Step-by-Step Guide to Rent to Own

Step-by-Step Guide to Rent to Own

In the world of Canadian real estate investment, there are several ways to recoup your investment in a rental property. Landlords who opt for a stake in the vacation or rental market get quick returns, though in smaller increments. In exchange for that quick profit, vacation rental owners have to deal with the daily hassles of renters and vacationers. Investors who work on a fast home flip get potentially massive payoffs. Of course, the initial investment is significant and, if the worst happens, property owners could end up holding the property for much longer than they originally intended.

Table of Contents - Step-by-Step Guide to Rent to Own

For those real estate investors looking for a strategy that falls somewhere in between those two extremes, Canada’s rent to own market has become increasingly popular in recent years.

If you have the capital to secure a property, finding the right tenant and the right rent to own arrangement could see a return on your investment in as little as a year.

A booming housing market

rent to own agreements used to be very rare in Canada. In recent years, however, they have become increasingly frequent. The reason for this issue is because of a prolonged phenomenon in the Canadian real estate market.

To understand, we have to rewind a bit. A little after the year 2000, the average cost of a home in Canada began to shoot upward. When the rest of the world entered an economic recession in 2007, Canada’s real estate market proved mostly bulletproof. Against all expectations, the cost for a home continued to grow. That trend hasn’t abated. The average value of a home increased roughly $170,000 between 2008 and 2018.

Despite that trend, Canada is more popular than ever. As more home buyers flock to the cities from within the country, immigrants are increasingly settling in the Great White North. In the last five years, immigration to Canada increased by more than 25 percent. All that increased competition for homes has driven the price of a new home even higher. What’s more, strenuous regulations in several provinces keep new construction very slow, so it’s difficult for new buildings to get erected at the pace required to meet the demand housing. And so, once more, home prices rise.

Why has rent to own become so popular?

As home prices continue to head upward, the Canadian government has been jealously guarding the security of the housing market by being slow to loosen the requirements to attain a mortgage. As late as June of 2020, the Canada Mortgage and Housing Corp announced that it would tighten the rules for getting a mortgage. Currently, those people with a 600 credit score or above can qualify for a home loan. As of July 1, that number will rise to 680. Homebuyers who are unable to provide 20 percent of the home’s value as a down payment may also find it tricky to acquire a loan.

In short, the average Canadian is finding it more challenging to acquire the credit score and get the money they need to get a mortgage. Enter the rent to own agreement.

How does a rent to own deal work?

The phrasing “rent to own” is suspiciously complex. What may first seem like a straightforward rental arrangement is very much an animal all its own.

When a seller has a property that they would like to sell, but they’re having trouble securing a buyer who can get a mortgage, they can opt for a rent to own agreement. Once you’ve found a reliable tenant (more on that in a bit), they will offer a portion of the home’s down payment as a non-refundable fee. The amount of the fee is negotiable, but it typically ranges from one to five percent of the home’s market value. This fee secures the buyer’s right to buy the house at the end of the rental period. It also locks in the purchase price of the home at the end of the rental period.

Rental periods in a rent to own agreement are subject to each party’s specific needs, but they usually range from one to three years. The amount of time you determine as your rental period is generally intended to give the buyer time to improve their credit rating so they can secure a mortgage at the end of the rental period.

Throughout the rental period, most landlords put a portion of the monthly rent aside as principal on the home purchase. Of course, monthly rent is often noticeably higher than market value to help offset these costs. For example, let’s say the average local rent for your property is $1,000 a month. If you’re operating on a rent to own option, most landlords would charge $1,200 a month and set aside $200 of that monthly fee for the home buyer to use to their advantage when they secure a loan at the end of the rental period.

Once the agreed-upon rental period is up, the renter is faced with two options. They can approach a bank and tout both their improved credit rating (since they’ve been paying rent steadily for the last year or three), and their increased equity in the home they intend to purchase. At this point, the bank can offer them a mortgage that they can use, in turn, to buy the house. The other option is simple: the potential buyer can refuse to buy the home, and the seller can start the process over again.

Types of rent to own agreements

There are two primary types of rent to own agreements: lease-option and lease-purchase.

A lease-option agreement consists of two contracts. The first is the residential lease that determines the overarching time period of the rental agreement. The second contract is known as an option agreement, which allows the homebuyer the—you guessed it—“option” to walk out of the deal at the end of the rental period.

A lease-purchase agreement also consists of two contracts. The first, the residential rental agreement, is identical to that of a lease-option deal. The second contract, however, is a contract for sale. This agreement obligates the buyer to purchase the home at the end of the rental period. A lot of times, a lease-purchase agreement is set up to ensure that if the buyer breaches one contract, both are breached.

A great bet for buyers

A rent to own agreement may seem heavily slanted toward the landlord, but it’s a good solution for a lot of homebuyers. One of the most common types of buyers who opt for a rent to own agreement is families with rough credit histories. A rent to own agreement allows these buyers to get a jump on owning a home and repairing their credit score.

Locking in a home purchase price two years before purchasing it is also an excellent way to make sure that buyers can save for a set amount without worrying about the Canadian real estate market inflating the price of the home by more than four percent each year.

In the meantime, homebuyers can put their personal touch on a new home. They can repaint and buy accent furniture. They can hang pictures and truly make the place their own. That’s something magical for prospective buyers because they’re investing emotionally as well as financially in their new home. Of course, that’s good news for real estate investors, too, because the more invested a renter/buyer is, the more likely they are to carry through with the agreement.

Why should I invest in a rent to own agreement?

In addition to the goodwill you’ll garner in the community, there are plenty of financial reasons to opt for a rent to own agreement. First, the investor’s patience is rewarded with the bonus payment at the beginning of the arrangement, Then, there is a steady stream of income throughout the rental period. Finally, when and if the house does sell via a traditional mortgage, it will often do so for the above-market value. In other words, if you’re willing to bide your time, a rent to own agreement can be extremely lucrative.

A nice fringe benefit of being a rent to own landlord is that a lot of the day-to-day maintenance costs are covered by the renter/buyer. After all, the assumption is that they are working to purchase the home, so why shouldn’t they start taking care of the place? The amount you’ll save on upkeep to your property could be enormous. The exception here is a lease-purchase agreement. During those rent to own setups, the landlord is often expected to take care of maintenance costs until the buyer officially makes an offer on the home.

So, it seems that for the right investor, a rent to own agreement can be extremely profitable. It just comes down to one major consideration. To make a successful go of a rent to own deal, you need to find the right tenant.

Part of the onus is on you

One of the most critical parts of securing a great rent to own tenant is attracting the right rent to own tenant. As a result, it’s important to make sure that you are keeping the property in good shape and making any necessary updates. A rigorous schedule of preventative maintenance is essential if you’re hoping to draw in someone willing to put the time, money and effort into maintaining a rent to own agreement.

A steady flow of income is essential

Just because a renter has a poor credit rating doesn’t mean that they aren’t making decent money. Before you move in a potential rent to own buyer, make sure that they have an established source of regular income that can cover their monthly rent, and that has been steady for at least the last six months.

If your renter is working on improving their rating to a point where it can qualify for a mortgage, you may also inquire as to whether or not they’ve taken steps to improve their credit score outside of paying regular rent to you.

Willingness to keep the property in good shape

Since you’ve gone out of your way to ensure the property is looking good, you also want to ensure that your renter is doing their best to keep things in good working order. If you’re especially concerned about a renter who is unable to maintain the property, you may want to adjust the residential rental contract (and their rent) accordingly. Another option is to schedule regular visits at the home throughout the rental period so that you or your property manager can put a personal eye on the property’s condition.

Don’t slouch on checking references

A renter who wants to buy their own home may have the best of intentions when they begin a rent to own agreement, but intentions don’t cover your back if the renter defaults on one or both contracts. As a result, it’s important to check their references (contact their employer and other provided references) so that you can be confident that they can cover their part of the bargain.

Ask for a letter from the buyer

Typically, this is a move reserved for only the most competitive real estate markets. Fortunately, if you’re living in pretty much any Canadian province, you are more than likely investing in an extremely competitive real estate market. If you want to get a feel for the kind of person you’re dealing with, you can ask for a letter from the buyer. You can ask for a bio or a few reasons they are hoping to buy the home, for example, but you can make the topic anything you want. The goal is to ask a buyer to provide insight into their personality.

What stage of life Is your tenant?

Finally, while you’re getting to know your prospective renter/buyer, you should consider what point they are at in their lives. For example, statistics indicate that expectant families are more likely to settle into their current surroundings for a long time to come. (So are pet-owners, incidentally.) Knowing these facts about a potential buyer can determine the plausibility that they will go through with the home purchase.

By following these steps, your rent to own property could become the star of your investment portfolio.

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