contract by which the owner gives another the right to buy property at a fixed price within a certain time. Bryant v. Cady, 445 S.W.3d 815, 819 (Tex. App.-Texarkana 2014, no pet.); Jarvis v. Peltier, 400 S.W.3d 644, 650 (Tex. App.-Tyler 2013, no pet.); Faucette v. Chantos, 322 S.W.3d 901, 907 (Tex. App.-Houston [14th Dist.] 2010, no 488*488 pet.); Casa El Sol-Acapulco, S.A. & Zu Corp. v. Fontenot, 919 S.W.2d 709, 717 n.9 (Tex. App.-Houston [14th Dist.] 1996, writ dism’d); State v. Clevenger, 384 S.W.2d 207, 210 (Tex. Civ. App.-Houston 1964, writ ref’d n.r.e.); Knox v. Brown, 277 S.W. 91, 94 (Tex. Comm’n App. 1925); Wall v. Texlouana Producing & Ref. Co., 241 S.W. 521, 523 (Tex. Civ. App.-Amarillo 1922, writ granted), aff’d 257 S.W. 875 (Tex. Comm’n App. 1924); see North Shore Energy, L.L.C. v. Harkins, 501 S.W.3d 598, 606 (Tex. 2016) (an option agreement “merely gives the optionee the option to purchase property or execute a lease within a certain time period”).

USE OF OPTION AGREEMENTS  IN TEXAS PURCHASE CONTRACTS and LEASES

Sometimes a purchase option is tied to a lease agreement. In other situations, the purchase option is a component of a traditional real estate purchase agreement, and serves to give a buyer  time to evaluate the feasibility of completing the purchase.

Most of the promulgated real estate purchase forms used in Texas contain option clauses, which may be invoked by payment of a small (typically non-refundable) option fee paid to the seller. Payment of the option fee secures for the purchaser the right to terminate the contract within a certain time period (the “Option Period”) receive a refund of earnest money.  In the context of purchase and sale agreements, options are an invaluable tool to mitigate a buyer’s risk.

Sometimes, investors and other sellers of real property entice would-be buyers with credit problems to enter leases that contain purchase options.  Under this arrangement, a tenant agrees to lease property as a “rental,” with an option to purchase the property during the lease term. Lease purchase options are popular among investor programs, and may effectively serve to provide persons unable to obtain conventional mortgage financing an alternative means of purchasing real property.

NOT ALL “LEASE TO PURCHASE” ARRANGEMENTS ARE TRUE OPTION AGREEMENTS

Many lease contracts contain vague “Lease to Purchase” provisions that look like purchase options, but do not meet the legal definition that has evolved through Texas court decisions. For example, some “Lease to Purchase” agreements do not contain a fixed price. Instead, they specify that the tenants may purchase the property at “market value,” without specifying how “market value” might be determined.

In the absence of a fixed price or other evidence that the parties had agreed on the meaning of “market value,” a Lease to Purchase provision may not be considered legal option to purchase. Cf. Jarvis, 400 S.W.3d at 650 (holding that an “option to purchase” provision in a contract did not provide an option agreement because it did not give the buyer a right to compel sale of the property and did not state a fixed purchase price).

A TRUE PURCHASE OPTION CONTAINED IN A LEASE IS AN EXECUTORY CONTRACT SUBJECT TO “Subchapter D,”  CHAPTER 5, TEXAS PROPERTY CODE 

Section 5.062 of the Property Code provides that, solely for the purpose of subchapter D, “an option to purchase real property that includes or is combined or executed concurrently with a residential lease agreement, together with the lease, is considered an executory contract for conveyance of real property.” Tex. Prop. Code § 5.062(a)(2). As previously discussed on this blog, Subchapter D contains many pitfalls for sellers under executory contracts. Accordingly, leases that contain true purchase options — including the right of the tenant to purchase the property within a certain time — must proceed with extreme caution.