Rent to Own Homes: How to Profit from a Lease Purchase
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In some parts of the country, homes are selling like hotcakes and multiple offers that are above the asking price are common. However, for most of the nation, this is simply not the case. Selling a home can be difficult and time consuming, costing the seller incredible amounts of time and stress. This article is going to look at a creative way to sell a house for as much as you want without any added costs or stress: the rent to own home ownership strategy.
Why Would Tenants Rent to Own a Home?
Sally and John are a hardworking, newly married couple just starting their lives together. Sally just started work as an independent makeup sales consultant and John as a foreman at a local home construction company. The couple understands the enormous benefit to buying in today’s rock-bottom market (low prices, low fixed interest rates) and want to buy as soon as possible. However, despite having decent credit, they do not have the down payment required to buy a house. Additionally, Sally’s self-employment income can’t yet be counted toward the minimum required income. How can you, as an investor, create a win-win to help the young couple get into a dream home and make your investing easier and more profitable?
You guessed it: a rent-to-own home ownership strategy.
Rent to Own Homes: Definition
A rent-to-own strategy, also known as a “lease option” or “lease purchase” involves leasing out a home to tenants with a legal agreement allowing the tenants the exclusive right to buy the home within a certain time period. In other words, Sally and John can move into the home, pay monthly rent, and buy the home at some point in the near future.
This process allows the tenants time to save up the required down payment, build their credit, establish longer job history, or repair whatever is making it difficult to obtain a mortgage. In the story of Sally and John above, the young couple could use a lease option to move into their dream house (the house you are trying to sell) and give them time to save enough down payment to buy the home with a typical down payment.
How Do Rent to Own Homes Work?
The process for finding great tenants is similar to any other rental property, including the important of advertising correctly and screening properly. For more information on finding, screening, and renting to quality tenants, see How to Rent Your House: The Definitive Step by Step Guide
After an acceptable tenant is found, the seller will sign the lease with the tenant, as well as the “option agreement.” Some landlords choose to use just one document for this (a lease purchase contract) while others use two separate documents (a normal lease plus a separate “option agreement.) Check with an attorney to see which is the best route for you to take.
Whether you use one document or two, the rent-to-own agreement essential states that you, the seller, cannot sell the property to anyone else within a specified time frame. This time frame can be whatever you agree upon, but typically term lengths are one to three years. The eventual purchase price is agreed upon at this point as well, allowing the tenant to “lock in” their purchase price and setting the sales price for the seller. The agreement also states the specific rules that the tenant will need to adhere to, as well as the responsibilities of both parties. Typically in a rent-to-own situation, the landlord will make repairs up to a certain dollar amount the responsibility of the tenant, but again, this is up to you to decide on.
For a great article on what to include in your rent to own agreement, see “The 10 Documents You Need for Your Lease Option Deals.”
The Rent to Own Option Fee
When a tenant signs the lease and option agreements, they will also be required to pay the rent, the security deposit, AND the “Option Fee.” The Option Fee is an upfront down payment found in most rent-to-own home ownership programs. By paying this fee, the tenant is essentially paying for the right of exclusivity on the home, so only they can buy the home and the seller cannot sell to anyone else. This is what separates a rent to own home from a typical rental home. The amount you charge can be whatever you can reasonably get, but typically is between $2,000 and $5,000, depending on the value of the home. This fee is nonrefundable but will be later applied toward the tenants down payment when they are ready to get their mortgage.
Additionally, a rent to own home ownership program typically will set aside costs per month from the rent to be applied toward the future down payment as well. For example, if tenants Sally and John pay $1000 per month, the seller (you) might want to agree to apply $100 or $200 per month toward that future down payment. If the tenants never end up buying the property – then that extra money each month is forfeited to the seller, along with the option fee discussed in the previous paragraph. It may be wise to add wording in the rental agreement that specifies that this monthly payment is only applicable for on-time payments, giving incentive for the tenant to pay on time.
Seller Benefits to a Rent to Own Home Ownership Program
Tenants Do the Repairs
As stated earlier, with rent to own homes you have the ability to require minor maintenance repairs to be the responsibility of the tenant. After all, they plan on owning this home someday, so this added responsibility will prepare them for that day. However, keep in mind that by shifting responsibility over to the tenant – many repairs may not be fixed or fixed properly.
Rent to Own Tenants Treat Houses Better
While not always 100% true, tenants who live in a home under the assumption they will soon own the home will treat the home with more care than they would a typical rental. This might include higher craftsmanship in repairs, better cleaning, and more responsible choices (removing shoes on carpet, no drinks in the living room, etc.)
Incentive for Responsible Payments
Because the tenant paid a fairly hefty “option fee” to move in and has been accumulating equity each month when part of their rent is being saved for help with their future down payment, the tenant has extra incentive for paying rent on time and eventually buying the home. This typically will translate to more responsibility in performing properly.
No Agent Commission Upon Sale
Normally when you sell a house, it can cost 6% or more for the real estate agent fees. When you find the buyer yourself, through a rent to own home ownership strategy, you are able to keep that 6%. This is true unless you find your tenant through a real estate agent, in which case you may need to pay.
Less Turnover and Turnover Costs
A Rent to Own tenant has a different mindset than a typical tenant: they want to be buyers. This means they are far less likely to quickly move away – giving you less vacancy costs. Additionally, if the tenant does move away, you have a security deposit as well as the “option fee” they paid at the beginning – so you are still in the positive.
Possible Higher Sales Price
When you sell to a rent to own buyer, they typically are less concerned with achieving the rock bottom prices that many buyers seek today. For those looking for a rent to own house, the price is far less important than the terms you can offer.
Rent-to-Own: The Ultimate Win-Win
The rent-to-own strategy’s strongest benefit is in the ability to structure the ultimate win-win for the seller. The seller is able to lock in a sales price, without real estate fees, at the highest reasonable price. If the tenant ends up buying the home: the seller wins, with the sale. If the tenant does not buy the home and moves out—the seller wins also because they get to keep that option fee and re-do the rent-to-own program with another tenant. If the house is trashed—again, the tenants option fee should cover any damages. All in all – there are far less risks for a seller using a rent-to-own strategy to sell a house.
What do you think? Have you used a rent-to-own strategy? How did it work out? Or have you thought about it but never tried? What’s been holding you back?
Leave me a comment below and let’s chat.