Rent-To-Buy

If Forbes writes something on rent-to-buy schemes in March and then the WSJ puts up a blog entry in November along similar lines, even the stretchiest blogger might have difficulty discerning a trend. But that doesn’t mean it isn’t a good idea. In fact, it would be great if we saw much more of it in this country.

Rent-to-buy means lots of different things to different people. Often, it’s a simple lease with an embedded option to buy the property at a set price on a set date — an attempt to give the buyer a bit of time to scare up a downpayment, and to give the seller an income stream. Typically the option is purchased for cash (1% of the purchase price seems to be standard) at the same time that the lease is signed; generally if the option is exercised, the price of the option is deducted from the purchase price.

Alternatively, rent-to-buy schemes can increase the rental price and apply rent payments to the purchase price: here the price of the option is likely to be embedded in higher rent payments rather than being an explicit up-front payment.

Both schemes, however, essentially just kick the can down the road: at some point one or three years hence, the purchaser still ends up getting a conventional mortgage and buying the property in question. If property prices fall significantly over the length of the lease, then you don’t exercise the option, or you go back to the seller and renegotiate. But if property prices fall after you buy the house, you can still end up owing much more money than the house is worth.

Then there’s a scheme I’ve heard of in Germany. Essentially it takes banks and mortgages out of the picture altogether, and sets up a long-term contract between the buyer and the seller. The buyer pays rent monthly, the house is essentially placed in escrow, and the buyer ends up owning the house after a set number of years paying rent. I like this scheme because it involves buying a house without any debt — and the buyer can even move house and sublease the property, so long as she continues to make rent payments to the seller.

The downside for the seller, of course, is the lack of a big lump-sum payment. But lump-sum payments are overrated, especially if you’re not buying a house yourself. Anybody downsizing from a two-home lifestyle, or intending to rent themselves in future, might find this kind of scheme very attractive, since it provides a steady income and they don’t need to worry about how they’re going to invest the proceeds of the sale.

Buying a house slowly, over time, is a great way of building equity without taking on debt — and it’s also a great way of making sure that you’re spending what you think it’s worth to live in a house, rather than speculating dangerously on future property prices. It’s also a great way of giving renters the same kind of emotional equity in their home — and the ability to make changes and improvements — that are generally the domain only of homeowners. Right now, when a lot of motivated sellers are looking to any possible way to move their properties, might be a very good time for these ideas to gain traction.

Comments

[Tony Petroski:]

Mr. Salmon. Rent to Buy, Lease to Own, Rent to Own is as old as the hills. I don't quite follow the "German" option outlined above. Who is the "seller" in the arrangement? The underwater owner?

The owner who is not underwater can now, and has in the past, financed his side of the deal in a contract for deed with a balloon payment while the buyer assumes the existing mortgage.

Nov 11 03:08 PM

[JeffDB:]

I'm sure there's a niche for that type of financing of a home and it may make good sense in some situations. But it seems like many of the benefits you site are advantages to the renter/buyer, but disadvantages to the landlord/seller.

The no down payment might be no big deal to some "sellers" but others might have a use or need for that money - ie. to pay for a home they are buying.

The ability to modify a home just like a "regular" homeowner but could lower the value of a home and be detrimental to the "seller" should the "buyer" decide to walk.

Not having to worry about a drop in the value of the real estate is obviously an advantage to the buyer, and yet that is a risk that has just been shifted to the seller.

In many cases the income stream might be perfect for the seller, and yet they take on the risk that at some point the real estate values in the area could drop significantly, the renter could just leave, or perhaps even damage the property, or have painted it pink ;) and the seller suddenly loses that income stream and is left with a property in a declining area with a need for capital improvements.

But, I imagine it is a method of "creative financing" that should be included in one's potential arsenal of coming up with ways to sell a property.

Nov 11 03:35 PM

[JohnBinTN:]

Agree with Jeff, 100%. To give a 'renter-to-owner' free reign to have 'the ability to make changes and improvements' would be absolutely stupid. We own our home, I do all the improvements myself (and I think I do good work). But when we moved in 2 years ago, some of the 'changes and improvements' that were done by the previous owners (OWNERS, mind you!) were poorly done, and IMO, absolutely hideous. We liked the house, and I knew I could fix their.... errors in judgment, so we bought at what we believe is a fair price.

The next door neighbor to our previous house painted their house a neon-lime green shortly before we put ours on the market (unsure if they owned or rented). It took 10 months to sell (not sure if that's the reason, but sure couldn't help with curb appeal!)

Good luck to all of these potential new 'landlords' - they're gonna need it!


On Nov 11 03:35 PM JeffDB wrote:

> I'm sure there's a niche for that type of financing of a home and
> it may make good sense in some situations. But it seems like many
> of the benefits you site are advantages to the renter/buyer, but
> disadvantages to the landlord/seller.
>
> The no down payment might be no big deal to some "sellers" but others
> might have a use or need for that money - ie. to pay for a home they
> are buying.
>
> The ability to modify a home just like a "regular" homeowner but
> could lower the value of a home and be detrimental to the "seller"
> should the "buyer" decide to walk.
>
> Not having to worry about a drop in the value of the real estate
> is obviously an advantage to the buyer, and yet that is a risk that
> has just been shifted to the seller.
>
> In many cases the income stream might be perfect for the seller,
> and yet they take on the risk that at some point the real estate
> values in the area could drop significantly, the renter could just
> leave, or perhaps even damage the property, or have painted it pink
> ;) and the seller suddenly loses that income stream and is left with
> a property in a declining area with a need for capital improvements.
>
>
> But, I imagine it is a method of "creative financing" that should
> be included in one's potential arsenal of coming up with ways to
> sell a property.

Nov 11 07:43 PM

[MartyT:]

The laws in Georgia (the state not the country) pretty much make it possible to kick out a renter at any time. I think the courts assumes that a landlord would never want to kick a good tenant out of a home. This has resulted in rent-to-own scams being an easy way to make quick cash and the courts make it easy as pie.

Most rent-to-own scams include a several thousand dollar down payment, a very low monthly payment, and a complicated contract. The victim pays the down payment then after a couple of months receive a notice of eviction for some made up violation (usually something like playing music too loud). The owner keeps the large down payment and finds a new victim.

The laws will need to be modified before rent to own is viable in the USA or at least Georgia.

Nov 12 09:33 AM

[nym:]

"...the buyer ends up owning the house after a set number of years paying rent." With no down payment we're talking 20 or more years here. The contract could end up in the seller's estate.

"...the house is essentially placed in escrow..." Not really: enforcement of the contract might require going to court. The seller would repossess, but at great cost. Unless the German government is the escrow agent and then they might as well get into banking. Hmm...sounds like our GSEs.

Nov 12 02:31 PM

[Thomas Smic...:]

Several acquaintances have done jail time extorting money from "victims" in rent to buy schemes. This has been a notorious (and notoriously profitable) urban scam for many years. It continues.

Nov 13 03:07 PM