Rent-To-Own

January 17,2015
Rent-To-Own
Real estate is not furniture. If you fail to pay, they don’t come with their truck when you’re not around and then take it away. I get these requests from time to time and, like most things, there are advantages and disadvantages to both parties. In most cases no one has thought deeply about this.

How does it work? There is more than one way. Most often what the buyer has in mind is a rental with the chance to buy it when the term is over. This is not terribly meaningful as neither party is obligated for much.

My favorite is that the buyer pays normal rent  plus an extra amount which is then calculated separately and subtracted from the total when (and if) there is a closing. If he fails to close as specified, then he loses it. If he performs as intended, then he gets a discount. I like this as each month it ties the buyer tighter to the deal and gives him a real incentive to buy it at the end. But if he doesn’t, keeping the extra  money may not be so easy as anticipated. Lawyers’ interpretations on this vary: some would say that by setting aside this amount gives the renter an equity interest in the property and you may have to get them to sign off to guarantee clear title to a new buyer, which probably will come at a cost. The wording of the document should take this eventuality into account.

I have also handled them as a two part transaction. First is a regular rental and second is an option to buy. Here the terms are spelled out - date, price, and so forth. But the buyer is not obligated to perform; he just gets the chance to buy before anyone else does.

As with a rental, I’d envision a sum of money changing hands, one that is substantial but not exorbitant. It can be called the “Security Deposit” and the seller can credit it at the closing rather than return it like normal in a rental. Note: a security deposit does not have to be the same figure as a month’s rent. In fact, it shouldn’t be. The selling price should be set in stone at our before possession. Or …you could agree to abide by whatever an appraiser says it is worth. Or each of you could have your own appraiser and average the two figures. Any way you handle it, you want the buyer to have skin in the game, to hold his attention and focus if things start to go hard for him. You have potentially more to lose than he does.

The Seller’s Side
Advantages:
1) It gets you a buyer and a potential sale that you might not otherwise have.
2) The buyer usually is willing to pay full price. It’s easier to say “yes” to this when you don’t have to fork out the money right away.
3) You may have some tax savings since all the money is not coming at once.
4)mYou are not automatically forced to pay off right away any loans you may have.

Disadvantages:
1) You’ve kicked the can down the road (which not always a bad idea), yet locked yourself into today’s price, thereby loosing any inflation you might get. If there should be deflation, the buyer will almost certainly just back out.
2) The buyer has a period of time to find out everything about the property and familiarize himself with all its warts. These may be things you’ve learned to live with and do not think so important. They may think differently. Remember, “The grass is greener…” Something new has an attraction that something old must compete with. In my experience the majority of rent-to-owns never close.
3) You lose the opportunity to sell it to someone else for $1,000,000 (or whatever).
4) Suppose the buyer gets into trouble, say he gets sued and loses, a car accident perhaps. Can they attach your place as part of the buyer’s assets? Would you have then to buy him out?
5) You could be forced to evict your tenant. This is a costly and unpleasant experience for both parties. Do you know how nice they will keep it?
6) You could lose your Star tax exemption if you move away.
7) If you have on-going expenses, loans perhaps, will you get enough monthly take care of that. If the money flow stops, will you still be able to service your continued expenses?

The Buyer’s Side
 Advantages:
1) You get time to get your affairs in order. This might be selling something, getting experience to get a special loan, or waiting for an inheritance or judgement to come in.
2) You get to know the place very well and hopefully can forge a bond with the owner.
3) Any appreciation probably adheres as your benefit.

Disadvantages:
1) You may waste a lot of time and never buy.
2) You can lose additional sums if you fail to buy. Walking away from it may not be as easy if you would think. Depending upon the wording, you might be sued for breach of contract.
3) What happens if the seller dies or becomes incapacitated? Or he gets sued big time?
4) From what I’ve seen, inheritances and expected lump sum payments mostly fail to materialize.
5) There are potential tax deductions that you will not be able to take advantage of.
6) Suppose you cannot get the money by the end of the rental. You may be forced to leave your new home and what you’ve worked for all those months.
You may decide you don’t like it as much as you thought you would.
Suppose the seller has judgements against him (either before or after you move in) or there is a flaw in the title. What then?

Yes, this is more complicated than you expected. The agreement between buyer and seller should take these things, and others into account. I recommend that a lawyer draw it up and another lawyer vet it for the other party. That could be money well spent in case something goes awry.