Rent To Own… What does this mean and is it a good thing?
Well, it can mean lots of things since “Rent to Own” is not a legal term, it’s defined by the parties. With so many variables, it’s hard to tell you about how these arrangements work, but here are some overly simplified explanations which will likely give you food for thought.
Rent with first right of refusal to buy
This is usually when one rents a home owned by a private landlord who plans to sell at some point and the buyer wishes to buy the leased properties, eventually. Perhaps the wanna be buyer isn’t ready because they need to sell another home first, or to get their temporary job turned into a permanent job, or any number of other factors. Maybe the seller can’t sell yet because the home is caught up in a legal dispute. Regardless of reasons, usually, the “first right of refusal” means that the seller would put the property on the market, and once they secure an offer, the renter has the opportunity to buy the property under the same conditions – including price.
For the buyer~ The “Pros” of this situation primarily revolve around buying yourself some time to deal with whatever is keeping you from purchasing today – income, assets, debt, credit or other issues. The “Cons” fall into the specific agreement. Will the home you live in constantly be for sale, with hopeful buyers traipsing through every weekend? When the seller says he has an offer, how long do you have to decide if you will buy the home? What if you can’t get a loan? If the property is sold to someone else, will your lease still be in effect? What if the seller never decides to sell? It’s important you understand the agreement.
For the seller ~ The “Pros” of this situations are… well, not much. I mean, if you want to sell now, then sell now. If you want to sell later, then sell later. Why make selling harder by having a first right of refusal built in? A “typical” agreement (if there is one) means the buyer only has to agree to the same terms any other buyer is offering, so you’re not getting any more money, and you don’t have a guarranteed sale. Further, if the wannabe buyer is controlling your property (meaning that they are living in the house), the landlord/seller may not have rights to show the property, or the buyer could deliberately sabotage your sale by damaging the property or making it difficult to show. I honestly don’t know why the seller would agree to a contract that gives the tenant a first right of refusal…. I suppose if it was the only way they could get the property rented, it might make sense. Otherwise, I am just not sure.
A few years back, I did negotiate a deal like this for a renter (Think: Tenant Agency – I represented the Tenant, NOT the landlord/wanna be seller) who thought they wanted to purchase the home they were renting. Their credit was keeping them from being able to purchase at the time. The seller only agreed to it because they were hoping the renter would purchase the property. The renter/wannabe buyer was not able to clean up their credit, and after 2 years they moved out and into a new rental.
Rent with option to buy
It sounds like the same thing, but it’s not. An “Option” is something you purchase, with or without a rental agreement. Once upon a time my dad owned property a developer wanted to buy, IF they could get approval to develop the land. They negotiated a full sales contract on the property, and they paid my dad $100K for a 3 year “option” to purchase the property under those terms. That means my dad could not sell the property to anyone else for 3 years, and during or at the end of those three years the developer either had to buy under the pre-negotiated terms or not. There was no required renegotiation of price or terms, regardless of market conditions, and the $100,000 was my dad’s to keep no matter whether the developer bought the property or not. What happened? At the time the sale went through, the market had increased… my dad felt like he lost a lot of money, the developer thought he got a deal. Then the market crashed…. the developer did not think he got such a deal after all. Approximately 10 years after the sale, the property is just now being developed. Negotiating a contract years in advance is really difficult since no one can know with certainty what market values will be.
In a “Rent with Option To Buy” deal, it would be the same thing. The only difference is someone would be occupying the property during the option period. I have seen agreements where part of the rent was an option fee, or instead of paying a deposit, the amount that would typically be a deposit was used as an option fee.
For the buyer ~ If the market increases and you have prenegotiated a lower price, then you get to purchase a property for less than fair market value. Maybe it will even look like a steal. If the market prices decrease, you may end up losing your option fee so you don’t have to buy an overpriced property. If a buyer plans to get a loan for the purchase, remember that most loans will require an appraisal and they will only loan a percentage of the then current value of the property.
For the seller ~ It’s kind of like the ‘First right of refusal’ – Why would you do this? It’s a gamble on the market… If the market is declining, unless your buyer is planning to purchase in cash (like the developers in the example I cited above) and are willing to buy even if the property is over priced, the sale is not likely to be completed…. but in that case, at least you get to keep the option fee. If the market is appreciating, you may feel like you “lost” money – very much like my father felt in the story above.
Here’s another example of how it can play out… I once negotiated a “Rent with Option” deal a seller in a declining market (Think: Seller/Landlord Agency – I represented the Landlord/Seller, NOT the buyer). The wanna be seller was “upside down” and could not sell for what he owed. The property was vacant and he was struggling to pay the mortgage. The wanna be buyer had credit issues to clean up, and asked for a 2 year option period. For that option, they paid $7000 at the beginning of the lease. The option fee provided a much needed cash infusion for the seller, and a contract for a price above what was owed on the mortgage. After two years, the wanna be buyers moved, having not ever cleaned up their credit. The wanna be sellers lost that home to foreclosure shortly after the tenants moved….but they never had to pay back the $7,000.
There is one other less common kind of “Rent to own” offering that I have seen. This is typically when a large landlord that owns apartment communities offers their tenants a credit towards the purchase of a home if they live in the rental community for a specified period of time, and then purchase a from a specific (likely related) builder later. About 20 years ago I worked at Cascades Overlook, which was owned by the original developers of Cascades (in the area of Sterling now called Potomac Falls). In an effort to create sales for a certain builder (who would in exchange purchase additional lots from the developer), our apartment community offered this program.
There’s really no down side to this since it’s no more than a marketing program. For the buyer, assuming they aren’t paying anything additional to be in this program, it’s nothing more than a coupon….Use it, or don’t. It didn’t cost you anything. For the landlord, in the beginning, it might induce tenants to rent at your community instead of a competitor, and later, if a tenant is planning on moving out, at least they might buy something from a company who might in turn buy something from you. For the seller/builder it’s like “free” advertising. Everybody wins.
So, “Rent to own” – is it a good idea? It really depends on what exactly you mean by “rent to own”. The key is that both parties need to understand each part of the agreement, and think through the pitfalls. Even ‘First right of refusal” agreements or “option” agreements can be good, under the right circumstances.
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Serving Northern Virginia
Disclaimer – I am sorry, for a variety of legal and business reasons, I can not field inquiries from areas outside of my service area of Northern Virginia.