Cash Flow Problem? Use Rent-to-Own (RTO) to Boost to $600+ per month

Invest With Great Returns and for a Great Cause

I attended a very helpful educational Real Estate MeetUp earlier this week. One of the topics covered was on Rent-to-Owns (RTO).

How Rent To Own Works

Investor and home buyer/tenant are the key parties in a rent to own deal. Here are their primary responsibilities:

Investor

Someone who buys a house as a temporary home owner with the intention to re-sell it to home buyer/tenant at a pre-agreed upon price at the end of the rent-to-own term. Investor's name goes on title at purchase. Investor qualifies for a mortgage and is responsible for financing and closing costs. 

Home buyer / Tenant

Someone who moves into the house with the intention to buy it from the investor at a pre-agreed upon price at the end of the rent-to-own term, usually 3-5 years. Home buyer treats the property as his own from the get go and uses the time to build up credit rating and down payment to qualify for a mortgage, buy the house from the investor and become the permanent home owner. Tenant / home buyer is responsible for all aspects of the buy-out at the end of the term.

Benefits For Investor

Rent to Own strategy can be a great way of investing for the following reasons:

• Great Cash Flow when compared to traditional hold & rent strategy
• No landlord head aches - home buyer / tenant assumes all home owner responsibilities and addresses all maintenance issues and repairs. Investor doesn't get calls or complaints.
• No repairs / maintenance - no need to budget for and worry about any unexpected home-ownership related problems, since home buyer / tenant covers them.
• Pre-determined Returns and Cash Flow - no guessing; the return on investment (ROI) is known ahead of time since the future sale price and length of term are part of the contract. 
• Helping a family realize their home ownership dreams and become home owners. 

Benefits For Home Buyer / Tenant

Home For You and Your Loved Ones

From home buyer / tenant perspective, rent to own strategy can be a great way to become a home owner for the following reasons:

• Own a home faster - choose a home and enjoy it before you can qualify for a mortgage
• Equity - build equity in your house before you even buy it
• Down payment - start with a 4-5% down payment, then gradually build up to the required 10% 
• Mortgage Assistance - use time to work with a mortgage professional to strengthen your credit rating and eliminate the risk of not being able to qualify for a mortgage at the end of the term.

Numbers 

Here are the numbers from a case study we reviewed at the meet up based on a recent Rent To Own property in GTA. This deal had a 3 year term with 4.4% annual appreciation used to determine the future purchase price.

Purchase Price: $394,900

Homebuyer Deposit: $16,000

Initial Investment: $78,780 (includes down payment remainder and all closing costs & broker fees)

Future Purchase Price: $450,354

Return from Sale: $43,728 (includes mortgage paydown and credits)

Monthly Cash Flow: $646

Profit from Cash Flow: $23,256

TOTAL RETURN: $66,984 = 28% annually over 3 years.

I hope this post gives you a good initial overview of what rent to own investing strategy does and how it can boost your cash flow. If you have any questions or would like to discuss in more depth, please post a comment in the comments section below.

PS Don't forget there are always cons and risks to any strategy! It might be a good idea to start with a reputable rent-to-own turn key provider if you are new to investing. 

Rent to Own Example - Double the money in 3 years

I attended a wealth building MeetUp today that covered 5 ways of building wealth in real estate:

1. converting a single home into a legal duplex
2. buy & hold 'first-time home buyer' type of property
3. rent to own
4. multi-unit properties, and
5. commercial real estate.

I found all of the material helpful, but rent to own strategy was presented in most detail, so I wanted to summarize it here.

Key benefits of rent-to-own for real estate investors:

- Tenants care about the house and are happy to maintain and/or improve it

- Tenants pay 15-25% more than the market rent monthly, which gives better cash flow

- Tenants provide a non-refundable deposit of 8-15K (3-5% of current house value)

- There is a pre-defined exit strategy with good ROI

- If tenants can't or chooses not to purchase the house at the end of the lease term, landlord keeps the deposit and the house.

Here is how rent-to-own typically works

• Tenant and landlord sign a standard lease agreement for a rental property. This agreement is governed by Landlord and Tenant board rules, so all typical regulations apply and can be used by the landlord/tenant in case of any issues (ex., landlord can evict a tenant for non-payment).
• Tenant and landlord enter into a separate 'Option to Purchase' agreement outlining an exclusive option for the tenant to buy the rental property at a preset purchase price at the end of the lease. Typically, the term of the lease is 3 years and buy-out price is calculated at 5% annual appreciation of current market value.
• Tenant pays a non-refundable fee up front This fee is the price for the opportunity to buy the house in the future. It's called "option money" Typically, the fee is 3-5% of the current property price. 
• Tenant pays rent plus a 15-25% mark-up on top. The extra money is kept by the landlord as a credit towards future purchase. 
• Landlord puts the tenant in touch with a mortgage broker, who works with the tenant on improving his/her credit history over the course of the contract. This way tenant has a better chance qualifying for a mortgage when the time comes.

Example:

Current market value of the house: 400K

Current market rent: $2,500 / month

Tenant pays up front: 3% of 400K = 12K (option money)

Tenant pays monthly:  $2,500 + 25% = $3,125 (includes credit money of $625 / month)

Lease duration: 3 years

Preset purchase price: 400K + 5% * 3 years = 460K

Credit accumulated by tenant:  $625 * 36 = $22,500 

Note: $22,500 is 4.9% of the purchase price of $460K, so the tenant is in a very good position to qualify for a mortgage with 5% down and become a home owner.

If tenant doesn't purchase the house, landlord will keep $12K of option money and $22,500 of credit money.

Suppose tenant chooses to purchase the house. Assuming the landlord originally bought the property for 400K with 20% down, 2% closing costs, and 3.5% 5-year fixed mortgage with 30-year amortization, he/she will receive:

Principal paid by tenant: ~20K 

+ Preset appreciation: 60K

+ Net cash flow during three years: say, $200 * 36 = $7,200

- Less: mortgage discharge fees of 3K.

Total: 84.2K profit. 95% ROI (more than 30% annual return).

Per above, rent to own strategy is worth considering on my path to 50 doors.