Rent-to-own done right

Many Canadian families are currently locked out of homeownership for varying financial reasons that have limited their ability to qualify for a mortgage or save up enough funds for a down payment. It’s hard to estimate the impact of recent mortgage regulations on the housing market and the accessibility of homeownership, but one can only assume more Canadians will find buying a home extremely challenging this year.

That’s why now may be the time for rent-to-own to finally get its due. Properly administered, a rent-to-own program provides a win-win scenario for both property investors and their tenant-buyers.

Those tenant-buyers are largely misrepresented by those who have little experience in the rent-to-own space. True, many prospective buyers are not able to purchase a home due to restrictions such as bad or unestablished credit, but many of them are new immigrants, self-employed or simply struggling to save a down payment. These are not down-and-out people living on the fringes of society; they’re just people in a suboptimal financial situation who need help securing a sufficient down payment, improving their financial standing (with the help of a mortgage broker) and achieving traditional financing.

The program does not have a one-sizefits- all solution with a set formula, which is a double-edged sword. Rent-to-own is flexible and can be designed to meet the needs of various clients with insufficient down payments or bruised credit ratings, saving a wide array of homeowners from the rigidity of the banking system.

But that flexibility can also be the bane of rent-to-own, allowing inexperienced investors to make critical mistakes that can kill a deal, leaving both the investor and tenant-buyer in dire financial straits. The following are three mistakes commonly made on the investor side of rent-to-own transactions. By avoiding them, you can help ensure that both you and your tenant-buyers get the most out of what can be one of real estate’s most rewarding arrangements.

Asking too much of your tenant-buyer
Make sure the tenant-buyer you select will be in a position to qualify for a mortgage at the end of the lease term. Ensuring that the combination of the initial deposit and rent credits banked each month will result in a sufficient down payment is the first step in setting up a proper rent-to-own arrangement.

When calculating the strike price – the amount the tenant-buyer will be required to buy the property for – you must estimate the sale price at the end of the lease term. If you set the formula for determining the strike price too high, the renter is likely to turn down the option to purchase; if they do agree, their finances might not support a mortgage that large. The property also might not appraise at the higher projected price.

For this reason, it’s vital to pay close attention to market conditions and property selection to ensure the strike price aligns with both affordability and your return goals. Everyone wants to sell their home for the most money, but rent-to-own is a true partnership. You must be sensitive to your tenant-buyer’s financial situation, which is why many buyers opt for rent-to-own arrangements in the first place.

Inadequate communication
Open and clear communication with the tenant is another key to preventing potential future conflict and minimizing misunderstandings. The terms of the agreement should be clearly written out in a legal contract and reviewed by a real estate lawyer.

It’s also advisable to establish some kind of relationship with your tenant-buyers. No one is saying they need to be part of your wedding party, but just as the right mix of consideration and generosity can contribute to ideal renter-landlord relationships, so too can it help keep your tenants feeling comfortable and confident. Yes, these people are legally obligated to buy your home, and establishing a relationship with them is not a requirement of the contract they’ve signed, but the nature of the transaction implies that you care about their well-being. Don’t be afraid to show it.

Insufficient vetting and financial assistance programs
Aside from conducting property market research and due diligence, you need to thoroughly vet your tenant. Some people simply aren’t in a position to qualify and shouldn’t be accepted as tenants, no matter how badly you want to help them or how badly you want the returns.

Working with the wrong tenant – one who backs out of the deal at the end of the lease period – might not seem like the end of the world since the option deposit and rent credits they provide are nonrefundable, but if that tenant walks, you’ll be forced to revise your exit strategy to accommodate the unfavourable situation. Treat tenants as though they were purchasing the home normally, and seek the assistance of a mortgage broker to prequalify the tenant and offer advice about whether it’s too much of a stretch for the tenant to qualify at the end of the lease term.

Throughout the lease term, the tenant has the opportunity to improve their credit, strengthen their employment history and save up a down payment large enough for a mortgage. Helping improve their credit is key. There should be a program in place to help your tenant-buyers improve their credit standing and manage their debts. Without that help, many rent-to-own tenants will remain in the same shaky financial boat at the end of the lease term, which could sink you both.

As the housing market in the GTA has come back to reality and sky-high appreciation is no longer guaranteed, the return to cash-flow fundamentals is increasingly essential. The ongoing mortgage qualification restrictions will provide a new pool of potential clients who may be able to afford premium rent but can’t qualify for a mortgage. This provides a perfect environment to use the rent-to-own strategy to achieve a stable and fixed return over the next several years.

 

PAUL D’ABRUZZO is a real estate investment advisor, industry-leading Realtor, speaker and private performance coach. He and his team specialize in the acquisition, purchase and sale of investment grade property in southern Ontario. Get free, instant access to real estate deals in southern Ontario before the general public and learn how to analyze them quickly and easily, just like the pros do, at investmentpropertyanalyzertool.com

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