: Rent to Own - Lease Option


canuck123
Sep 10th, 2009, 10:59 AM
I own a couple rental properties and have been asked by alot of prospective tenants about a Rent to Own Lease/Option.

For those of you who know how it works, couple questions:

1. How do you determine a price for the house for both parties to agree on. Would we each get a realtor to do a makret analysis...?

2. Is there a set amount they would pay ontop of the rent? i.e. The current rent is $1600, do we have to agree on a certain amount every month ($50 - $400), or could they pay whatever they'd like each month - like an open line of credit? Is this a mush? And would they get this money back if they decied not to pull through with the purchase at the end of the term?

3. The otion fee/deposit, how do we determine this? What % of the purchase price is this usually? I know this is non-refundable.

4. I am going to try and get a 5 year term, but what is the stanard here?


I have done a fair amount of research on this, and there are adv/disadv for both parties, but I believe the landlord/owner has the upper hand usually. I just want to know for anyone who's done this before how it has went for them and their experiences.

Thanks in advance

SINC
Sep 10th, 2009, 11:12 AM
I own a couple rental properties and have been asked by alot of prospective tenants about a Rent to Own Lease/Option.

No experience with this but I do hope you get "a lot" of response to your request. ;)

MLeh
Sep 10th, 2009, 11:38 AM
How well this works depends a lot on the motivations of the buyer and the seller.

You're right - the landlord does usually have the upper hand in these situations. But ...

Are you motivated to sell this property? If you are, it may work, because a lease to buy arrangement means that the owner gets a little less rent, but is selling the property (which may be their prime motivation), while the purchaser pays a little more rent than market rate but is building equity in the property.

You need to determine the value of the property and how much of the rent/lease payment will be accrued to the capital cost of the property.

So, get a realtor or two to give you a market analysis on the property. Generally speaking it's not good to use the property tax assessment value as a guideline because they're not very accurate. And then you have to come to an agreement with the potential purchaser on the value and the date of the valuation. Is the value the value when they start building equity, or is it the value at some later date? In a rising market the equity built will not offset the rise in the value of the property.

Then you need to work out the rate of return on investment on the capital cost. You get to bank the money they are paying extra, but right now money in the bank isn't making a lot of returns which is why a lot of people are exploring the lease-to-own option.

Generally speaking a 'lease-to-own' agreement is for people who are desperate to sell their rental properties, and the purchasers are people who can't save in any other way except to pay it to someone else. In other words: poor credit risks. It is a way for them to get into the market, but not the best way (The best way, of course, being for them to live as cheaply as possible while saving their shekels and then buying, but that's hard for many folks to do). Depends upon the market.

I'd stay away from the option myself, unless, of course, the rental market has tanked and you're desperate to sell.

eMacMan
Sep 10th, 2009, 02:06 PM
How well this works depends a lot on the motivations of the buyer and the seller.

You're right - the landlord does usually have the upper hand in these situations. But ...

Are you motivated to sell this property? If you are, it may work, because a lease to buy arrangement means that the owner gets a little less rent, but is selling the property (which may be their prime motivation), while the purchaser pays a little more rent than market rate but is building equity in the property.

You need to determine the value of the property and how much of the rent/lease payment will be accrued to the capital cost of the property.

So, get a realtor or two to give you a market analysis on the property. Generally speaking it's not good to use the property tax assessment value as a guideline because they're not very accurate. And then you have to come to an agreement with the potential purchaser on the value and the date of the valuation. Is the value the value when they start building equity, or is it the value at some later date? In a rising market the equity built will not offset the rise in the value of the property.

Then you need to work out the rate of return on investment on the capital cost. You get to bank the money they are paying extra, but right now money in the bank isn't making a lot of returns which is why a lot of people are exploring the lease-to-own option.

Generally speaking a 'lease-to-own' agreement is for people who are desperate to sell their rental properties, and the purchasers are people who can't save in any other way except to pay it to someone else. In other words: poor credit risks. It is a way for them to get into the market, but not the best way (The best way, of course, being for them to live as cheaply as possible while saving their shekels and then buying, but that's hard for many folks to do). Depends upon the market.

I'd stay away from the option myself, unless, of course, the rental market has tanked and you're desperate to sell.

Not much to add except if real estate catches an updraft then the buyer can exercise his purchase option and flip out gaining him a quick $20-50,000 with no risk whatsoever. OTH if property values take a nosedive he can bail and buy some other property and all he is out is what he would have been paying for rent.

canuck123
Sep 10th, 2009, 06:23 PM
On a 3 year term, there is no way a property will raise $20-$50K in value, unless they put in ALOT of upgrades. It has alot to do with specific market conditions, but in 3 years, realistically you are looking at a $10-$15K max value.

Sonal
Sep 10th, 2009, 06:39 PM
Don't sell yourself short. Depends a lot on your property and the market at the time.

Back in 2002, I got married and bought a house. 3 years later, I got divorced and sold it. Rise in price was nearly $115,000, which was a 25% gain. We didn't do a thing to it, except replace the A/C when it conked out.

Heck, under current conditions, my condo has gone up by roughly 20,000 in the 2 years I've owned it, and I haven't done anything to it either.

cowasaki
Sep 10th, 2009, 09:40 PM
I have no idea about this subject, but I would get one helluva lawyer.

My primary concern is who pays for something that is broken during the rent to own phase? I suppose that's why you get a good lawyer!

REISkills
Sep 11th, 2009, 02:08 AM
I coach rent to own in Canada, all provinces.

The way to "positively condition" the tenant to be a "home-owner in training" is:

- give them the local tenancy laws - links to the law - tell them you know better than they do, and are not in any mood to debate the law.

- tell them you want people that "Rent To Own" from you to do MORE than the law requires, not LESS, but by law you can not force them to act like home owners.
- Have a Resident Rules sheet that they sign that is not part of the Province Lease
- Tell them keeping the property neat and paying either on time or before rent date will GUARANTEE their option keeping in tact. If they are 1 hour late, they get a Pay or quit.
- If you want to invalidate their (seperate) option to purchase because they were lazy with their payment, that is your business.

The big question is:
What if the tenant does get denied for financing and has done nothing wrong, done his best?
Well, extend the lease, and the option, with higher rent and more option payment!

Rent to own is about HELPING THE TENANT GET FINANCING. Get a mortgage broker involved!

If you have a PITI Payment say $2000 a month, and say market rent is $1500, then consider:
Rent for 12 months = $1500 per month
Extra Monthly Option Payment = $500
Total: $2000

You can avoid a negative cash flow that way.

If you want to protect /reassure the tenant that the property will not be sold, you can record a Memorandum of Option against the title.
If they get a lawyer, that will make you look good.

RE: Exercise Price: The Sales Price can be agreed now or a formula can be used based on a new appraisal.

My thoughts are, use a formula, such as:

"The exercise price is 1.05 times the new appraisal price."

You can stipulate the appraiser at the time of the sale. I recommend the appraiser be a member in good standing of the Appraisal Institute of Canada.

The lender is not going to fund a mortgage much higher than appraisal.

There is more info at REISkills.com for both US and Canadian Lease Options.

I hope this assists all who read it,

Brian Gibbons
REISkills.com :)

canuck123
Sep 11th, 2009, 11:37 AM
Thanks for the response, great info!!

Just a quick question though, you mention serving the tenants a pay or quit notice. Isnt that only in the states? I thought the earliest termination date you can give someone is 10 days, and thats only if they are doing something illegal, otherwise 14 days if they dont pay...

REISkills
Sep 11th, 2009, 04:15 PM
Gee, got my US and CA rules twisted :)

See Information - Rent (http://www.ltb.gov.on.ca/en/Key_Information/STEL02_111478.html)

If a tenant is late with their rent, what can the landlord do?

If a tenant does not pay rent on the date that it is due, the landlord can give the tenant a Notice to End a Tenancy Early for Non-payment of Rent (Form N4). This notice gives a tenant who pays rent monthly 14 days to pay the rent due or to move out. If the rent is not paid, and the tenant does not move, the landlord can make an application to the Board for an order:

* requiring the tenant to pay the rent that is owing, and
* evicting the tenant if they do not make the entire payment by a specified deadline

See the Board’s brochure on If a Tenant Does Not Pay Rent for more information.

If a tenant is often late with the rent, the landlord may give a Notice to Terminate a Tenancy at the End of Term (Form N8) for persistently paying rent late. Daily or weekly tenants must be given 28 days notice and in all other cases, the tenant must be given 60 days notice. In this case, the landlord can apply to the Board for an order evicting the tenant right after giving the tenant the notice.

See Information - Rent (http://www.ltb.gov.on.ca/en/Key_Information/STEL02_111478.html)

canuck123
Sep 11th, 2009, 04:17 PM
yea, I know all that already, its just that you mentioned the 'pay or quit' notice. they have that in the states only, which gives them 3 days... alot better than 14!!

REISkills
Sep 11th, 2009, 05:37 PM
canuck123:

Yes its different.

That is why I like rent to own, with a tight lease and at least 2 months rent as move in option payment, plus rent.

In case of an eviction, you at least have cash to weather the storm!

You generally have vacancy, clean up, other cost. :)

eMacMan
Sep 11th, 2009, 06:46 PM
On a 3 year term, there is no way a property will raise $20-$50K in value, unless they put in ALOT of upgrades. It has alot to do with specific market conditions, but in 3 years, realistically you are looking at a $10-$15K max value.

In Calgary we saw our little bungalow double in price over a 3 year span. Had also doubled over the previous seven. Housing markets can get extremely hot as well as the current ice cold. Only things we did were a partial roofing job, HW tank and a minor bathroom renovation.

Sonal
Sep 11th, 2009, 07:39 PM
REISkills, keep in mind that in Ontario, even with the 14 day notice, most tenants don't actually move out in 14 days. Pragmatically speaking, you can probably count on 2-3 months to fully evict someone for nonpayment of rent, depending on how quickly they get to cases where you live. Even if you act immediately.

If you are renting to someone in Ontario, you can come up with all the agreements you like, but ultimately if it is not supported by the Act, you are going to be SOL if you have to go in front of the Landlord and Tenant Board, as the Act supercedes all other agreements. Be very careful.

Doesn't matter how tight your lease is, leases are largely unenforceable in Ontario.

canuck123
Sep 11th, 2009, 08:37 PM
In Calgary we saw our little bungalow double in price over a 3 year span. Had also doubled over the previous seven. Housing markets can get extremely hot as well as the current ice cold. Only things we did were a partial roofing job, HW tank and a minor bathroom renovation.

It has alot to do with the local market and city developments... In 99% of the markets, (in canada, ontario) houses wont appreicate more than 5% per year, and never ever double their price in 3 years... Congratz though!!

REISkills, keep in mind that in Ontario, even with the 14 day notice, most tenants don't actually move out in 14 days. Pragmatically speaking, you can probably count on 2-3 months to fully evict someone for nonpayment of rent, depending on how quickly they get to cases where you live. Even if you act immediately.

If you are renting to someone in Ontario, you can come up with all the agreements you like, but ultimately if it is not supported by the Act, you are going to be SOL if you have to go in front of the Landlord and Tenant Board, as the Act supercedes all other agreements. Be very careful.

Doesn't matter how tight your lease is, leases are largely unenforceable in Ontario.

You are right, it takes 2-3 months to evict someone, but what REIskills is saying, when you do that Rent to Own option, you have a deposit fee which they pay you which saves you, big time!

Say you have a deposit fee of $2000 (minimum) and their last months rent as a deposit. The first month they dont pay you, you give them their notice - worst case scenario it takes 3 months to evict them. You have last months rent, and the deposit fee to cover those months!!! Good plan sir.

Sonal
Sep 11th, 2009, 09:21 PM
You are right, it takes 2-3 months to evict someone, but what REIskills is saying, when you do that Rent to Own option, you have a deposit fee which they pay you which saves you, big time!

Say you have a deposit fee of $2000 (minimum) and their last months rent as a deposit. The first month they dont pay you, you give them their notice - worst case scenario it takes 3 months to evict them. You have last months rent, and the deposit fee to cover those months!!! Good plan sir.

I would be very careful here.

The Act specifically states that a Landlord cannot hold a deposit greater than 1 month's rent.

So if you end up in the Tribunal with the wrong adjudicator, it is possible that they will determine that this was an illegal deposit and order you to return the money. Now I know that you are positioning this as a deposit against the future purchase, but no matter how well you write your agreement, that is no guarantee that the adjudicator will see it that way. Some of them are good but some of them are truly terrible.

As always in landlord and tenant issues, a really good tenant is much better protection against problems than a really good agreement.

Another way to do this, which we have done (in a somewhat different scenario) is to rent to them at a higher rent for 3 years (or whatever) and then tell them that as long as they are in good standing (rent paid on time, no damages to the house, etc.) you will credit so much of their rent towards their purchase--you could do this by knocking down the purchase price, or putting it towards their downpayment.

We have done that in condo conversions, where we would allow the existing tenant to purchase their own unit, and we credited them with 10% of the rent they had paid to us during the past 5 years. (Provided they were in good standing with us.)

If they disappear or flake out on you, well, you've charged them a higher rent anyway... you just keep that money and rent the place out again.

ErnstNL
Sep 11th, 2009, 09:52 PM
I used to own a rental property and one year the tenants asked about purchasing the property by the same lease to purchase agreement. I was uncomfortable about this type of arrangement, the interest rates at the time were in the 12% range (1980's) and I had a 25 year amortization period.
When I rented it, the buyer's market was poor, the rent was low, just enough to keep me below the capital gains claims.
I felt that if the renter defaulted, they would try to claim their "investment" back as part owners of the property. (Capital investment)
Also, responsibility for insurance, liability issues etc. scared me off. If they can't get a mortgage from a broker, because banks aren't the only way to procure a mortgage, they are a bad risk.
Actually I could have legally been the mortgage holder (lender) but without CMHC to back me up, it was dicey at best. Be very careful. No loose arrangements here.

gordguide
Sep 12th, 2009, 11:14 AM
" ...
Another way to do this, which we have done (in a somewhat different scenario) is to rent to them at a higher rent for 3 years (or whatever) and then tell them that as long as they are in good standing (rent paid on time, no damages to the house, etc.) you will credit so much of their rent towards their purchase--you could do this by knocking down the purchase price, or putting it towards their down payment.

We have done that in condo conversions, where we would allow the existing tenant to purchase their own unit, and we credited them with 10% of the rent they had paid to us during the past 5 years. (Provided they were in good standing with us.)

If they disappear or flake out on you, well, you've charged them a higher rent anyway... you just keep that money and rent the place out again.
..."

Exactly how it's done in SK. Which brings up another point ... residential tenancy are the domain of the province and in some cases the city and without mentioning it, everyone here is citing Ontario law that will not apply elsewhere. No problem with that, but please say so.

eMacMan
Sep 12th, 2009, 02:26 PM
I know one individual who tried this twice in an ice cold market. After repairing the damage the first guy did he got a lawyer to draw up the next agreement. Second guy skipped out in the middle of winter owing 2 months rent. Utilities were unpaid as well. Unfortunately gas was disconnected before the water resulting in burst pipes and lots of water damage as well. Won a judgment but was never able to collect on it.

REISkills
Sep 12th, 2009, 06:48 PM
" ...
Which brings up another point ... residential tenancy are the domain of the province and in some cases the city and without mentioning it, everyone here is citing Ontario law that will not apply elsewhere. No problem with that, but please say so.
This is a good point, always go to a local real estate lawyer expert in evictions. Once you get your contracts in order, you can generally repeat the process over and over, but it costs cash for good legal advice in the beginning. :cool:

canuck123
Sep 12th, 2009, 07:32 PM
I know one individual who tried this twice in an ice cold market. After repairing the damage the first guy did he got a lawyer to draw up the next agreement. Second guy skipped out in the middle of winter owing 2 months rent. Utilities were unpaid as well. Unfortunately gas was disconnected before the water resulting in burst pipes and lots of water damage as well. Won a judgment but was never able to collect on it.


This is just an example of a VERY weak landlord, thats all.