Rent to Own: What Comes First, the Tenant or the Property?
When my husband Dave and I decided to make real estate investing our full time job, we had been investing together for seven years and had built up a multi-million dollar real estate portfolio. We were in a strong financial position for the long term but our short term cash needs were not being met by our properties alone.
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To increase our monthly cash flow we turned our attention to doing more rent to own deals.
Rent to own rental properties provide higher rental income, lower expenses and typically attract better tenants.
And when you combine those benefits with the fact that bank financing had become a gigantic challenge for many people in Canada, the timing for us to move into this market on the West Coast of Canada was perfect.
To learn how to do rent to own deals in Canada we turned to Nick and Tom Karadza, a team of two investing brothers in Ontario, Canada that had been doing rent to owns for nearly a decade for themselves and their brokerage clients. And with some great coaching from them we quickly closed on our first rent to own deal, putting $7,500 in our bank before we even closed on the property and then adding $600 every month in positive cash flow every month after we took possession.
We had found our cash flow solution! We quickly adjusted our strategy to focus on buying one new rent to own deal a month for 2010. And, that’s what we’ve been doing.
Rent to own isn’t new to most folks reading this blog. But what might be new is the debate we’re finding amongst different rent to own companies in Canada (and now within ourselves) and that is:
What works best? Finding the tenant or finding the property first?
The Property First Rent to Own Strategy
Nick and Tom taught us the property first approach and it’s worked exceptionally well for us. Basically we buy homes in the starter family category for the market we are investing in and we only buy homes that are at or ideally, below, the average price of a home in that area. Then we advertise to find tenants for that property.
This gives us total control over the property we buy and the deal we make. It allows us to market to find the best deals in our target areas, like this gorgeous rancher with a market value of $350,000 that we’re going to close on next week. It’s in a super convenient location, it’s in such good condition you’d think it was brand new and we’re buying it for $330,000.
The tenant buyers that we hope will sign the lease this week will be agreeing to buy that home from us in 24 months for $378,000. And, in the meantime we will be pocketing over $400 per month in positive cash flow from the property.
It’s a great deal for us. And for the family that could not get financing because of a divorce that messed up their credit and tied up their assets it’s an even better deal because they can build up equity while waiting for their divorce to settle.
But this property has been a challenge for us to rent. We love this gorgeous, perfectly maintained and conveniently located rancher yet we’ve found that many prospective tenants weren’t interested. It was either too far from the specific school their kids attended or it was just too small for them (it’s 1333 square feet so this was a bit surprising to me, but we now understand that the majority of our market of tenant buyers are looking for 1500 square feet or more). As we struggled to find good qualified tenants to rent to own this property from us we started to wonder if author and real estate investor Mark Loeffler has it right with his tenant first approach.
The Tenant First Rent to Own Strategy
The tenant first strategy is simply marketing to find a tenant and then working with the tenant to find the property that they will rent to own from you. You pre-screen the tenants and even take a small deposit fee from them up front before you start house shopping. Then you have your tenant work with your realtor (who knows your criteria) and they pick their home. Then, you buy it.
This is different than how we’ve been doing it because we find and buy the properties and then find the tenants to place in them.
In his book Investing in Rent to Own Property Mark Loeffler explains that he prefers the tenant first strategy because when the tenants select their own house they are more emotionally invested in the home, there’s no risk of not finding tenants for the property you buy and the tenants are involved in the process from the start which reduces the expenses and stress many investors have to take on early on in the process to do rent to own deals.
There are plenty of benefits to this approach – especially the way Mark teaches it – because you qualify the tenant before you buy the property, you can ask for a higher deposit because they are selecting the property, and the tenants pay for and attends the property inspection. But, you lose quite a bit of control over the deal you’re making.
The Jury Is Still Out … But …
Now that we’re working on filling our fourth rent to own in 2010 we’ve found ourselves with three qualified applicants looking for specific homes. We have allowed ourselves to hit sort of a hybrid situation where we have taken applications from the tenants and we’re house shopping with them in mind. At the same time our tenants are out looking at houses too. They forward us any listings they like and we review them.
But here’s the challenge and the reason I don’t know if I like the tenant first approach:
We’re finding that depending on the tenants, some fall in love with properties that are out of their price range, in need of maintenance we don’t want to be responsible for, or are just not the kind of property we want to own if something happens and they aren’t able to buy it from us in the future. And … the biggest reason of all is that the tenant is involved in the purchase of the property reducing our ability to patiently wait for the best deals and find the best properties.
We just had an offer accepted on a property on Monday that is market value. We’re paying market value for an investment property and the only reason we’re doing that is because we have a line up of tenant buyers that will jump at the opportunity to rent this property from us. The high demand is a very good thing. We’re going to be able to cherry pick the best tenants for this property and command the best rent rates. But, we’re buying a property we wouldn’t have otherwise purchased for the simple reason that we have tenants pestering the heck out of us to find them properties in this area.
I don’t want to lose a month’s rent if we buy a property we can’t fill, but I think it’s much worse to find yourself rushing to buy a property at market value that you don’t really want to buy just because you have a tenant you like that really wants that home.
Now, this particular home is a good one. And it’s not that we don’t really want to buy it, but it is at market price and we’ve been really enjoying the profit margin involved with working hard to find the deals that are under market value.
I find it very tough to tell someone that has already started decorating their daughter’s room in their mind that I won’t buy that house for them. Even if the reason is legitimate like I am concerned about the water issues or it’s overpriced. It’s still not something I enjoy. I guess I just want to make people happy not let them down. And one of the hardest things we find with the tenant first strategy is explaining to someone why they can’t live where they want to live because there is no way they will be able to buy that home from us in a year or two given their current income levels. When they are out shopping at houses it seems they lose track of the fact that they can only afford a $300,000 home when they see how gorgeous the $365,000 one is.
I’m grateful we have built up such a big database of people interested in working with us, but I would rather them fall in love with a house I have to offer than a home I never intend to buy.
So I like the tenant first approach for a lot of reasons but I think we’re going to stick with the property first – the only thing is I now know EXACTLY what streets to buy on and the minimum size of home I need to buy – and when I do that I know I can fill the property with only a few phone calls. The folks in my new target area can look forward to finding magnets on their mailboxes, letters in the mail, flyers in their papers and business cards in their coffee shop saying “WE WANT TO BUY YOUR HOUSE”. When a great deal in that area comes up we’re jumping on it because we are still doing the property first approach but now we have a line up of tenants ready to take them too.