Rent-to-own might sound like the relic of a distant past, but what’s old is new again. Popular when mortgages offered double digit interest rates and banks didn’t easily write mortgages, these rental options fell in popularity with the rise in homeownership. Now that banks are back to making it harder for buyers to get approved for mortgages, some renters are looking to rent-to-own as a possible solution.
That may make sense for renters and buyers, but what about landlords who may or may not want to sell? Rent-to-own carries a lot of risk for owners. You commit to a tenant, hoping at a certain point in the future, they’ll buy the property. But if they decide not to, they walk away and you’re left holding the bag.
Before you jump into a rent-to-own or lease option, make sure you know how it works and that you understand all the risks.
How Rent-to-Own Works
Popularized in the 1980s and 1990s, rent-to-own is now referred to as a lease option. Typically, the lease option is a long-term commitment between you and your tenant. Your renter agrees to lease the property for a specified amount of time, usually two to five years. After that time, they have the option to buy the property for a price you agreed to when the lease began.
During the rental period, your tenants pay their monthly rent plus a lease option fee. It’s around 10 to 15 percent of the overall rent. If you charge $1000 for the rent, the lease option fee would be $100 to $150 more per month. The funds from the fee are deposited into an escrow account. Once the lease is over, the tenants can use that money towards a downpayment or closing costs. If the tenant walks away from the deal, you keep the cash.
The Risks of Rent-to-Own
Offering a lease option isn’t without it’s risks. At the end of the lease agreement, the tenant can walk away and look for a new home. You’re left with a home you thought would be sold and now have to market it to rent or sell. You might also be left with a nightmare situation where you have to repair and replace what the tenant neglected. Even if the tenants decide to buy, there’s the risk that the property appreciated beyond the price you agreed to a few years before.
There is risk in everything you do. You can’t prevent it, only mitigate it. If you decide to offer the lease option, require the highest lease option fee possible. That way, if the tenants walk away in a few years, you’ll have the necessary cash to take care of the property until you rent or sell it. Also, spell out very clearly what the maintenance and upkeep agreement will be and what the tenants will be responsible for. This can help you later if they leave behind expensive problems for you to fix.
The Lease Option Agreement
Unlike the typical lease agreement, there is no standard language or format for a lease option or rent-to-own agreement. Work with a real estate attorney to make sure your agreement is fair to both parties but that you’re protected from as much risk as possible. Here’s what to include in the lease option agreement:
Security deposit: How much, where it will be, and under what conditions it will be returned or not
Lease option fee amount: Typically it’s one to two percent of the total cost of the home or 10 to 15 percent of the monthly rent
Eviction: Your tenants are renters until they’re buyers. You should have the means to evict for nonpayment of rent and other reasons as you do any other renter.
Fee information: Where is the money being held; how will it be turned to the renters; and under what circumstances do you retain it.
Sale agreement: The agreed upon price, any pre-conditions by seller or buyer, contingencies, and what the seller will pay.
Repairs and maintenance: Who is responsible for what, just like you would include in a standard lease agreement.
Rent-to-own isn’t a common solution for landlords, and it’s not one to be taken lightly. By agreeing to a lease option with a renter, you’re tying up your property for a few years. There’s no guarantee that it will end in an easy sale. The more skin your tenants can have in the game - through the lease option fee/down payment - the more likely they are to keep to the terms of the agreement. In reality, though, you may be giving up the option of a quicker sale when you agree to a lease option. Give it a lot of thought before you jump in with both feet.
If you’re unsure whether a lease option is right for you or you need some help managing your rental properties, work with a team who can answer your questions, keep you legal, and make sure your properties are protected from bad renters and bad lease agreements. ERA American Real Estate can make sure your rentals are marketed, rented, and taken care of so you can focus on what matters most.