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 Nobody Talks About: Three Reasons Rent to Own Investing Can Stink

Julie Broad Real Estate InvestorI’m not being dramatic here. Rent to own deals can be really crappy.

I’m not against them. We still do rent to owns. We’ve done a lot of them in the last four years. We have a training program to help our coaching clients learn how to do rent to owns. However, I am against the fact that I hear nothing but great things about rent to own deals in the education sphere and the reality is that there are some things you should understand before you dive in.

There are some really lousy things about rent to own deals, even when you do everything right.

Rent to own is when a tenant rents your property with the option to purchase it. You set their purchase price at the beginning; they pay a fee (which can become part of their down payment) for the option to purchase it in the future; and a portion of their rent is a credit that builds up over time towards their purchase. There are two approaches to rent to own – tenant first and property first (learn more about property first and tenant first here).

Both approaches generate more cash flow because the tenants are paying a higher than market rent for their property in exchange for credits that build up towards their purchase, and they are responsible for basic maintenance. Also, you typically don’t 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.

When I quit my job, we evaluated all of the options for cash today. Wholesaling requires constant marketing and funnel management. If you’re not constantly finding sellers and buyers, you aren’t making money. Flipping is stressful and higher risk. It also requires you to be consistently working on a flip or you won’t be filling your cash needs. We felt being a realtor would reduce the focus from our own deals and since we were planning to do a deal every month or so, we knew we’d need a lot of focus for that. And property management is not something we really enjoy, so we didn’t want to create a business around it.

That left us with rent to own as the best solution for us.

By changing a few of our existing rentals to rent to own, and adding just a handful of rent to own properties to our portfolio, we were able to boost our cash – with the option fees and the increased cash flow – to a point where we were comfortable financially from our real estate holdings. We also liked the fact that rent to own helps good people get into home ownership. 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.

We like rent to own because if we want to take a month off from working on our deals, we still make money. We can’t say that about any of the other strategies I noted above.

However, rent to own is not a perfect strategy, and I’m not a huge advocate anymore. When we started doing them, I was excited. I loved that we were helping people and making a great income doing it. Four years later, I like it as an exit strategy. It’s a great tool for your tool box but I don’t think it’s a great business model. If you only do rent to owns right now, you will want to read this carefully. Maybe it’s working today but it has some serious challenges. Let me explain why.

Three Reasons Why Rent to Own Investing Isn’t Always Great for Your Business

First, you can’t always do rent to owns.

Market Cycles Impact Rent to OwnThe market conditions have to be right. If you are in a very hot market, you will end up selling your property for quite a bit less than you could have made, had you sold it on the market normally. On the other hand, in a market that is flat or heading downwards, pricing a rent to own in a way that is fair to a tenant and that will still make you money is extremely difficult.

And, even if the market in your area is doing okay; if the overall economic sentiment is poor, people will have a hard time believing the house will be worth the same as it is today, let alone slightly more when you sell it to them in 1, 2 or 3 years.

If rent to own is your only strategy in your business, what are you going to do when the market is not good for doing rent to own? And what are you going to do if your cash flow suddenly drops dramatically because of a market shift that makes new rent to owns difficult and existing ones fail?

Second, it really sucks when someone walks away from $15,000 or more!

If you’re a sensitive person who cares about other people, you’ll never find comfort in the fact that you still make a good profit when a rent to own fails. There’s nothing to celebrate when a family leaves hard earned money behind, even when you’ve done everything in your power to make it work.

Our first failed rent to own weighed so heavily on us. It was a couple that I would have bet my own house they were going to buy their rent to own home from us. They were pretty much the ideal rent to own tenant, or so I thought. Less than a year into it, they walked away from $18,000 in deposit and credits. We tried everything to work with them but their minds were made up. It made absolutely no sense to us why they walked away. We still don’t understand. And it weighed on us. Eventually we came to terms with the fact that we’d done everything we could do to make it work and the tenants understood the contract and still chose to walk. But, coming to terms with something is very different than actually feeling good about it.

The market has softened where we invest and we’ve had more people walk (from their rent to own…and all their credits) in the last twelve months than we’ve had close on their deals. It gets a little easier to swallow, but it never feels good. It also makes it harder and harder to want to do more. I’m less excited about the prospect of helping people with a rent to own because I am starting to see that no matter what we do, we’re only going to help half the people we work with.

Plus, while we explain the potential of a failed sale to our investment partners and we always have a plan B of being able to rent it out as a regular rental if we need to, it still feels like we’ve failed our partners when the deal doesn’t go through. They expected to have their investment capital returned to them in 2 years and that doesn’t happen if the tenants walk. Most of our partners understand and realize their return remains strong despite the failed rent to own, but some of our partners are really disappointed when the property doesn’t turn over. Disappointing someone feels terrible too.

Third, there’s minimal wealth creation in rent to own.

http://www.dreamstime.com/stock-images-flying-dollar-bill-image27023354Rent to own adds cash flow to your business, it’s a great way to sell a home without a sales commission and it can generate a solid return for a money partner but you aren’t getting wealthy. I love buy and hold real estate because you make money with mortgage pay down, cash flow and appreciation. You also enjoy great tax benefits. With rent to own you make money mostly from cash flow. The appreciation in the property largely goes straight to the tenant as you credit their rent and recover their deposit when you sell. The mortgage pay down is always minimal at the start of a mortgage so you never really get much benefit from that. And, the tax benefits are reduced by the fact that rent to own is considered an active business and not taxed the same as regular rentals (which is usually taxed as a Capital Gain/Loss when you sell).

I’ve grown tired of the churn required to run a rent to own business. We did a deal every month because we had to keep the deals coming in to continue to fund our business and make up for the cashflow we lost when one would sell. It’s tiring. I love collecting houses. I am a fan of building wealth and knowing my financial future is secure because I have a monopoly board full of little green houses. With rent to own, we’ve bought some really great houses that we no longer own. It was so much work to find those great deals, fix them up, find and educate the tenants, only to sell the property before we really realized all the financial benefits. I am thrilled I helped some really great people buy a wonderful home in a great area but now I can only drive by and say “I used to own that house.”

I am grateful for the cash flow that rent to own’s give us. It also allowed us to transition from my salary to our real estate business in a much shorter time frame and with fewer properties than a buy and hold strategy ever would have. I’m not against rent to own – I am sure we’ll use it again when we’re ready to exit from a property – but I am not going to pretend it’s the greatest business model ever because I don’t think it is. I think it’s an important tool for your real estate investing tool box. I think it can be a great way to sell a property, help a family and give your business a little more cash flow. I just don’t think it should be the only thing you do as an investor.



1st Image Credit: Julie Broad
2nd Image Credit: © Alain Lacroix | Dreamstime.com
3rd Image Credit: © Nilikha | Dreamstime.com


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