One real estate strategy that I’m quite familiar with, but never written about, is rent to own or lease option homes. What is a rent to own home? It’s pretty much exactly as it sounds. It’s where an investor, or home owner, rents out their property to a tenant, but gives the tenant the “option” to purchase the home after a certain period of time at a predetermined price.
Home owners sometime use this strategy as an incentive to get their home sold, even if it means taking payments for a certain period of time. Home buyers with not so great credit, and low amount of savings for down payment, may find this method of financing attractive. It enables them to get into a home right away, while building their credit and down payment through rent credits.
For the investor, selling a house via rent to own or lease option is very similar to selling a covered call. The tenant has to pay the investor an upfront “premium” for the option to purchase the house, this is called the “option deposit”. At the expiry, which is negotiated between the investor and tenant, the tenant has the option of purchasing the house at a predetermined price. The option deposit, along with any rent credits, are used as part of the down payment on the house.
How does rent to own work?
- House is listed as a rent to own with monthly rent at the high end of rentals in the area, and a small option deposit (1-2% of property value). The option deposit goes towards the purchase of the home and is non-refundable.
- Tenants are screened for decent credit, employment and potential for purchasing home at end of the term.
- Tenant moves in, landlord collects rent and option deposit upfront. A separate lease and purchase agreement is signed.
- A small portion of the rent, called a rent credit, is put against the purchase price of the home. The rent credit is at the discretion of the investor.
- If the tenant decides not to buy, the tenant loses their option deposit and rent credits.
- Rents are typically higher;
- Option deposit collected upfront;
- Tenant is responsible for maintenance and repairs;
- Tenant typically treats the home as if it is their own; and,
- Guaranteed sale price if tenant exercises their option.
- Setting a ceiling on selling price of the house, especially in appreciating markets;
- The initial due diligence required to screen tenants; and,
- Tenants can walk away from the deal at any time, but investor is bound by terms of the purchase agreement.
- Tenants can “test” the house and the neighborhood and can walk away from the deal at any time.
- Tenants with mediocre credit can build their credit over the term and build their down payment via rent credits.
- Tenant pays premium rent for the “option” to purchase the house. If the tenant decides not to buy, the option deposit is lost.
- Bank financing is not guaranteed at the end of the term.
From an investors perspective, this is one way to make money via real estate, however, placing a cap on the selling price is the deal breaker. Personally, I’d rather build equity over time and keep the property for the long term. However, I can see this being a viable solution for home owners who are having trouble moving their home in a buyers market.
Do you have any experience with rent to own homes in your area?