Author Topic: ethical "rent to own" deal?  (Read 4457 times)

Mr Mark

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ethical "rent to own" deal?
« on: August 20, 2014, 06:38:50 PM »
Wondering if anyone on the forum has done a successful and what id consider ethical rent to own deal, or technically a lease option, of some flavour.

House would sell for 55 ARV, and rent for 800.

Could possibly pick it up for say 40k, the flip to a renter who wants a path to buying. Perhaps get a 5% deposit.


babysteps

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Re: ethical "rent to own" deal?
« Reply #1 on: August 21, 2014, 10:14:26 AM »
Apologies on a very long response, hopefully it will be helpful (at least some of it!).

We have done many rent-to-own deals as the owner/landlord (functionally, as a lender).  PLEASE check your local regulations first, both for rental registration/zoning/etc and for rent-to-own laws which can differ by state.  Not sure it's worth the brain damage if you are looking at only one (or two or three) deals.  But it is potentially a great income stream!

How ethical a rent-to-own deal is will depend both on the deal terms and on how you as the seller choose to enforce those terms.  We have heard of many rent-to-own sellers whose terms and enforcement are strict enough that almost no-one successfully buys a home from them - nothing illegal, but may not meet your definition of ethical.

Conceptually, we aim for a monthly payment that is competitive with local rents, plus a small "own it" premium.  Usually this means the client is paying a (fully disclosed) premium to what a cash buyer would pay for the home.  Generally we buy scratch-and-dent houses and rent-to-own to clients whose credit is also scratch-and-dent.  We sell the homes as-is, the client does the renovation.  Client needs to have good personal references, a legal source of income that can support the payments, and fix-it skills (personally or within their family).  Depending on the situation, we will consider paying for some materials for fix-up if the client is doing the work (generally not more than $4,000 or so)-this is worked into the terms of the deal; we always explain what the payment would be without any fix-up$ so the client understands what they are signing up for. 

Many other folks who do rent-to-own focus on contractors or investors, not end-users, and do *not* finance any fix-up activity.  Our aim is as much to create for-profit (for us) sustainable (for everyone) housing security (for client) as it is to maximize profit, your view may well be more strictly focused on profit.

We typically structure as a 15 yr lease (sometimes 20, if rent-to-owner wants lower payment) with a separate option that specifies a "buy out" price each year - basically tracks what the principal owed would be if the deal were a mortgage not a rent-to-own.  We classify any "down payment" as an option fee (there are other choices).  Biggest accounting risk as I see it: *if* the buyer doesn't buy us out early and fulfills most or all of the lease (buy out is well below comps), we would likely have to reclassify as an installment sale rather than rental income followed by a purchase.  Our lease payment is calculated to include property taxes and insurance for the home (but not contents), and can rise if those rise.  We have been using this structure intensively for about 3 years now, and I would guess most of our clients will either buy us out early or exit their lease early (without completing a purchase), so that accounting restatement risk may not be as big as you think *if* you mostly have low-working-class clients as we do.

If a rent-to-own client is more than 30 days late in payments, we are not obligated to honor the option but we may choose to. 

We sit down and explain everything in plain English, then read through the entire lease and option with the client and answer any questions.  Some clients are no-hassle, others are self starters but want a lot of feedback during renovation, some crash and burn quickly in which case they sign a release and we bring someone else in.  Even with references it is hard to guess which type of client someone will be until they actually get in the house.  If you don't mind property management and a bit of social work, this can easily support you and create a solid, long-term cash flow.  Otherwise it could be more hassle than the cash makes up for.

Mr Mark

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Re: ethical "rent to own" deal?
« Reply #2 on: August 21, 2014, 02:52:10 PM »
Thank you for the thoughtful reply.

15 yr lease. Wow. Most of the other stuctures ive looked at are like 2-3 yr option periods. I was hoping for a 5 yr term, perhaps with some kind of optional extention.

I figure by leveraging a quick clean cash offer I can get it for 40, sell for 55+, get a non refundable 5k deposit, and 900 a month rent, with a 150 per month refundable credit after 1st year rent paid. Tax and insurance is 2k yr.

by getting a well vetted wanna-be owner in there, I'd expect lower maintenance plus zero vacancy rate, minimal PM issues, all of which boosts COC returns. You can do the math on the above.

I also intend to work with the community group, who have a legal advice arm, and will likely help select a worthy tenant/owner and support with deposit, budgeting,  etc etc. I'll keep them involved to create a transparent win win for a good family, yet still protect the investor. Area is rising. Likely cap gains in 5 years could be 50%+, which would help assure a financing deal later.

usmarine1975

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Re: ethical "rent to own" deal?
« Reply #3 on: August 21, 2014, 03:13:03 PM »
Nothing personal on either side.  For myself I wouldn't sleep well doing this.  It takes advantage of someone not necessarily in a good financial situation.  Many that I have seen with this market approach never actually sell the property.  They get a higher payment monthly because of the rent to own and end up moving to another client to do the same thing over.  If you want to help those with financial issues get into a home it's my opinion better options exist.  Rent to Own is only really good for the individual doing the sale.  Again just my opinion, I consider it on the same level as the car dealerships that will offer credit to anyone.  Anyone with any financial sense wouldn't Rent to Own.

Disclaimer I have invested in the Lending Club so I guess in a sense I am doing the same thing just in a different model.  Higher interest rates on those that can not get other loans at lower prices.  Might have to reconsider that investment. I have a very small amount invested with them but still something to consider.

Was interesting to read the methodology that you use.  Thanks


sammybiker

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Re: ethical "rent to own" deal?
« Reply #4 on: August 21, 2014, 05:02:27 PM »
Great reply babysteps, thank you. 

Would you mind going through a recent deal, including numbers?  In addition, what area of the country are you using this method?

Great post, lots of information, looking forward to hearing more.  Thank you!

Mr Mark

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Re: ethical "rent to own" deal?
« Reply #5 on: August 21, 2014, 06:57:09 PM »
Usmarine

well, exactly. It has a terrible reputation.

BUT

If there is a family who are supported, motivated, and just truly need help, such a deal would help them tremendously, in that the deposit and rent credits would be there, the property would be maintained, taxes would actually be paid, and appreciation would be high probability.

Ethical.

Yes, as an investor it looks pretty awesome if the tenant is supported and can meet rent. If they can close the option, you get your money back, nominal,  plus 9k. If they default, you keep the house, the 5k deposit, and 2k in extra year 1 rent.

usmarine1975

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Re: ethical "rent to own" deal?
« Reply #6 on: August 22, 2014, 06:57:22 AM »
I guess I should give a little background on why I think the way I do regarding lease to own.  I have a family member that did use the lease to own.  Basically they borrowed money on this home which they were renting to fix up the one they now live in.  In essence it put them in a place with the 2nd mortgage in which they can't really afford to sell or put any money into the property they rented or leased to own.  Nominal Rent rates are also to low for what they owe on the property.  And in their opinion the 2nd mortgage needs to be paid by the 1st property even though the money wasn't used on that property. 

So they found a family couple kids divorced situation, and money trouble.  Essentially they couldn't get credit.  They started out fine making the more then normal rent payment because of the lease to own agreement.  It worked for a a year or so not exactly sure on the time line but in the end it did not.  The couple was horrible at managing money and they didn't clean or even try to keep the property in good condition.  (they literally destroyed it)  Plaster was pulled from the walls, I mean it was horrendous which I have seen before with just a rental tenant.  Needless to say it was a couple of months without payments, constantly late payments, and a precarious situation in which my family member kept making allowances etc... for the intended purchaser.  It went sour they were evicted.

I helped clean out the place and let me tell you the crap that these people had is just beyond understanding.  I got my bike and my wife's bike from this house as my family member wanted nothing.  Computers were left, clothing, dog crap, food in the carpet, damaged cabinets, and furniture.  A 3 yard dumpster could have been filled.  Another family member is still sorting the stuff to try to get what is valuable.  In the short they had to replaster walls, paint the whole house, fix cabinet doors, remodel a bathroom, clean up the basement, and get rid of a ton of junk. 

I don't doubt some good people with bad history exist.  I have a tenant that went into foreclosure about 7 years ago and they have been great tenants ever since.  The moral of the story is the same as a tenant you need to pick your person wisely or it could go south.  And when it goes south it goes in a hurry.  I just had a friend call me letting me know one of his properties has been condemned by the city.  The tenant moved in 8 months ago after he renovated the property and it now needs renovated again.  He is going to let the City take it over for unpaid taxes.  (LOCATION is the issue)

I don't say these things to scare you but to warn you.  The most important thing when considering a property is the LOCATION.  The 2nd most important thing is getting a GOOD tenant or lease to own recipient.   GOOD LUCK.

Mr Mark

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Re: ethical "rent to own" deal?
« Reply #7 on: August 22, 2014, 08:01:15 PM »
Thanks for the honest and detailed reply US MARINE

I will take what you said into account. Like I said,  I don't really want this deal.

But if I can get a 3rd party investor who is ok with some good numbers and insured downside... wecan allmake some money.

Blindsquirrel

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Re: ethical "rent to own" deal?
« Reply #8 on: August 22, 2014, 08:21:40 PM »
 I have sold one house out of a half dozen where folks did rent to own. All of the folks who paid an option fee and did not buy the house did not get their finances in order as I ask that they buy the house with a regular loan, the purchase price is 10% under the appraised value. (We only buy foreclosures in need of repair). The guy that did buy his house got a heck of a deal and is happy to this day and sends me Christmas card. ??? whatever, we made 40K on the sale anyway. I have tried to get long term tenants to buy their houses and they bloody will not do it!  Have 2 tenants that have bought the GD house for me 1.5x over and could buy the house for less than half of the rent- also they are getting a steal on rent vs the market.  My view is it is a fine way to find tenants a tad better than average but a poor way to sell a house.

usmarine1975

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Re: ethical "rent to own" deal?
« Reply #9 on: August 22, 2014, 09:33:13 PM »
Anything I say should not be taken offensively. My view is limited to what I have seen and experienced. Certainly good people do sell homes this way.  Like any business the bad ones also exist. Its just not a path I have chosen. I also don't flip homes. I buy for the long term. Its what I am comfortable with.

Weedy Acres

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Re: ethical "rent to own" deal?
« Reply #10 on: August 29, 2014, 07:57:06 PM »
I've never seen someone with "scratch and dent" credit have $5K to put down on a house.  So don't count on finding that sort of windfall on a rent to own.

babysteps

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Re: ethical "rent to own" deal?
« Reply #11 on: August 30, 2014, 03:10:50 PM »
sorry for the delay...haven't been on line much lately!

We live in the Southern Tier of NY State (roughly Binghamton to Hornell, also includes Bath, Corning, Horseheads, Elmira, Owego).  The median house price in our county is roughly $76,000 (yes, you read that correctly).  There is relatively little national bank lending activity.  In the last real estate boom prices didn't go up much here, and they didn't go down much in the crash - market is stable to a fault.

Here is an example of a recent deal:
3 bedroom, 1.5 baths, 1,416sf, built 1920's
tax assessor's opinion of market value (think of as an ARV figure), $62,796
nice school district, okay neighborhood, less great block

Short sale.  Bank had approved a deal, but buyer's lawyer was unwilling to close due to a small title issue (which our lawyer was able to cure to our satisfaction).  Listing broker called us about 13 months after we'd initially looked at the property and asked if we could close before the approval expired (about 4 weeks at that point).  That's the only time this has happened, but most properties we purchase are between $10,000 and $25,000 acquisition price.

our purchase price $18,500; total due at closing (atty fee, transfer taxes, etc) $19,546.13
rent-to-own client gave us $4,000 option fee (this is a bit unusual, sometimes we get one month down or a nominal amount, but the wife's Dad wanted to help)

lease 20 years $900/month, this includes the up to $8,000 available for repair money (so far they have used about $6,000).  If they use less than $8,000 in repair money, that in effect shortens the term of the lease slightly.  We pay property insurance (structure only, clients need renter's insurance for personal property) and real estate taxes (roughly $2,200 per year currently).  The monthly payment increases when taxes or insurance go up.

Signed lease same day as we purchased the property, mid-July.  First payment due Sept 1st (we often give a payment holiday until the target move-in date).  Already have received said 1st payment.

If they use all $8,000 in fix-up funds and pay on time each month, at the end of the lease we give them the deed and they own the house free and clear.  This is spelled out in the option agreement.

Option buy-out schedule is most similar to a mortgage for $83,000 at 6.63% interest or so: year one, $83,000; year 2, $82,000; year 3, $81,000 and etc. down to year 17, $36,000; year 18, $28,000; year 19, $12,000; year 20 (before final month), $5,000.  Our implied interest rates vary based on risk (both credit of client and condition/location of property) and amount of capital gain; this interest rate is toward the low end of what we have done; some range as high as 11%.

We allow lump-sum pre-payments and redo the "amortization" for such pre-payments but do not change the monthly payment (so shortens the life of the lease).  Option expires if client is more than 30 days late with rent at any time.

Clients are a 20-something married couple with one child.  Husband has a steady job at a local manufacturer.  Wife works part time as a nurse's aid.  Wife's father is a contractor and will do anything to help his grandson.  They have repaired the roof, re-done all interior surfaces (new floors, new paint, some new drywall, all new ceilings), new water heater, etc. and spruced up the exterior landscaping.

sammybiker

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Re: ethical "rent to own" deal?
« Reply #12 on: August 30, 2014, 05:29:11 PM »
@babysteps, thanks for the detailed breakdown.

I just got back from 33hour fly in/fly out visit to my area of operations, met with a local mortgage broker that sets up lease options in the area - screens leasees, works with them to build credit over a 24mo term and ultimately arranges conventional financing at the end of the 24mo lease term.  In return, they purchase the property at top market value while making a monthly lease payment, of which 15% goes towards principal.

They pay repairs/maintenance, I pay taxes & insur.

Needless to say, in 33hrs, I walked through and put under contract a solid small ranch in a great school district that almost has enough meat for a retail flip but will make a great first "lease-option-flip" project.

I pulled in some private money on this one...they are excited to be making 9% annual (which I pay out of the lease payments - interest only, balloon payment after the end sale)...and I'll have a nice profit in 24mo (really 30mos, giving time for renovation, lease installation, conventional financing & close) with none of my own monies into the deal - oh and I'll cash flow a bit every month on top of everything. 

Numbers:

28k acquisition
2k holding/misc
10k reno

40k all in - funds provided by private money, paying 9% annual ROI (interest only payments of $300/mo - balloon payment after sale).

Leasee to pay 2.5k non-refundable deposit + $700/mo.  I nego'd w/mortgage broker a 25/75 split (he accepts 1.9k fee, I keep remaining as damage deposit)

This property could go on the MLS today at $62k, likely sale @ 55k as per recent comps.

This market will lease-option for $65k and we'll have people knocking the door down trying to get in.

I look forward to updating as the process moves along.

I'm continuing to purchase great single family properties for long term RENTALS in this area.  Along side, in a separate swim lane, I'll get creative and go after these sort of deals, putting two parties together with a healthy spread in the middle.  And it can be scaled :)
« Last Edit: August 30, 2014, 05:41:18 PM by sammybiker »

sammybiker

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Re: ethical "rent to own" deal?
« Reply #13 on: September 03, 2014, 07:43:33 AM »
A good article on getting lease options right by partnering with a mortgage professional.

http://www.biggerpockets.com/blogs/1226/blog_posts/8749-the-lease-option-magicians

Mr Mark

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Re: ethical "rent to own" deal?
« Reply #14 on: September 03, 2014, 08:50:05 AM »
Nice link - thanks!