One of my favorite techniques for managing a property and profiting off of it is to offer it on a rent to own basis.
There are many advantages to using rent to own as an exit strategy. First you get non refundable option money from the tenant buyer. I have gotten up to $15,000.00 on two different occasions from tenant buyers. Let me repeat, it is non refundable. Compare that to a month's rent for a security deposit. Second I can get an aggressive price for my property. I find the highest comparable properties that have sold in my area, then I take the average appreciation for that area and use that to calculate my price (more on that in a minute). The third factor is that I get the person to treat the property as their own. I treat them like a homeowner so my lease says that they are responsible for all maintenance issues. I live 6 hours away from most of my single family home properties and I don't worry about them and I don't get phone calls. We are finally starting to get more aggressive rents. It was tough when anyone with a pulse could get a loan. We are now finding people that can not get qualified for a loan because lenders are tightening guidelines (the borrower was expecting to pay $1900 for a property) and we are renting the property to them for $1550 when we were struggling to get $1395. The tenant feels like they are getting a great deal.
When structuring your rent to own deals you want to take into consideration your plan for the property. If you are looking for a quick sale I would suggest setting up a one year rent to own and collecting a substantial amount of money down (around 5% or more of the purchase price). The short term gets people working on getting approved quickly and they also don't want to lose out on that money that they put down. If you don't really want to sell the property set it up on a 3 year rent to own and take less money down (3% of the purchase price). In three years life happens to people. They get divorced, break up, get a new job, have more children, etc., etc. Also, if they don't have much money at stake they will forget about it and move on. If you don't care if the tenant buys or not set it up as a 2 year rent to own and get as much money as you can. Some tenants will work on getting financed and some won't. We give them all the resources they need but what they say about leading a horse to water is true.
When pricing a property I use the highest comps (comparable properties that have sold in the area) that I can find and then I appreciate the property as aggressively as I can with the market conditions. I appreciate the property for the period of the rent to own agreement (1-3 years). So for example if the property shows that it is worth $200,000 today, the market appreciation is 6%, and I am selling on a 2 year rent to own here is what the numbers would look like:
- Sale Price $200,000 x 6% = 224,720 (this number is compounded over 2 years)
- Monthly Rent: $1550 (we won't take into consideration the 6% bump in rent that we get after year 1)
- Down Payment: $6,000 (This number is subtracted from the equity of the sale price)
My purchase terms look like this:
- Purchase Price: $180,000
- Monthly Payment: $1300
- Down Payment: $0.00
Total Profit in the deal: $250 a month for 24 months $6000.00 in cash flow, $38,720 in back end profits and $6,000 in up front money for a total of $50,720. That isn't bad for about 10-15 hours work.
I would suggest not going any longer than 3 years on a rent to own. If you do go longer the tenant may try to claim that they have an equity position in the property. If they succeed in claiming an equity position I have to foreclose instead of evict. Foreclosing is a much longer and more expensive process.
The paperwork for this transaction includes a lease document and an option document. You want them to be separate documents so that if you ever end up in front of a judge there isn't an argument that they thought they were buying the house, not renting it.
There is a tremendous need for this type of service right now. There are many people that are going through foreclosure and who can't get qualified for loans. These people still want to live in a home and have the opportunity to own it. The more people that you can serve the more money you can make.
On Monday there will be a post on how to fill your rent to own property quickly for top dollar.
