Rent to Own: Here is a super informative guest post from Anita Flegg, an expert real estate investor on the rules for success in rent to owns.
Rent to own (RTO) is a wonderful investment strategy. Not only is it generally very profitable, it also feels great to help people.
I knew I wanted to invest in real estate, but I didn’t know how to begin, and I certainly had no idea there were so many different strategies. One of the first courses I took in 2009 was on the topic of Rent-to-Own investing – they called it “Lease Options” – and I was hooked. It seemed like such a great way to create win-win situations. I started buying RTO deals in 2009, and within three years, I had tripled my net worth. At the same time, my first RTO tenants were buying their home from me. It was thrilling!
As wonderful as Rent to Own feels when it goes well, it can also go very badly. It is important to keep the end in mind at all times: The two goals of RTO are to help your tenant/buyers improve their financial situation enough to be able to buy their home, and to make a profit. If you don’t achieve these two goals, you don’t have a sustainable business.
Real estate investing, in general, is a “people business,” but for RTO, it’s even more the case. When you partner with an RTO tenant/buyer, you are holding their future in your hands, and they have put their trust in you at a time when they are vulnerable. No one likes to open their financial situation to others, especially when it’s bad.
There are many variations of the Rent to Own strategy. The two main categories are Tenant-first and Property-first. In the Tenant-first model, the tenant is found and qualified first; then they help find the right home within the rules set for them. The main advantages of this model are:
The tenants fall in love with the home and the neighbourhood and are less likely to leave before the term is up. They also have a sense of control that comes with making their own choices, and that gives them a better start.
You don’t risk having a house that is empty for an extended period waiting for the right tenant. This can lead to money stress that results in you putting an unqualified RTO tenant in the house.
In the Property-first model, you imagine the type of person or family you want to help, and then buy a house in an area they will want to live in. The main advantages of the Property-first model are:
You buy exactly the kind of house you know is desirable in your target area, for your target tenant. This helps with re-sale in case the tenant doesn’t buy the house.
You have more opportunity to negotiate a discounted purchase price when you don’t have an eager RTO tenant looking over your shoulder, or telling the realtor they love the house and must have it.
Whichever model you choose, you need your own rules for what kind of tenants and what kind of property you will invest in, and just as important, what kind of tenant and what kind of property you WON’T invest in. Whatever your specific rules, remember to respect your intuition. No matter how “right” the deal looks, if you are uncomfortable, either insist on changes, or walk away. Always be prepared to walk away. My most problematic deal, and one I am still paying for, is one in which I decided to ignore my feelings about the difficult tenants because I had already committed to them. I would have done all of us a favour by walking away as soon as the tenants became demanding and uncooperative.
Rent to Own: My top rules (formulated because I have made, and paid for, exactly these mistakes):
Never buy a rural property. Often your only insurance, in case of the tenant abandoning the deal, is your ability to sell the house if something goes wrong, and it is much easier to sell an urban property.
Never buy a refinance. Sometimes you might be offered an RTO that involves rescuing people who are about to lose their house to the bank. While this seems like a nice idea, and we really want to help these desperate people, this doesn’t usually doesn’t set the tenant up for success. While we want the tenant-buyer to treat the house as their own, it’s important that they never forget who actually owns the house. It’s much harder for people who aren’t even moving at the start of their contract with you to change their habits, and usually, they will have to change their money habits.
Find out why your prospective tenant-buyers are in the position of needing a rent-to-own. I’ve found that people are most likely to succeed in repairing their credit when the problem was caused by a job loss, illness, or divorce; that is, external causes. They are less likely to succeed when their credit is in bad shape because they have had bad spending habits over the long term. People rarely change their long-practiced habits, no matter what kind of credit counselling and rebuilding services you offer.
Choose tenants you like, and who you will enjoy working with. Spending three (or more) years working with difficult tenants will very quickly suck the joy out of the business.
Decide where you are comfortable investing, and stick to it. Remember that if you decide to invest at a distance, solving problems – including selling the house if it becomes necessary – is more difficult and more expensive because you will probably have to visit the house. Also, if you invest outside your home province, you must understand the landlord-tenant rules in case a problem arises and you end up trying to explain RTO to the local landlord-tenant board.
No matter how lucrative the deal looks, confirm for yourself (using your team) that the tenant is likely to succeed in buying the house. The mortgage broker evaluating the prospective tenant/buyers for you looks at their income and debts, and calculates the maximum mortgage payment they can afford. From this maximum payment, and the insurance and tax payments they will have to make after they buy, the mortgage broker calculates backwards to the price of the house the tenant can afford. When you help them choose a house, make sure they stay within that house budget. In most RTO models, the tenant/buyer also needs a deposit of some kind, along with a realistic plan for turning the deposit and option fee amounts into a big enough down payment to allow them to buy the house at the end of the term. Taking deals that you know will fail is unfair to the tenants, and turns you into one of those real estate investors who gets their name in the nightly news.
And perhaps the most important rule: once you have set your rules, don’t break them no matter what. Just because the deal looks incredibly profitable, it is a bad idea to bend or break your rules. In my experience, it bites you every time. Hard as this seems, remember that you can’t help everyone. Your RTO business can only thrive if you treat all decisions as business decisions.