Rent to Own Can Be A Win Or A Loss – It’s Up To You
Rent to Own Can Be A Win Or A Loss – It’s Up To You

Strategic investors are continually striving to increase the yield and cash flow from their investments. Some of the strategies they attempt will work, while others will prove to be less promising than initially thought.

These strategies come and go in waves. One strategy that has been around for a long time but seems to be gaining a resurgence of attention is the Rent to Own (or Lease to Own) strategy.

With the release of his book Investing in Rent-to-Own Property , Canadian Mark Loeffler was definitely a catalyst in the awakening of this strategy. This strategy can serve sellers, investors and home-buyers if done correctly, legally and with the right intentions. The strategy can be a home run for people living and investing in Canada’s real estate hot spots, but it has also spawned some negative applications of the RTO strategy among some less-than-desirable investors.

BEWARE OF THE QUICK BUCK ‘EXPERTS’

Over the decades, we at REIN™ have been testing and investigating the reality behind this strategy. Throughout that time we have witnessed some amazing positive outcomes, however, we have also noticed that whenever a strategy becomes more popular, those less scrupulous are also drawn toward it as they chase the latest perceived ‘Quick Buck.’ Of course, what this does is start to sully the reputation of a strategy or the legit people who have been doing it for years.

Legitimate investors start the process and go about it in an ethical fashion, and then the less legitimate investors rush in because they see the dollar signs and an ‘easy cash’ opportunity. These less legitimate investors start to adjust the system to put it grossly in favour of the investor (rather than the home buyer), with the hope that the homeowner will default so that they can keep the deposits – the exact opposite of why this strategy came to being.

AGREEMENT MUST ALLOW BOTH PARTIES TO WIN

The key to any deal, especially Rent to Own, is a clearly communicated agreement between the owner (often an investor) and the eventual homeowner. In all situations, this agreement must be fair and be vetted by both parties’ lawyers (separate law firms) so that all parties understand the risks, the refund policy of the initial deposit and extra monthly payments. To make sure that the goals of both parties are met, the investor must get a good solid return on their investment dollars, and the homebuyer get in a position to repair/build their credit so that they can eventually move into their goal of home-ownership.

INVESTORS WIN NOT JUST FINANCIALLY

There are certainly some benefits to the Rent to Own strategy. As sophisticated investors know, planning ahead and doing your due diligence on both the property and the ‘renter’ is paramount. Some of the draws to an RTO strategy are substantial:

1. More committed tenants – Your Lease Option ‘tenant’ has more of an ownership stake in the property and may treat the property with more care than they would if they were just renting. In fact, in some cases, a committed ‘tenant’ will begin to renovate/repair the home while they live there because of pride of ownership. Make sure, if this is the case in your deal, that you clearly lay out how these costs and value increases will be dealt with in the future (at sale or default).

2. Potential for fewer property management issues – Having a more committed tenant could create fewer management issues and should make your day-to-day management more ‘hands-off’. A carefully chosen ‘Lease Option’ tenant will treat the home as if it is theirs; a home-owner mentality often times makes it feel more of a teamwork approach to maintaining the property and the relationship. Some investors have even tested having a ‘Lease Option’ tenant live in the upstairs and manage the basement suite for a cut of the rent (or credit towards eventual purchase price). This allows the upstairs tenant to gain important experience in managing their future basement tenant.

3. Huge demand – There is a large market of good people who do not qualify for a conventional mortgage – maybe new immigrants to Canada, have just moved from one job or region to another or don’t quite have enough money for a down payment. With this strategy you can assist them in building the needed credit for the banks to eventually want to provide them mortgage financing.

These are just to name a few, but as an investor, you begin to see how this strategy can be a nice addition to your portfolio strategy, especially in rapidly moving markets.

TIGHTENING CMHC RULES MAKE RTO MORE POPULAR

The new CMHC mortgage rules have really tightened and put more restrictions for that first-time homeowner to buy a property. Although the Rent to Own trend started long before these mortgage changes came into effect, this tightening has brought it more to the forefront. The most important component and ultimate goal of a sophisticated RTO investor is the successful exercise of the option and ultimate purchase of the home by your tenant buyer. To purchase the home, the tenant buyer needs financing. Without financing you don't have a win/win therefore repairing or creating the credit needed is paramount.

BUT WHAT DO BANKS SAY?

Comments from investors using the Rent to Own strategy revealed that there is a distinct lack of knowledge amongst many lenders on all aspects of Rent to Own. You've all heard the saying, “A confused mind says no”. Well, many lenders seem to be confused about Rent to Own financing and where it fits in their portfolio.

Some lenders are confused enough that, by policy, they won't touch Rent to Own either. Other lenders will finance Rent to Own but in a limited and unsatisfactory way.

When it's time for your tenant buyer to look for financing, both he and you can waste a lot of time trying to deal with lenders whom don't want to deal with you. At the very beginning of the process (even if the renter won’t be buying for a few years) you should connect with a mortgage broker who deals mostly with investors and who thoroughly understands Rent to Own and, most importantly, which lenders will finance Rent to Own. At a minimum, I suggest that you have lenders lined up at least six months before you think financing might be required. A great place to find these mortgage brokers and bankers is by speaking with fellow investors on the discussion forums at myREINspace.com.

DOWNSIDE TO ALL STRATEGIES

Sadly, the actions of a bad few taint every type of investment, from stock markets to real estate and everything in between. This is true for Rent to Own strategies, some of the misperceptions can arise from legitimate fraudulent behavior (by the investors OR the tenant buyer), however in many cases the bad reputation can come from a simple misunderstanding of the deal or the process. As with any investment strategy, clear communications and independent legal advice solves most problems in advance; however, common problems still arise. For instance:

1. The buyer truly does not understand the deal when it comes to the refund policy surrounding initial deposits. I even suggest that there is an ‘interpretive – plain English’ supplement to the agreement on this important subject that clearly outlines what happens in the following scenarios:
    a. The Tenant Buyer decides not to close on the property in the prescribed time
    b. The Bank demands more down payment than the tenant can produce
    c. The Owner/investor gets into financial trouble

2. The contract does not match the verbal agreement with the owner and the Rent to Own buyer (hence the reason that both parties MUST get independent legal advice).

3. ‘Bad’ owners that put Rent to Own buyers into properties in a situation that the buyer has a very good chance of defaulting on their monthly payments – so that the owner can keep the up-front deposit. Doesn’t happen very often, but when it does it hurts everyone involved.

MARKET CONDITIONS

For both investors and buyers to note, Rent to Own deals do not work as well on either side in a declining market. Eventually, ‘transfer’ prices can be less than the owner’s purchase price, or if a purchase price has already been set at the start of the agreement and the market appraisal comes in below that at transfer time, the Rent to Own buyer may not be able to get the full financing they need to make the deal happen. The Rent to Own phenomenon is even starting to show up in Montreal.

Like everything in the financial world, this is a strategy that works and is legitimate but only if the full intention is to make it work. It is also open to some easy manipulation from both sides of the agreement. Careful study of legitimate and legal strategies is critical BEFORE you add this strategy into your portfolio. This is not the time to take shortcuts.

Some detailed information for sophisticated investors who want to do it right is available here at myREINspace.com.

No matter what side of the Rent to Own strategy you are on, be it buyer or seller, having sound legal advice and knowing all the details of the agreement BEFORE you sign on the line is imperative to insuring a win/win deal. There is no reason for one party to gain and the other to lose, so cover your bases and set yourself and the other party up for success.

Do your homework and you will be able to increase your cash flow and reduce your management issues.

Rent to Own Can Be A Win Or A Loss – It’s Up To You was last modified: July 5th, 2013 by maddy
 

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