Rent to Own Homes: How does work?
Rent to Own Homes
Here are some pointers and tactics for rent-to-own house investors.
The essay outlines how to purchase low, sell high, produce a positive cash flow, and spend as little money as possible out of pocket.
This information is mostly intended for investors. You should not (must not) have any emotional attachments to any of your properties as an investor.
You're in this company to make a fair and honest profit, and you'll sell your home(s) when the time comes.
Your objectives should be to purchase low and sell high, to produce a positive cash flow while owning the property, and to utilize as little of your own money as feasible.
So, how should you go about buying a home for your rent-to-own business?
Keep yourself in your comfort zone. Stay in your native state if you are unfamiliar with the rules and regulations of other states.
If you need to "touch and feel" (see) your properties, keep them within a reasonable driving distance.
Don't travel to specific neighborhoods if you're not comfortable with them, whether they're urban blight or elite luxury. There are several options inside your comfort zone. All you have to do is look for them and wait.
Buy low: Finding a motivated seller is the best way to achieve this. Here are some obvious methods for locating that seller:
1. Look through the MLS listings in your desired location(s) for properties that have been on the market for more than 90 days.
2. Examine public records for foreclosures and/or tax liens.
3. Go through the obituaries in your desired city (s). Perhaps there is a house in the estate that needs to be sold.
4. Look through public documents for divorce filings. A house must frequently be sold to settle a judgment.
5. Place free wanted ads in local publications and on the internet (for example, JSC Rent To Own Homes).
6. Look for a high-growth location with a lot of construction activity.
There will be folks who are unable to sell their houses because builder incentives have attracted all qualified purchasers.
These areas are often quite desired, and there are often motivated sellers who are unable to sell.
Doesn't it seem like an opportunity?
Here's your chance. The individual you will try to locate to rent the property after you buy it is unlikely to be a qualified buyer in the eyes of the builder.
Builders prefer bank-qualified purchasers. Typically, customers looking for a rent-to-own option do not qualify for a bank mortgage. All you need to do is find a suitable tenant or buyer to relocate into that coveted neighborhood.
Allow your good renters/buyers to discover their own rent-to-own homes. If you have a good perspective renter/buyer who asks for your assistance (and you will if you do your job correctly), give them the option to locate their own rent-to-own homes.
You must establish the ground rules, or people will believe you walk on water. It is extremely advised that you establish a working connection with a reputable realtor who will adhere to your ground rules, take your renters/buyers on showings (most houses are listed anyhow), and spare you the hassle of doing this yourself.
Bottom line: If you discover a motivated seller, you should be able to purchase the property for less than the appraised worth.
Sell high refers to the option price you will establish with your renter/buyer in this circumstance.
Keep in mind that if your renter/buyer could qualify for a mortgage today, he/she would most likely not be your renter/buyer. He or she would just buy a property without your assistance.
Furthermore, the renter/buyer is most often a dissatisfied tenant who wishes to become a purchase. In other words, you have a driven prospect who should recognize that you are a businessperson who is entitled to a FAIR return in consideration for the risk you will take to assist them.
Bottom line: your prospect is unlikely to be price-sensitive, and he or she will likely accept any reasonable offer.
A reasonable options price, in my opinion, should be the present appraised value plus a sum equal to the average yearly rate of rising compounded annually for each year of the option period (not necessarily what you paid for the property). Allow me to illustrate with an example:
To begin, attempt to limit all of your option periods to one year. It works in favor of the seller/landlord. Assume you own a property worth $150,000, and prices have risen by an average of 8% in the last year.
Positive cash flow is defined as the amount of money received each month minus the amount of money spent each month.
You obviously want it to be a positive number.
1. First, consider ways to reduce the amount of money you spend each month:
Your mortgage loan consists of: You may put a significant deposit down to reduce your monthly payments, but this is not advisable.
Finding a reputable lender who is ready to work with you is the finest thing you can do.
They are present. Because a reputable lender recognizes that you will bring in numerous deals, most up-front fees should be considerably lowered, if not eliminated.
You should be allowed to borrow up to 90% LTV amortized over 30 years without needing to acquire mortgage insurance.
You should avoid fixed-rate loans with high-interest rates. You want to sell the property quickly, thus a 30-year variable rate loan with a fixed interest rate period of 3 or 5 years will be far superior.
In this example, we borrow $135,000 at 5% interest for 30 years. That works out to about $725 per month (principal and interest).
We also pay $300 per month for taxes and property insurance.
The tenancy: Your tenant is more than simply a landlord. He/she has the legal right to become the owner of the house.
As a result, the renter should acquire a sense of ownership and be responsible for the majority of minor maintenance concerns that come with any house.
Get a reputable real estate attorney and an accountant to help you with ownership.
They should be able to explain the benefits and drawbacks of personal vs LLC ownership, including liability concerns.
This will assist you in determining the degree (and cost) of insurance that you will require.
2. Now consider ways to raise the amount of money you receive each month:
Here's a little-known fact: more than 90% of people who get into a rent-to-own arrangement do not exercise their option after one year!
Do you recall how I mentioned you should strive to keep all of your contracts to one year?
Aside from giving you more control over your finances, this little-known truth may be quite beneficial to you, the business owner.
Please remember that if you have a good renter who is unable to exercise his or her choice, work with them.
You should renegotiate a second year to your advantage, but not to the detriment of a good renter.
OK, here's what you should think about:
Using the preceding example, a reasonable contract might provide for an option consideration of $8,000 (to be fully applied toward the down payment upon exercising the option) and a monthly rent of $1,100 per month, of which $100 will be applied toward the down payment if the monthly rent is paid on time.
After one year, presuming that all rent payments were made on time, the tenant/buyer will have amassed $9,200 in credits ($8,000 + $100 per month).
If the option is exercised, the actual monthly rent will be $1,000. If the tenant/buyer fails to exercise the option for whatever reason, the contract states that the $9,200 is forfeited.
Offer the tenant/buyer more credits in return for a higher monthly rent to enhance your cash flow.
For example, in exchange for $1,300 per month, provide the renter with a $400 rent credit for each on-time payment.
It may now be regarded as a monthly net rent expense of $900, with total equity accumulated of $12,800.
If you present this appropriately, you may be able to persuade the renter to pay a higher rent! If you correctly acquire the property, you will have a lot better cash flow and still make a fair profit if you exercise the option.
If the option is not exercised (and there's a good chance it won't be), you get to retain all of the rent money.
But, once again, bear in mind that if you have a nice renter who is unable to exercise his or her choice, work with them.
You should renegotiate a second year to your advantage, but not to the detriment of a good renter.
Use as little of your own money as possible: With attention and patience, you may acquire property for less than the appraised worth.
Rather than paying the decreased price, pay the appraised worth and set aside the difference for, say, renovation.
Please accept this money in the form of a bank cheque. Assume, in the above scenario, that you are able to negotiate a purchase price of $140,000.
Inform the vendor that you will pay $150,000 and that they must provide you with a bank check for $10,000.
You will now finance 90% of the $150,000 purchase price, which is $135,000. A down payment of $15,000 is required.
Because of the $10,000 allowance, your true out-of-pocket expense is $5,000.
In summary, we will assume that the tenant/buyer takes advantage of the extra rent credits, pays all rent payments on time, and exercises the option after the first year.
Using the above example (which is based on a composite of actual deals) and excluding incidental fees.
Here is the deal:
1. $17,300 in cash spent ($5,000 out-of-pocket down cost plus $1,025/month P.I.T.I.).
2. Received cash - $23,600 ($8,000 option consideration plus $1,300 monthly rent).
3. obligation on mortgage: $135,000.
4. Sale proceeds of $149,200 ($162,000 minus $8,000 option consideration minus $4,800 rent credits).
Cash flow profit = $6,300 ($23,600 - $17,300).
Profit on selling = $14,200 ($149,200 less $135,000).
The total profit is $20,500.
$20,500 profit divided by $5,000 out-of-pocket expense is a 410 percent return in one year!!!
It can only get better if the renter does not exercise the option.
