Why RENT TO OWN?

If you have perused my profile here you'll know that RENT TO OWN properties are one of my favorite market segments.  I feel very strongly about this, especially given the current market conditions.

Why?  There are a number of reasons:

We have seen a collective perfect storm in the real estate and construction industries over the last 3 years.  Speculative buying artificially inflated home prices as well as construction costs.  We know that bubble has burst.  So where does that leave us now?

In short, our economy has an abundance of qualified professionals and skilled craftsman that are out of work.  A large percentage of home buyers (most buyers who purchased in this market in the last 5 years) are underwater on their mortgages.  Investors who bought during peak market conditions now find their investments have depreciated or are no longer profitable.  The combination of depreciating real estate values and limited, reduced or eliminated revenue streams means people are having a hard time paying their mortgages.

All these things are factors that amount to a distressed economy.  This means there is a large mass of desperate people unsure of the direction they should take.  Now this is an entry for another day and I promise to cover this topic soon- but there are a number of avenues a distressed property owner can take to find resolution.

The title of this entry is RENT TO OWN and I haven't said a thing about it yet.  Let's get to it!

We know people are losing their homes at historic rates.  Where are these people going?  Some people are moving in with family members while others may find a friend to call roommate.  A large percentage of these people are transitioning from homeowners to renters.  This can be a devastating pill for a family to swallow.  It is not the end of the world, although it may feel like it sometimes.

This is where rent-to-own becomes attractive.  Maybe the client has lost his/her home to foreclosure. Maybe a client has strong revenue resources but damaged credit due to the housing market conditions.  Both can find their way back to home ownership by utilizing RENT TO OWN.  People with damaged credit find traditional lenders reluctant to lend, especially in the case of recent foreclosure.  Some people with GOOD credit have a hard time getting a loan so little opportunity might exist for someone whose credit has been damaged.

In the case of RENT TO OWN properties, decisions are made on an individual, case by case basis and the note holder is not a traditional lender.  Typically the property owner holds the mortgage and can work out a sale price and payment plan that is beneficial to both the new tenant and the property owner.  The property owner is happy to have a tenant in place with a vested interest in the property.  This in theory means reduced risk of damaged or neglected property for the property owner (as is often the case in traditional rental history.)  The property owner also holds the note (consequently the title as well) until the lease and purchase agreement has been satisfied.  This is another plus for the investor/ property owner as they can take back the house in the event of a default.

If you find yourself forced into the rental market, consider RENT TO OWN.  If you are going to be paying rent anyway, I would argue it makes the most fiscal sense to have that rent going towards something you will eventually own.

Let me give you a physical example as to how RENT TO OWN can be more beneficial than the route of traditional lending.  Let's say a single family home is listed for $185,000.  An offer is accepted at $182,900.  The new buyer has gone the route of traditional lending.  They put 3% down ($5,487) and have a 30 year fixed mortgage at 6.25% which puts their payment around $1,100/ month.  Some traditional lenders tend to not like what I'm about to say but I digress.  

If you look at the amortization over the life of the loan you might be frightened by what you see.  I want to look only at the first 10 years of the 30 year note and compare it to the same property on a RENT TO OWN lease over 10 years.  

In the case of traditional lending, you will pay $13,108.35 per year for 30 years.  That's $393,250.50 for an $189,900 home!  Again, looking only at the first 10 years of the traditional loan- that's $131,083.50 paid to the lender after ten years. Of that $131k, $103,119.14 of your money goes to interest on the loan while $27,964.36 of your money goes towards reducing the principle.  103k of 131k in interest...that's 78%!  Seems funny that your interest rate is 6.25% but during this period 78% of everything you pay is going toward interest.  That leaves you with only 20 more years and $262,250.50 worth of payments to go.

In the case of RENT TO OWN the owner of this same home agrees to the following terms with a new tenant- 10% down of the agreed purchase price.  In this instance the owner and the buyer agree to a sale price of $245,000.  Now you may be saying to yourself, well there you go- that's the problem, you're paying 245k for a house that is worth 189k.  It's not quite that cut and dry.  The rent to own buyer and  seller agree to this higher selling price to account for interest and appreciation.  Please see me through to the end of the example! So the buyer has put 10% down or $24,500.  The balance of the note is $220,000 for the 10 year term.  They agree to equal monthly payments- or $1,833.33 a month.  

If you consider that real estate "traditionally" has appreciated at a rate of 3% a year over the last 25 years or so (bubble years excluded of course), what is that 189k home worth in 10 years?  You might be surprised to learn that home is worth $246k if it appreciates 3% every year for the next 10 years! 

Another factor to consider, the original property owner has some risk exposure here regarding appreciation.  What if the real estate market heats up in 8 years and the average appreciation of homes is 5%?  In this case, the new buyer would have paid 245k for a house that is now valued at 293k!  That would mean the new buyer has about $48,000 equity in their home and if they sell- have made 19.5% return on their investment! 

You tell me, which deal makes the most sense to you?