Rent to own home? Good, bad, ugly?

[MotoSook]

The wife has a former co-worker who is very interested in our old house. They want to rent to own with a $10,000 down payment, and they would take care of all upkeep except for home insurance related issues. The husband is an out of work carpenter and as part of the deal, he will trade labor to build our guest house. Not sure about this yet, but might as well get some opinions.

The are short selling their current house (more expensive home than our house and they are upside down) and will probably not be in a good positon to get mortage fianancing anytime soon. This stirs my spidey sense. Would they be responsible to our contract? If not, I don't want to go through the legal mess to termiante and evict.



What could go wrong? Any successful RTO experiences here, as renter and rentee?

[Hard-Deck]

BAD. Either rent it out or sell it. If a person cannot buy a house now but wants to PRETEND to buy it's financially risky for you.

[turbo6bar]

I see a little upside and a lot of downside.

If he's out of work, assuming he's not independently wealthy, he's not in a position to trade labor. They need flexibility and fixed expenses. What if the husband gets a job in another county? Renting gives flexibility. Later, they can buy a house.

If you work past the issues, consider their income. Can they handle the rent easily? Check the credit report.

Lastly, if you are not interested in the legal hassle of terminating the lease/option and kicking them out, you shouldn't enter the agreement.

I realize selling a house isn't easy these days, but be careful. Don't make someone else's problems your own.

[MotoSook]

Still want to hear more about rent to own, but what's to be concerned about if we simply rent to them or someone else?

ETA: I'm pretty busy these days and don't had time to be a landlord. I can't see making a profit if I farm everything out...things that need fixing amd such at the house.

[jyl]

I guess there are various ways to structure a rent-to-own.

I think of it as, if the renter pays something above market rent for the right to buy the house at a given future time for a pre-agreed price - an option to buy.

The renter would probably want some portion of his past rent to be credited toward the purchase price. He should pay more for that, as it equates to him paying less for the house - see below.

The renter cannot be compelled to buy at that future time. He has the option to buy, which he'll exercise if it is right for him. If he decides not to buy, all the owner gets is the rent that has been paid to date.

Seems to me, best to consider the "rent" and "option" issues separately.

#1. Sell, or rent it out. Depends on whether the market rent, net of all costs (management fee, insurance, maintenance/repair, vacant periods, cost to evict, etc) exceeds the return you'd get from selling the house at the market price, net of costs (commission, seller costs) and putting the money in low-volatility, low-risk investments. There are considerations of tax too - everything has to be figured in after-tax terms. Simplified example ignoring taxes: If you think a low-risk investment returns 3%/yr and the house would sell for $300K net of costs, 3% is $9K/yr, if market rent is $12K/yr net of costs, then renting looks better.

#2. If rent, sell an option to buy? Simplest way is to figure out what the option is worth to the buyer, then charge him at least that much. Suppose it is a 1-year option, there is a 50% chance that in 1 year, the currently $300K house's market price will go up by +$15K (+5%), and 50% chance it goes down -$15K (-5%), and the strike price (purchase price) is $300K. The buyer has 50% chance of making $15K (pay $300K for a house worth $315K) and 50% of losing nothing (don't pay $300K for a house worth $285K). The option is worth, more or less, $7.5K = 50% x $15K + 50% x $0K. So you want to be paid over $7.5K for the 1-year option. Well over - because you're giving up something worth $7.5K, so if you sell it for $7.5K, you're making nothing. Note that the option price is pretty expensive relative to the rent.

#3. The above does not include any portion of the prior rent being credited toward the purchase of the house. If you do that, you're effectively selling the house for less - reduce the strike price accordingly, and the option price needs to go up. Suppose 1/4 of the year's rent ($3K = $12K x 0.25) is to be credited toward the house purchase in 1 yr, that means strike price is $297K = $300K - $3K. So the option value is $9K = 50% x ($315K - $297K) + 50% x $0.

Bunch of other considerations too.
1) I don't know tax, which may be a big deal. Also, if no broker commission gets paid should the renter exercise the option, that could be a big deal.
2) There may be local laws regulating this? Not sure.
3) You'll want a well-drafted contract, so factor in legal fees.
4) I assume you'll hire a manager/maintenance company so there'll be no midnight ''toilet's clogged'' phone calls. Also assumes there is sufficient security held, and insurance maintained (w/ the right terms) so that you will be literally indifferent if the renter damages or burns down the house.

Caveat: I'm not a real estate guy, the above is just how I'd think about it.

[cstreit]

Souk, gonna put on my paranoid hat here...

1. Can you boot them if they don't pay the rent?

2. What if the guy gets a new job. How many years will it be before he finishes your folks new house?

3. What happens if he doesn't finish the house. Will another contractor wanna pick it up?

Seems like a good situation IF he keeps his end of the bargain. Will he? You sure?

[sc_rufctr]

Originally Posted by Snapper33

BAD. Either rent it out or sell it. If a person cannot buy a house now but wants to PRETEND to buy it's financially risky for you.

Really the best advice. They may be nice people and all that but don't let that influence your decision.

Do the best (safest) thing for you and your family.

[techweenie]

This is also known as a "lease option to buy."

I turned one down on a house I was selling because I got a bad vibe from the buyer, and he wanted to make alterations to the house that would have reduced its curb appeal.

Real Estate Lease Options - Do your homework!

[Evans, Marv]

Doesn't sound good to me. I agree with either renting it or selling it, but not to them. Why? Beause they are friends/acquaintences, and if anything negative happens, they'll feel entitled to special consideraton. I'd tell them I don't want to enter into a business agreement with friends.

[Laneco]

Bad.

I know or have seen probably 8 or 10 examples of "rent to own" and absolutely ZERO of them resulted in ownership. The result of each of them was the "buyer" doing modifications and treating the house as if they owned it, then never buying it and leaving the real owner with undesirable or not-to-code modifications.

If the house you are selling cannot be financed, that's a different story. Effectively do an owner-carry with a high interest rate and all the down payment you can get. But if it is a financeable house, then either sell it or rent it.

angela

[MT930]

Originally Posted by Snapper33

BAD. Either rent it out or sell it. If a person cannot buy a house now but wants to PRETEND to buy it's financially risky for you.

Yea pretty much sums it up.

If you want an income stream Rent.

If you need the cash Sell.

[turbo6bar]

1)The husband is an out of work carpenter and as part of the deal, he will trade labor to build our guest house.

This more of a handshake type of deal, I suppose. What if you don't like his work? What if he, as Chris suggests, finds another job and puts you on the back burner? If things go well, it could be great, but if things break down, it could be pure heil.

2) Would they be responsible to our contract? If not, I don't want to go through the legal mess to termiante and evict.

They are given a period of time over which they may exercise the option to buy the house. They aren't obligated to buy the house. At the end of the period, you can renew the lease/option with more option money, renegotiate the rental rate, or kick them out. The fact you don't want to go through the legal mess to terminate and evict is worrisome. It indicates that you may not be willing to take action to protect your best interest(s).

Think of lease/option as two contracts. You have a rental contract, and a contract covering the purchase option. If they don't live up to the contract, and they don't leave, you can evict. What you don't want to do is give the impression they own the home and have equitable interest. Then, you cannot evict.

Like I said before, screen them like any other prospective tenant. Credit check. Review income. If they pass that screening, AND they are willing to give you $10k in option money, I'd seriously consider them.

Coming at this from a pessimist point of view. If it passes screening, and you can get contracts written properly, go for it.

[john70t]

(disclaimer-I know little about these laws. I knew a guy who did a land-contract and resold the place a few years later).

The good:
-Big down payment/security deposit.
-Down payments/rent are higher than normal.
-Option for the buyer to obtain financing and purchase in entirety at any time.
-Place is filled with vested people.

The bad:
-Big liability if it turns into a meth lab,or gets structurally-modified/re-decorated "creatively"...let's say. This could very easily get more expensive than the $10,000 deposit.
-Eviction of homeowners for non-payment may fall under stringent new Federal laws, not local judge/sheriff.
-Non-payment of utilities, taxes, etc. could come back to haunt you.
-Loss of insurance coverage and other protections.

A well-crafted agreement would be needed at a minimum, along with active oversight of the terms.

[MotoSook]

IIRC, they originally wanted to rent from us. Their current home is in the same town and they want their kids to got to their current school and be close to the schools and parks (or house is). I didn't like the idea originally, because they have a dog. I just don't want to deal with torn up yard, interior damage and smell when they move out later (or they don't excercise an option to buy). Even if I required 2 months security deposit, I just don't think I could ever get the house back to being "pre-renter with dog" condition.

We are not upside down on the house and the house can be refinanced by the right buyer, but lots of buyers are passing up the house for larger foreclosures at the same price or less. Good luck to them because the foreclosures always need more work than they think. Our house is in move in condition, yet we are having a heck of a time selling. So right now, renting may be a good option.

I don't want to give the impression that I won't evict or terminate a contract if it isn't working out. I will kick my own family out, but I just don't want nor have the time to deal with the paper work and run around. I am committed to my day job 12 hours a day most days, which means I have no time to do much else when I get home. So being a landlord will be stressing my time and patience.

So if they we have a solid contract with them, what could really go so wrong? I won't hesitate to evict if they don't uphold their end. As for the carpenter labor as part of the payment, I wouldn't do this without a specific contract with payment and expectation very well defined. As a project manajer, I wouldn't have it any other way.

[jyl]

Sounds like you might want to rent to someone without a dog.

Are they willing to pay what the option is actually worth? I don't know what dollar figure you come up with, either using my methodology or another, but it should be significant. Can/will they pay a very large premium over the market rent of the house?

You know, I don't really understand why they want to do a rent-to-own. How long will it take to rebuild their credit enough to finance a house? X years? If it is that long, are they going to pay the fair price of a X-year option? Option value goes up with longer time periods, is X is several years, that would be a very significant sum indeed, and if the value of the house goes down, or they have to move, or they can't pay the rent and get evicted, or for whatever reason they don't or can't buy the house for the agreed price, they get nothing. Talk about speculating on real estate. Does a rent-to-own actually build anyone's credit - I don't see how.

I'm sure there is a way to structure the deal to make it work for you. Not sure it wil work any better than simply renting the house and selling it in X years.

[Zeke]

Lease option boils down to part of the rent accrues toward a down payment. Trading labor as rent credit is unwise for all the reasons stated above. Trading labor for straight rent is not too bad a deal. If the house is not up to speed, you could write out an improvement plan where periodic goals must be met or it would be considered as non payment. You can always write in a cash value so the renter can opt to pay money instead of the labor trade.

For him to build value while gaining financially towards the purchase is all negative for you.

Lease options were popular in times when property was going down in value because if the lessee walks, you keep the credits. There is usually a substantial deposit up front to place the burden on the lessee to perform. 2 months deposit is nothing.

Down payments are serious business. I would offer a lease option in return for a year's prepaid rent and the typical credit is 50% or less.