Rent To Own – Part One, For Sellers

It’s a tough market right now. If you happen to live in a place where this is not the case, drop us a line and let us know as there might be a finder’s fee waiting for you. If you’re a seller who is trying to unload a place or a buyer who is wary to make a commitment, renting to own might be something to think about. No, I’m not talking about those cheesy commercials that air around Super Bowl time talking about how you can get a new plasma TV for just $29 a week. I’m talking about offering tenants a lease with an option to purchase. How does this work and who benefits? Today’s entry focuses on the advantages and disadvantages to sellers.

The market today is crazy and prices are as questionable as ever. Most potential buyers are holding out to see if prices come down. Sellers who don’t need immediate cash aren’t selling. Most troublesome, many buyers who could get a loan a year ago (or two months ago) can no longer qualify. However, you might be in position where a move or change in employment has forced a sale. Most rent-to-own sellers are folks who have already moved into a new home and are making double mortgage payments while waiting for their old place to sell. Obviously, having a renter come in to help cover the mortgage payment allows the seller to breathe a little easier. But with a lease option, it could lead to a sell that will leave both buyer and seller happy.

What is a lease option(or rent-to-own)? The difference between just having a renter verses a lease option is focused in the option: the tenant purchases an option to buy the house later. This is called an option fee and is usually 1-5% of the purchase price, which is credited back to the tenant if he chooses to buy. The option forces the seller to not sell the property until the tenant decides whether or not they want to buy.

Normally with a lease option contract, the purchase price is negotiated prior to entering into the deal. As the seller, this means you will probably sell your property two years from now at today’s prices. Obviously, this could work for or against you. However, you can include a “right of first refusal.” which means that at the end of the lease term, your tenant will be given the absolute right to purchase your house, but at a price to be determined by you. This alternative essentially equals a win-win for you as the seller.

Typically, a lease option agreement stipulates that part of the monthly rent check is held in escrow for a down payment if the renter buys the house at the end of the lease. If the renter doesn’t buy the house, the seller keeps the escrowed money. The percent to which you negotiate be credited towards this down payment should be determined by your desperation to sell. The standard credit is 33%, but motivated sellers may be inclined to increase this percentage. Since lease options are a great way to get people into a home that otherwise couldn’t due to a large down payment, your property will immediately attract more interest than others. Further, lease option tenants will often agree to top-dollar purchase prices because of the opportunity it affords them: to own.

Additional benefits to sellers include continued income tax deduction benefits, including depreciation, up until the option is exercised and upfront cash from the potential buyer in the form of rent plus the non-refundable option fee money.

The drawbacks? Most obviously, no instant cash payoff. Other than the aforementioned upfront cash, you will have to wait out the lease term to see the big dollar signs from your property. You also must be sure to carefully screen your tenants: you don’t want someone who will tear your house apart and leave you with costly repairs for when you try to sell again. This is my primary concern with the Virginia condo we currently have on the market. If it doesn’t sell by year’s end, we will probably rent it out again. Since we had brand new carpet installed to make it market ready, I’m going to insist we only consider female tenants (The Fair Housing Act does not apply to single-family housing sold or rented without the use of a broker.) Sorry guys, but let’s face it: girls on a whole are just cleaner than boys. There’s a reason men’s deodorant is stronger than the stuff for the ladies. However, lease option tenants typically are excellent tenants who strive to preserve their potential equity, so this might be an option for us.

Be sure to consider the tax implications. If your property has appreciated significantly since the time of your purchase, you are allowed to exclude up to $500,000 of the profit if you have lived in the property two out of the past five years ending on the date of sale. Be sure to consider that the tenant might not buy at the end of the lease and your house may sit vacant again before you are able to sell.

The most important keys to the lease option are adjusting the terms to fit your need to sell, and finding earnest buyers. How can you accurately gauge a person’s sincerity in wanting to buy your home? Bring in a professional: let your dog be the judge. They can smell evil. Stay tuned for “Part Two, For Buyers . . .”