The Best Type of Home for Rent to Own Investing

house keys

The tenant ditched on me. Now I am stuck with this house 20 minutes out of town that I can’t find another tenant for. I guess I will try to sell it but the market is not very good.

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.

Good luck!

And if you want more on rent to own investing – you should definitely check out these additional articles we have on our site:

What’s Better for Rent to Own Real Estate Investing?

Rent to own is when a tenant rents your property with the option to purchase it. They move in with the intention buy it from you in the future. You set their purchase price at the beginning, they pay a fee for the option to purchase it in the future, and a portion of their rent is a credit which builds up over time towards their purchase.

As I discussed in How to Make More Cash from Real Estate, Rent to Own real estate investing generates more cash flow because the tenants are paying a higher than market rent for their property and they are responsible for basic maintenance. You also don’t typically need property management because of the quality of tenants that move in and because they are responsible for taking care of repairs up to a certain dollar amount ($300 in our case but many other investors have their tenants handle up to $500).

We’re also helping fill a gap in the market and our tenants are grateful for it. Our rent to own tenants give us big warm hugs, invite us for dinner, make us handmade thank you cards and invest in fixing up the homes. One of our tenants painted the interior and exterior, built a garage and fenced the back yard of his home.

Typical rent to own tenants are folks who are new to Canada and haven’t established credit, they are going through a divorce and their assets are tied up, they’ve beat up their credit because of a health reason, they haven’t saved enough for a full downpayment to qualify for financing or just one set back has kicked their credit down to a point where the banks aren’t interested. They need a helping hand because the banks won’t help them and the other options available don’t make financial sense for them.

Most investors agree that rent to own real estate investing a great to create more cash flow but where the debate does arise around rent to own is what comes first: the tenant or the property?

No matter which approach you do, screening your tenants is critical. Beyond the usual tenant screening of reference checks, employment verification and credit score review, you must make sure the tenants have income levels that will allow them to qualify for financing in the future. You must review their debt load to make sure a bank is likely to work with them in the future. You also need to review their plan to correct whatever issue they have, to make sure they know what steps they have to take to qualify for financing in the future. Honesty from a prospective rent to own tenant is imperative.

Where rent to own can get a bad reputation is when it’s abused by investors who skip this step. Some are lazy, some don’t understand how it works but some actually do it intentionally. They put a tenant in a home knowing the tenant will never be able to buy from them. They take the deposit and the elevated rent and when the tenant eventually cannot buy they just rent it out again – keeping all the deposits as extra profit. That’s unethical and is not how rent to own should work.

What is property first and tenant first?

Tenant first is when you have pre-screened your tenant. They have passed your rigorous screening process, have the income and the deposit and are ready to go house shopping. You, typically, send them out with your realtor to look for a house that they want you to buy. Your realtor has your criteria of where and what you’ll buy. They find their dream home that meets your criteria and you buy it for them. The theory is that they will be more committed to the home because they picked it. Generally a lot of investors also charge a lot more to the tenant directly such as inspection because the home was picked by them.

Property first is when you find and buy a property and THEN find a tenant who wants to rent to own that specific property from you.

The challenge with property first is that sometimes you don’t find a tenant quickly. The reality is that the pool of people who are suited for rent to own is only a very small percentage of the rental pool. That means sometimes it can take a month or two to fill a rent to own property, and every once in awhile you may find yourself turning it into a regular rental just because it wasn’t attracting a tenant buyer (tenant buyer is what a rent to own tenant is often called).

We have had to turn a couple of rent to own properties into rentals in the last three years because they didn’t fill as fast as we’d hoped, so it happens, but we have decided not to do tenant first.

Why We Generally Do Not Like Tenant First Rent to Owns

We tried to do a few Tenant First deals but we found it hard to do good deals with the tenants and their emotions involved. They fall in love with a house and don’t care that it’s $15,000 over market price. They want that house. You can explain to them all day long that that house is a little over priced and how about this one instead, but they don’t care. You can only say “no” to somebody a few times before they get irritated and move on. But the reality is that if you buy a home that is overpriced at the start you’re setting your tenant up for failure!

In order for rent to own to work if you buy a home for over market you need to set a starting price that is above today’s value.

Right now we’re generally appreciating our properties from today’s value by about 3% and no more than 4% each year.

If we pay market value (And when the tenant and their emotions are involved we find you almost ALWAYS pay at least market value), do we then add closing costs and any improvements to that value? If we don’t, we won’t make a strong return. If we do, the price we set for our tenants to buy from us at may not be feasible and the bank will not loan to that value.

To maximize the likelihood our tenant will succeed AND we will make a great return we need to buy properties for LESS than their market value. We can’t do that when a tenant is involved.

Besides – I am a real estate investor. I love helping people but I make money when I create a great deal. Everything unwinds from there if the tenant is the one in charge.

I am not going to buy a house that doesn’t set my tenants up for success. I am also not going to buy a house that doesn’t have other exit strategies or options for alternative plans.

There are risks and rewards and pros and cons to both approaches but we love to invest in real estate because of the CONTROL we have. Relying on someone else (the tenant) to pick the property is like giving my money to an advisor and just trusting that they’re going to invest it as well as me. I’ve learned that nobody loves my money like I do. My tenant certainly doesn’t. When I pick the property based on location, characteristics, and only buy the types of homes that are much more in-demand by the masses (the starter family home for instance), I set myself and my tenant up for much higher chance of success.

Here’s a video Dave created on the same subject:



Are Rent to Own Deals a Good Idea?

As part of our 12 Months to $1 Million membership program we host two group coaching calls per month. We’ve been receiving fantastic feedback from our members, and quite frankly, we really love to chat with our members and help them out with their biggest questions.

One of thing that keeps coming up is the subject of rent to own deals… we kept touching on them for various reasons until finally one person wrote in and said “Are they a good idea?”. So we spent about 18 minutes carefully explaining them and what the advantages and disadvantages are.

We’ve got that excerpt from the call for you to listen to today!
It’s 18 minutes long.


Published on December 16th, 2009

All About Rent to Own Real Estate Deals

In recent years, especially in Western Canada where we live, a lot of real estate investors have found it tough to make the ‘numbers work’ on buy and hold deals. The biggest challenge is finding a deal that you can buy for a price low enough that you can cover all the costs with the rent it will generate.

While home prices sky rocketed over the last 8 years (up to 2008 anyways), rental rates took a slow and steady path upwards.

One of the ways we’ve been able to continue investing in Western Canada and still make money from our investments is to buy properties and then find tenant buyers for the properties. That is, we’ve done a rent to own real estate deal.

rent to own real estate deal in kelownaThe most recent example is from a single family home we purchased in Kelowna, BC.

For our readers that are unfamiliar with how the Rent to Own (RTO) strategy works, here’s a brief summary.

The rent to own strategy is just like how it sounds, a tenant rents your property with the intention (and option) to buy the property at some point in the future (and at a pre-determined price).

To help your tenant prepare for the purchase you charge them a rental rate over and above the market rate with a portion of their rent building up as a rent credit.

For example, if a single family home (3 beds, 2 baths, 2 storeys, good neighbourhood) rents for approx. $1,300 per month as a standard rental unit, in a RTO, the tenant may pay $1,700 per month and $400 of that $1,700 goes towards the purchase of the property (when and if they buy).

Thus, if the renter (known as a Tenant-Buyer) elects to purchase the property after 1 year, they will have $4,800 ($400 times 12 months) towards the purchase of the property. This, coupled with an Option Fee (similar to a down payment) which the Tenant-Buyer (TB) pays to the Landlord at the beginning of the rental period, goes towards the purchase price.

Here’s a quick look:

 Purchase Price for Tenant-Buyer: $350,000
 Option Fee from the TB: $10,000
 Monthly Rental Credits from the TB: $4,800
 Net Cost to TB when they Purchase: $335,200

In essence, the TB no longer has to come up with $350,000 when they buy the property, they now have to come up with only $335,200 (plus standard closing costs). And, if the Tenant-Buyer is able to obtain good financing, they may only need to put down a few more thousand to make-up the difference between the purchase price and the mortgage amount. This effectively helps the Tenant-Buyer to get into a home and start building equity right away (it’s like forced savings) instead of having to put aside $500, $600, $700 per month into a crappy (low interest) savings account.

So, why would a renter choose to do this option rather than just saving and buying later or even buying now? Several reasons:

1 – They may not have a large enough down payment today to qualify for the mortgage

2 – Their credit may be damaged and so they need some time to correct it to ensure they can get the best rates and terms available (why pay 10% interest with bad credit today when you can build up down payment credits in a RTO, improve your credit and obtain 5% interest tomorrow?)

3 – They want to get into the home ownership market today because they think houses will be too expensive for them a year or two from now but again, they may not quite have the down payment, credit, or even income to obtain ideal financing today

4 – They may want to “test” being a homeowner. Perhaps the renter has never bought their own home and doesn’t know how much work/costs/time being a homeowner can consume versus being a renter. The RTO strategy gives them a feel for being a homeowner, without having to come up with a ton of cash (for the down payment and closing costs) to buy today.

Now, why would you, the real estate investor choose to use the rent to own strategy?

1 – Helps create positive cashflow on single family homes because you can charge higher than market rents

2 – Essentially locks-in your return should the Tenant-Buyer exercise their option to buy

3 – Little property management required as your TB effectively is the homeowner

4 – Few extra expenses as your TB pays for regular maintenance costs and any upgrades they choose to add to the home

5 – If the TB purchases the home within 1, 2, or 3 years (the standard option to buy term length), you get your capital back and can turn around and invest in something else

6 – Get all the perks of a standard rental property (tax write-offs, principal paydown by your tenants, cashflow) but you also get a built-in appreciation factor (something a standard rental does not have)

7 – If the TB chooses not (or is unable) to buy the property, you retain all the rent credits and their Option fee (they are non-refundable) and your return on investment essentially doubles. You can then turn around and do another RTO with a new TB

8 – Get an immediate return on your cash through obtaining the Option Fee which can often be as much as 50% of the cash you put in

9 – Potential less worry about what the tenants are “doing” to your property as your TB are essentially the homeowners

10 – If you buy smart, little to no work is required to shape-up the house…it’s already in great condition

11 – Feels good to help individuals “get into” the homeownership market

A Look at Real Numbers: Why we chose the rent to own strategy on the home we recently purchased in Kelowna.

Purchase Price: $351,500
Appraised Value: $355,000
2 Year Option Agreement Price: $383,000
Option Fee from the Tenant Buyer: $7,500
Monthly Rent: $2,000
Monthly Expenses: $1,350 (this includes P&I, taxes, and insurance)
Positive Cashflow: $650 per month

So, over the 2 year period, we’ll have earned $23,100 from the Option Fee and the monthly cashflow. In simple numbers, this is a 26% return on our down payment AND it doesn’t include the appreciation built in nor any principal paydown.

Not a bad investment at all, especially considering there will be little we have to do along the way.

One of the things people always say is “What if the tenant doesn’t buy it?”.

It’s a risk (and you should always be analyzing the risk in your real estate deals). But, it’s worth noting that it’s not really a bad thing if the tenant buyer decides not to buy after the 2 year period. At that point we will probably have a bit of maintenance to do on the property and then we will do another rent to own deal on the property. We will get a new deposit, set the new purchase price based on a new appraised value, and we’ll continue paying the principal down on the property with the rent. At that point our return will jump up considerably.

Now, what are the reasons NOT to choose a RTO strategy?

The opportunity to make single family homes cash flow makes this strategy very appealing but it is not for everyone. There are some reasons that a rent to own strategy might not work for you and your goals. Here’s some reasons why:

1 – Smaller population of Tenant-Buyers than regular renters so it may be more challenging to place good, quality TB’s than in a regular rental unit

2 – It doesn’t make much financial sense to pay a property manager to over see a rent to own property given the limited amount of work involved. However, that choice means that it will involved more of YOUR time

3 – If your target market area is in high demand from competitive owner-occupied buyers, you may have more trouble buying good, high quality properties (because there is so much competition)

4 – You have to remember that someone that makes a good renter is not necessarily the same person you’re looking for as a tenant buyer. Your market includes people with bad credit. It also includes people that have gone through some financial challenges because of divorce, job loss or just bad money management. These are people you might not rent to under normal circumstances but you will be considering them as a tenant buyer. Your main concern here is their ability to make the monthly payments. You aren’t as worried about their credit. You want someone that is going to be likely to take good care of the property and can potentially buy it in a few years. You aren’t looking for the perfect candidate that could buy it right now!

5 – If the TB exercises their option to purchase at the pre-set price and property values have skyrocketed since you agreed on that pre-set price, you won’t obtain that large appreciation

6 – It’s still a rental property and somewhat illiquid (compared to stocks, bonds, and other investments).

The Rent To Own strategy is just another tool for your tool belt. It’s not for everyone, but it does make it possible to generate strong cash flow from properties that would otherwise never stand a chance of covering their costs and putting money in your pocket each month.

And the good news is that Rent to Own is really not that different than a standard buy and hold deal.

The tools required to find, buy, place, and manage a rent to own property are similar to a standard Buy and Hold(and so you can apply the principals from one technique to the other quite easily), but this strategy can also give you that “feel good” emotion that comes with helping a prospective homeowner get into the market (and you can profit from that too!).

Published on October 16, 2009

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