Rent-To-Own: To Do or Not To Do?
In real estate investing, there are many strategies for investors to choose from. It all depends on various factors such as your experience level, location, or types of investment property you are choosing. For new real estate investors, strategies like flipping, buy-and-hold, and rental homes quickly come to mind. But there is a strategy that you shouldn’t overlook, especially when you just started with real estate investing, and that is rent-to-own.
Rent-to-own is a great way to build wealth for beginners, while at the same time helping families buy their first houses. Let’s take a look at what exactly is rent-to-own. And when and why you should consider doing this strategy. You’ll also learn the potential risks of this strategy, and how to avoid them.
What is Rent-To-Own?
Rent-to-own is where an owner agrees to lease their property for a period of time (usually a few years), after that period the tenants have an obligation to buy the house at a predetermined price. During the rental period, the tenants will also contribute toward the purchase of the property in 2 ways:
- Tenants pay an up-front, non-refundable fee called the option fee, which is around 3-7% of the total house value. This fee will be deducted toward the purchase of the property when the tenants decided to go through with their decision to buy the house. In case the tenants decided to not buy the house at the end of the rental period, the owner will get to keep the option fee.
- Tenants will also pay an additional monthly rent fee (about 10-15% of the monthly rent), the additional money paid will be put toward the purchase of the house. Essentially you act as a bank allow the tenants to make their payment toward the purchase while living in the same house.
With the option fee, you will make a quick profit at the start of the rental period. Even when the tenants choose to walk away from the deal, you still get to keep the fee, which makes it a win-win situation for you. This fee also benefits the tenants by reducing the total price of the property in the end.
Rent-to-own allows you to easily add cash flow in the form of monthly rent to your investment portfolio. In addition to the monthly rent, the 10-15% rent fee can’t be refunded in case the tenants don’t want to purchase the house anymore. On the flip side, rent fee can be used to pay for the closing costs, which further reduce the financial stress for tenants at the end.
Tenants who agree to do rent-to-own are usually very responsible and will take good care of your investment property. This is because the property will be their future house. This will reduce the maintenance expenses and give you the peace of mind that your property will not likely be destroyed.
The Buyer is Already Here
With a contract in place, you already have a buyer, thus removing the stress of finding a potential buyer through a real estate agent. This alone makes rent-to-own a great investment strategy for new real estate investors. As a newbie, there is nothing worse than running frantically to find a buyer, worrying that it will not be sold. Using rent-to-own, not only you’ll have tenants who are paying you every month, but also willing to buy the property afterward, providing you with a guaranteed profit.
Tenants Are Unable to Buy The Property Afterward
Unfortunately, there is no guarantee that the tenants will be able to afford the property after the renting period. An event such as job loss can prevent the tenants from going forward with the purchase. The tenants will have no choice but to move out, forcing you to find another tenant and start the process all over again. You still get to keep the option fee but seeing the tenants leave behind thousands of dollars is not a pleasant thing to do.
Losing Potential Extra Profits
The housing market is growing fast, therefore your house might not be at the same value 2 3 years from now. So when you set your house’s purchase price when the market is down, you have unintentionally sold your house for less than what it’s worth. The tenant now has the right to purchase your house, regardless of how much the value go up in the future. A bigger profit could be made by selling the house to a stranger
The Profit Comes S-L-O-W
If you are looking to make a fast profit, rent-to-own is not for you. You are better off doing fix & flips, where you can purchase a house and sell it 4-5 months later. Rent-to-own is better for building cash-flow slowly, with securities such as option fee and monthly rent fee.
Rent-To-Own: Should You Do it?
Overall. Rent-to-own is a secured way of slowly building wealth over time while helping tenants purchase their first houses. However, it is not recommended as the only real estate investing method you should use. Before doing rent-to-own, you should consider its pros and cons, and weigh it against other investing methods. And lastly, think about which strategies would best suit your personal circumstances.