Rent-to-own dangers / cautions

12 Replies

Though I have rented accommodations before, I have little experience in Rent to Own. I have a young nephew who is looking to Rent to Own a small home in Mexico, and he is asking me about what kind of contract terms should be involved. I am concerned he is walking into a mistake, what are some of the threats or dangers he should be aware of when considering this option?

Some general thoughts:

(1) All of the diligence due for a typical house closing should be done for a rent to own. Most importantly, he needs to make sure there are no liens on the property. 

(2) He should distinguish between renting with an option to buy, and renting with a promise to buy in the future. The latter is much more risky, because there is a chance he will not be able to afford the property or obtain financing in the future. An option contract is generally safer. Worst case, he loses the money that he paid for the option but walks away without exercising his option. 

(3) He should try to figure out why the seller is willing to do a rent to own or non-traditional financing. Most likely, your nephew is dealing with a very sophisticated party. He should lawyer up before signing any contract with the seller. 

(4) He should consult with someone with a lot of market knowledge before paying a dime for an option contract. He might be in a depreciating market and pay for the right to buy it for above market value in the future.

(5) He should read some books on investing (E.g., Rich Dad, Poor Dad). In particular, he should realize that a primary residence is not an asset but a liability (at least from a cash flow perspective), and that it is often better to rent than own, especially if future plans are uncertain and/or he can invest the difference in low cost index funds. 

Disclaimer: This post is for informational purposes only and is not legal advice. This post does not create an attorney-client relationship with anyone. 

Jacob Rhein said it best. I can only add that rent to own in many cases is a very beneficial agreement for both buyer and seller. 

Great advice @Jacob Rhein ! My landlord recently asked me if I would be interested in a rent-to-own option on a 2 bedroom/2 bath condo that I'm living at in Oceanside. It struck me as odd that he would offer a rent-to-own option, and it didn't sound like a great idea to me given the possibility of a depreciating market and the premise that a primary residence becomes a liability. If I'm going to invest in a primary residence it's better to use an FHA loan, limit my stay to one year and then rent it out. Thanks for the advice!

Rent to own is designed for those without the ability to qualify for conventional financing. In the past it was designed to fail so the owner could rinse and repeat several times with the same property.

Honest rent to own operators will insist that the client receives financial counselling through out the process so that when the term is up they will qualify for conventional financing.

Great thread. This topic was discussed at a meetup I attended which got interesting. This clarifies most of my worries. Thanks. 

Hi all!
I’m new to BiggerPockets. Have been reading some posts from time to time. Why did I joined BiggerPockets? Becuz my wife and I are planning to search for a home in the St. Louis, Missouri area. We are currently living in an apartment and getting tired of the rent increasing every year. The apartment only offer 1 year lease and no 2 or more years of leasing. In my thoughts, should we buy a condo/house or go for a rent to own a home in the St. Louis area. From what I’m hearing is that rent to own a home can be a scary scam. Should we get a lawyer for this?
Your wisdom and help are greatly appreciated. Thanks for your time to read my post.
-GComas

We are doing a land contract on a commercial property that we own.  The couple can't get conventional financing for the space and wanted to rent. I wanted to sell it so I offered them the land contract. It helps me by not having to take on the expenses and of the property and there are tax advantages to spreading out the payments. Plus, the space is empty as it was a retail store that we closed so it's costing me at this point. They have a equitable stake in the property (I'm not sure I'm using the right terminology). It protects them from not getting booted from the lease too. There are plenty of advantages to both parties if the mutual goals are understood. We are going through a title company and lawyer to draft the contract and make sure it's recorded. 

@Trevor Seed We started using the lease option model in Arizona with our properties and have found it mutually beneficial to both parties. Here is an example:

We are just finishing a rehab on a home that the ARV is about 190k. We will be selling it. For $199,900 on a 4 year option with an option fee of $4900.

Benefits to us:

1. We are able to sell it for more than maket value today.

2. We get the option fee as profit up front that lessens our amount into the property.

3. The tenant is the buyer and we don’t have to pay realtor fees.

4. The management and maintenance is minimal for us because the tenant is expected to take care of the maintenance the same as they would if the were to have closed on the purchase with a loan from a bank. Honestly the maintenance should be pretty minimal since the property was a fully rehabbed.

5. The tenant tends to take good care of the property since they look at it as their own home.

Benefits to the optionee/tenant

1. They get into a home today that they wouldn’t otherwise qualify for where hey can plant their roots.

2. They don’t have to worry about the landlord selling the property while they are living there and the new landlord not renewing their lease and making them move.

3. The have a future price locked in so if the market appreciates greatly they can buy the house under market value, or if the market goes down they can walk away from the house without needing to sell it and losing money in sales costs.

4. They can customize the house to their liking (within reason of course).

So a lease option can truely benefit both the tenant/buyer and the seller/landlord. 

While not at all sure about the real estate laws/mechanisms in Mexico, we are familiar with lease with option / rent-to-own.

As a landlord/seller, I only would use lease with option--lease must not mention option, nor option mention lease.  Keep those completely separate; if things go south and tenant does not pay rent, a simple eviction could be used.

In rent-to-own, if part of the rent is going towards purchase price of the property certain equitable rights transfer to the tenant/buyer.  Worst case there, if they don't pay you monthly, an ejectment (think foreclosure/court) procedure could be required.

In a land-contract, I'd have the escrow agent hold an executed deed from seller to buyer until contract is fulfilled and stay aware that any judgements or liens against seller, subsequent to signing the land-contract, could still attach to the property.

This is not legal advice--just lessons learned in the real world.

Good luck!

@Shiloh Lundahl be careful with point #4 of 'benefits to us' - one of the biggest ways owners have gotten into hot water with RTO is passing maintenance / repairs onto the tenant - as they are just that, a tenant, UNTIL they purchase. So, adhering to your state's Landlord / Tenant law, tenants typically are not responsible for maintenance / repairs. It's all in what your contract says.

@Vince Mayer how can RTO be a scam? @Thomas S. already mentioned it. If you look at past conversion rates on RTO's, they are not great. The Option is typically non-refundable. In the past, many Landlords knew this, made the Option exponentially high, knowing most don't convert, then when they either get behind on rent, or don't convert, they keep the Option, then do it all over. 

It can be done correctly, and the one's that do typically either hold the hand of the tenant to get their credit up, or require them to go through a repair company. 

From the tenant side - you want to make sure taxes are being paid, no liens, etc. 

@Steve Christensen In our lease contract it states that the actual rent is a certain amount and that we give them a $100 discount each month to take care of any maintenance issues but that if they call us to start taking care of these maintencence issues then the rent moves up to the higher amount. Of course the $100 is that much higher than the amount that we are planning for. 

Now if there is an issue with the major mechanicals of the home, or an issue with the AC unit, then we come in right away to get that fixed. Because of how hot Arizona can get, if the AC unit is not working correctly, a landlord can get in major trouble if they don’t get it fixed right away. Also, all of our homes are rehabbed to a certain standard to where there should be no major problems during the option period and if there are then we did not catch it before they moved in and we will step in and fix it. 

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