How Does Rent To Own Work?
Discover the basics of rent-to-own lease agreements, how they are structured & many ways they benefit you as a landlord. This comprehensive beginners’ guide to understanding rent-to-own lease agreements will set you up for success as a landlord.
If you’re anything like most landlords, it is inevitable that you will encounter rent-to-own lease agreements.
Typically, this comes from a tenant or prospective tenant interested in purchasing your property (or at least having the option to) when their lease term is up. Another common reason that landlords and property owners first discover the option of rent-to-own (RTO) lease agreements is when they have failed to sell their property in the current market and are eager to drum up money fast.
Although you may have never before considered offering rent-to-own leases, know they can be an extremely beneficial option for landlords craving healthy revenue streams. But first, you must understand how these agreements are structured and how that impacts their ability to either benefit or harm you as a landlord.
Use this comprehensive beginner’s guide to rent-to-own lease agreements as a road map to navigating and executing your first successful RTO agreement.
What Is A Rent-To-Own Lease Agreement?
To begin, let’s address what “rent-to-own” really means. Essentially, it is a rental contract that features either a purchase option or purchase guarantee in addition to the traditional rental terms of any standard lease.
This unique agreement allows tenants to rent your property while also paying towards their downpayment each month. In exchange, this gives your tenants the first option to purchase your property on a pre-chosen date.
You could say that this is a two-for-one agreement that acts as both a rental lease and purchase agreement at the same time. You could also say that this is a win-win arrangement that gives you additional security as a landlord knowing you have potential buyers already on the hook while allowing tenants to grow into the responsibility of homeownership.
A Landlord’s Guide To Rent-To-Own Lease Agreements
What exactly does a lease-to-own agreement require? Your standard lease-to-own agreements will be broken into two parts that are either combined into one agreement or signed separately; the purchase option and the rental agreement.
The Lease Agreement
The rental agreement portion of the contract will be very familiar to you as a landlord because it will look like any other standard lease agreement. The difference you will notice is that this contract is more focused on the exact terms of the tenancy, the responsibilities of each party (think maintenance), the timeline, and the rent amount.
The Purchase Option
The purchase option is basically an additional rider that gives your tenant the right or option to purchase the property when the lease is up. However, it is just an option and does not legally bind most tenants to the purchase.
Usually, your tenant would start by putting down their option fee to secure their right to purchase, you would both agree on the future purchase date and price, and then your tenant will pay you rent plus rent credit ( an added payment that goes towards the downpayment).
How Rent-To-Own Lease Agreements Benefit You As A Landlord
Easier Upkeep
Tenants planning on buying the property at the end of their lease term are far more likely to respect the property and take good care of it; reducing your maintenance costs and providing valuable peace of mind.
Better Sales Price
If the market doesn’t currently support your net profit goals for selling your property, an RTO agreement will help you achieve a higher sales price because renters are often willing to pay a premium for the option to buy.
Revenue Streams
Not in a hurry to sell? These lease agreements will establish a healthy stream of income while giving you added hope for a future sale on the horizon should the desire ever strike.
Attract Potential Buyers
Often, frustrated sellers are able to attract the right buyers by offering this type of lease option which is often very attractive to a special pool of reserved buyers and renters that may already love the property but are holding off for an option like this.
Retain Option & Escrow
Perhaps the biggest perk is that you get to keep all of the funds set aside for the purchase and the option fee, even if your tenant does not decide to purchase at the end of their lease term.
The Landlord’s 7-Step Guide To Successful Lease-To-Own Agreements
- Select The Type Of Agreement You Want To Use
As the landlord, tenants will expect you to take control and have a rent-to-own contract prepared for them. In step one, you will select which type of agreement to use. There are two primary types of RTO agreements:
- Lease Agreement with Purchase Agreement: tenant is contractually obligated to purchase when the lease is up.
- Lease Agreement with Purchase Option: tenant has the option but no obligation to buy the property at the end of the lease agreement. This is the more popular option among most landlords.
- Decide The Purchase Price
The purchase price of the property should always be established upfront and that is step two of the process. For more flexibility, you can include multiple purchase options if you wish. Generally speaking, you should determine the value of the property based on local comps and then add 5-10% to the price to account for inflation.
- Collect Your Option Fee
Next, collect the option fee which your tenant pays you to secure their purchase option. Basically, they’re buying the right to buy the property on the pre-determined date. This fee is usually negotiable but will range anywhere from 1%-7% of the purchase price of the property. This is a one-time fee and it gets taken off the purchase price when the sale occurs.
- Decide The Length Of The Rental Period
If you are anything like most landlords, your rent-to-own lease agreements will last anywhere from one to three years, depending on how much longer you want to hold onto the property.
- Set Rent & Rent Credit Amounts
In step five, you will determine how much your tenants will owe for both their monthly rent and rent credit payments. That rent credit is being paid towards the downpayment of the property and is usually 25%-30% of the monthly rent. Concerned about managing rent credit funds? Many landlords transfer the rent credit payments directly into an escrow account until the sale transpires.
- Review Remaining Lease Terms As Usual
Aside from the slightly unusual tenancy terms, most rent-to-own lease agreements will resemble standard rental agreements. However, you should still review all the other terms and clearly outline exactly who will be responsible for repairs.
- Follow Up With Your Tenants
As the end of the lease approaches, check in with your tenants to determine if they plan to buy the property and make sure they are securing the proper financing to do so.
The Bottom Line
Rent-to-own lease agreements are an excellent win-win for both landlords and tenants when careful attention is paid to the details of the purchase option and lease agreement. Ready to move forward? Rent Spree offers you the option to automate the process and eliminate many of the traditional headaches that come with screening potential buyers/tenants, collecting signed agreements, and tackling maintenance requests.
Now that you understand how to successfully execute a rent-to-own agreement, you have the ability to generate passive income before selling your property at a premium to buyers that you know will cherish the property. Remember, in some cases, it is better to sell a property and move on from the burden of responsibility and rent-to-own agreements offer you the landlord, and your tenants, a means for a smooth transition.
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