The Best Type of Home for Rent to Own Investingby
Our client was pretty upset. Before working with us, he had taken some training around rent to owns. He was told that tenants who choose their house for a rent to own are more committed and more likely to buy. When this family asked him to buy this house for them, he thought it was the perfect opportunity to help someone and make some extra monthly income.
They were making a great income. Their credit was poor because a few years back one of them was injured on the job and they fell badly behind on their bills. They are all caught up now, and just need a bit of a hand to become home owners again.
So – he happily purchased this home for them and set it up as a rent to own.
Unfortunately, it’s just not true that a tenant picking their home is more committed than if you pick the home and 14 months into their contract, they decided to move out. Now our client was stuck with a house that wasn’t easy to get rid of.
Rent to own is when a tenant rents your property with the option to purchase it. They move into it with the intention that they’re going to buy it and they have a piece of paper that gives them the option – not the obligation – to purchase it. You can’t sell it to anybody else because they have the option to purchase it.
You set the future purchase price at the beginning. You charge higher than market rent with a portion of their rent building up over time towards their purchase and they give you a larger sum of money that serves as their option fee.
Rent to owns offer you a way to sell a home without paying realtor commissions. It is also easier to manage and gives you higher cashflow each month than a regular rental, but there are also some really good reasons not to make rent to own investing your entire business model.
The biggest issue, next to ensuring you have properly screened and educated your rent to own tenants, is what kind of property will work the best for rent to own investing?
If ANYTHING goes wrong with the house – you are responsible. The tenant can walk away.
If the tenant doesn’t want the house or decides the value has dropped too much, you’re stuck with a home that is worth less than you’d expected.
If the prices rise up rapidly, the tenant can buy at the predetermined price, turn around and sell the home, and keep all those extra profits for themselves.
You take on all the risks, and will not benefit if the market has a quick rise.
So – your first consideration should not be what your tenant wants – it should be what works best for a rent to own investment model.
What is the home type that is the easiest to sell, the most stable in value and generally the easiest to rent out?
In every single market in Canada, and probably in the world it is the STARTER FAMILY HOME. The home type that first time home buyers enter the market with. The only catch is that this is slightly different depending on the market. In Toronto and Vancouver, the starter family home is arguably a condo. Most people in Toronto enter the home market through a condo and later, as they can afford it, they move into a house.
In some other areas in Canada, like Surrey, BC or Brampton, ON for example, it’s a townhouse. In most average sized cities, it’s a 3 bedroom 2 bathroom house. The starter family home for your area may be different but it’s still the category that gives you the lowest risk for rent to own. (We only do rent to owns that follow the same model we use for Buy and Hold – Properties with a CAUSE).
The key to ensuring you make a great return and you set your tenant up for success is to buy a property for UNDER the average price in the area and ideally under their market value.
Why You Should Focus on Buying UNDER the Average Price for an Area:
If you stay just below that average price you’ll enjoy a greater demand for that property because it’s more affordable. If you go too much below the average, however, you’re probably just getting into rough neighbourhoods.
In Nanaimo, BC where we’ve done the majority of our rent to owns, the average price has been around $360,000. We’ll typically look at buying houses for around $280,000-$300,000 – so around 20% below the average. These homes usually need some cosmetic work which boosts their value before we find tenants for them.
By buying properties a little below the average price in a good, safe, family friendly area, we ensure that our product (the home) has more exit options for us if our tenant buyer doesn’t buy.
We know a few guys that focus on luxury homes for rent to own but when you buy an $800,000 house that will only get $3,000/month rent as a regular rental, what do you do if your tenant doesn’t buy it from you and the market is too soft to sell it without taking a loss? You can try to do another rent to own, but it’s a small percentage of the rental market that is a good fit so you might have to wait a few months while you find someone new. In the meantime, how large are the mortgage payments that you have to make?
We talk more about this as it relates to buying a home the tenant picks in What Comes First? The Tenant or the Property.
Always ensure your rent to own will at least break even as a regular rental.
A few years ago in Nanaimo the property assessments dropped across the city. Right after they were mailed out to the houses, we had several rent to own tenants say they weren’t going to buy. They were walking away. We suspect they took a look at the assessed value and thought there was no way they were going to pay the purchase price for the home. In most cases, their home was worth a lot more than the assessment reflected so this was really frustrating. Rarely does the assessed value accurately represent the market value of the home – (as I discuss in the video if you click this link). It’s in the ball park but it’s not accurate. Unfortunately our tenants made decisions without discussing with us and we received several move out notices all at once.
It was not a happy moment for us as we wanted the tenants to buy the homes from us.
We considered selling but the market was soft and after realtor commissions, we wouldn’t make our investment partners a good return. Thankfully, we had the option of renting each of the properties out as a regular rental if we wanted to. These homes, as regular rentals, are pretty close to neutral cash flow but at least they cover the costs. If you buy homes for rent to own where the numbers don’t work as a regular rental you create one less exit option for yourself.
Choose a Great Quality Property in Good Condition
You don’t have to buy it in great condition but when you offer it up to folks for rent to own it must be in good condition to get the best results.
The rent to own tenant is way pickier than your regular tenant because they plan to buy this home. It’s permanent in their mind. Tenants are often ok with not having a new roof as long as it’s not leaking or a less efficient furnace if they can use the fire place. They will put up with a lot more stuff because it’s temporary. They’re just renting and there’s an end to this situation. They also don’t have to spend money when it is time to replace the roof or put in a new furnace. A rent to own tenant looks at the house thinking that they will need to spend that money if it’s not already done (just like a potential home owner would if they were looking at buying the home).
Layout issues can really be a problem with a rent to own as well.
We bought one property for our rent to own program that rented in a split second, but we tried to fill it as a rent to own for a month without any interest. It’s in our primary neighborhood where we have had a TON of success with rent to owns and the house is adorable! We were shocked when we couldn’t find a rent to own tenant for it but it’s because the rent to own tenant is WAY pickier than a normal tenant.
The problem with this particular home, we came to realize, is that it has two bedrooms up and two bedrooms down. It also doesn’t have a garage. Tenants will put up with this layout and lack of garage if the rent rate is right, the place has charm and their kids are close to their school, but someone who is looking to buy the home, is much less keen.
We probably could have eventually filled it as a rent to own if we waited long enough, but we didn’t want to carry the costs longer than we needed to so
we turned it into a rental. As a rental it has filled and stayed full for many years. Lessons learned along the way but we share so you won’t have to learn the hard way.
There are many reasons that rent to own investing could be a good option for your next property (or as an exit out of a property you already own), but you want to make sure you’re buying homes that make great investments with multiple exit options. It doesn’t matter if you’re starting with a qualified tenant or an investment property – the most important thing to always remember is that you’re an investor and the deal has to make sense today and in the future.
And if you want more on rent to own investing – you should definitely check out these additional articles we have on our site: