Homeownership is not always easy to achieve for all Canadians, and for many and a lease-to-own strategy might be the answer. Suzanne Sharma digs deep to find how experienced investors can benefit as well
April 22, 2009 – It’s no surprise that a lease-to-own option is a viable solution for renters who want to become owners. It allows buyers with a less than perfect credit score to reach their goal of homeownership faster.
However, investors can also reap the rewards of a lease-to-own arrangement, making it a win-win for both.
“For investors, lease options make their properties more accessible to a wider market of buyers,” says Andy Santoso, president at Strategic Housing Corp., Vancouver. “Sellers also enjoy the benefit of collecting premium rents before selling their properties for a higher price.”
The process to break into this market is comparable to a buy-rent-hold investment. The main difference is how the property is advertised.
Essentials
Simply put, a lease-to-own, rent-to-own or lease-option allows a tenant to rent the property with the option purchase it in the future. The procedure usually takes one to three years on average. During that time the tenant works to improve their credit score, so they can be approved for a mortgage, and saves for a down payment.
Two contracts are involved in this agreement: a lease contract and an option to purchase contract.
“As a tenant, you would pay a non-refundable option fee which gives you the option, without obligation, to purchase the property at any time during the lease term for a fixed price,” says Santoso.
Usually, the owner charges a higher monthly rent but a portion of it is credited towards the purchase price, or is put towards the down payment. If at the end of the lease term the tenant is unwilling or unable to purchase the property, he loses any equity built up in the property.
“For this reason, you should be strongly committed to purchasing the home when entering a lease-to-own agreement,” says Santoso.
The qualifications for renters to enter such an arrangement are similar to the landlord and tenant screening process. A credit check is usually performed and the renter must provide references, proof of income and information on assets and liabilities.
“In some cases, you would just need to provide the option fee, security deposit and first month rent,” notes Santoso.
Pros and cons
The obvious advantage of a lease-to-own is it aids tenants in becoming homeowners sooner, while they accumulate a down payment and restore their credit. Equity is built with each monthly payment, so tenants have a share in the property. Also, a lease-to-own often provides more flexible terms as opposed to conventional financing.
However, this option isn’t for everyone. The most important consideration is that while a lease-to-own is intended to help the tenant attain homeownership, there is no guarantee that they will qualify for financing.
“Ultimately, it is up to the buyer to decide whether the property is something that he or she can afford,” says Santoso. “In most cases, buyers should consider a financial plan which may include credit repair, savings, debt consolidation or an investment strategy.”
Many lease-to-own companies work with their clients to best prepare them to qualify for a loan at the end of the lease term. This is accomplished by advising the tenant about healthy credit habits and allotting a portion of the monthly rent towards the down payment.
Alex Kluge, relationship manager at Home Owner Soon Inc., Toronto, says about 20% of the clients’ monthly rent is designated towards the down payment.
Another consideration is most companies carry only a small inventory of lease-to-own properties, usually about three, and the tenant is asked to select one of these, notes Kluge.
The tenant is restricted to these homes even if the property isn’t ideally suited for them, so it’s recommended to research the conditions of the option first.
Fix appreciation
Investors can benefit from a lease-to-own as well. Primarily, they profit from a slightly higher monthly cash flow through a premium rate. Furthermore, the fixed price at which the home will be sold allows the investor to enter the deal with confidence, since they know ahead of time what their return will be.
A fixed appreciation model, typically 6% per year, should be utilized, notes Mark Loeffler, investor relations at Home Owner Soon. This is outlined in the option to purchase contract so both parties are aware of what they are agreeing to.
The method to get involved in a lease-to-own is similar to any other investment dealing with tenants in that all references and proof of income should be verified. However, it differs slightly in the way it is advertised because renters must understand the terms of the agreement.
The common concern for investors in a lease-to-own is that it may not guarantee a sale at the end of the term. One possibility to alleviate this issue is to choose the tenant-buyer first and allow them to pick their property. This, of course, should be done within reasonable limits.
“We use a buyer selection program,” says Loeffler. “We approve the candidate first and then help them find the right house. This is good for many reasons as they can choose the exact house they want and stand a better chance of purchasing it at the end of their term. As well, you have a renter from the day you close on the property.”
This system can take anywhere from four to six weeks. Approvals take about 48 hours, provided the applicant has submitted their supporting documentation, says Kluge. Once approved, the client views properties with one of the company realtors, who keep the interests of both parties in mind.
Another positive factor for the investor is that in most cases the tenant will provide a sizable, non-refundable deposit to secure the option to purchase contract, according to Santoso. “This mitigates the risk for the investor, since the tenant-buyer is providing equity profit for the investor if he defaults on his option to purchase.”
Investors who are wary of single-handedly entering a lease-to-own agreement may get involved through a third party company. This type of investment comes with a lease-to-own agreement signed between the company and the investor. The investor is able to purchase a property by assignment, and doesn’t require a joint-venture agreement because the investor still retains 100 per cent ownership.
The company will then sub-lease the property to a pre-qualified tenant and provide the investor with the option deposit and monthly rental income throughout the term, usually 24 or 36 months, or until the option to purchase is exercised by the tenant, says Santoso.
From the January 2009 issue of Canadian Real Estate
