Lease-to-Own: Today's Real Estate Sweet Spot

Looking to jump-start sales in a slow market? You might want to consider rent-to-own transactions. Here's how they work.

By Robert Freedman
September 2009

Banks are looking for more money down and better credit scores—exactly the opposite of what many households are capable of bringing to the table because of the struggling economy.

That puts real estate practitioners who are familiar with rent-to-own transactions in the perfect position, two specialists say.

"How do you put together deals when homes aren't selling and buyers aren't qualified?" asks Wendy Patton, a real estate broker in Clarkston, Mich., and a lease-to-own trainer. "You make it possible for the two of them to meet in the middle."

Patton defines that middle ground as the rent-to-own option, because many households who today can't afford to buy would nevertheless jump at the chance to become a buyer down the road by applying some of their rent to their eventual purchase of the property.

Exploring the Rent-to-Own Option

In fact, Brett Furniss had so much success structuring rent-to-own transactions as a real estate investor several years ago in Charlotte, N.C., that he launched a brokerage that specializes in the deals. Today, his niche matches nicely with the tough economic picture, he says.

"Rent-to-own is what the market looks like now," says Furniss, broker-owner of BDF Realty in Charlotte. "Banks are looking for more money down and higher credit scores, yet the reality is that households have lower credit scores and less money to put down."

The secret to rent-to-own success is to introduce the idea to your sellers and buyers rather than wait for them to bring it up, because few will do so, Patton says.

On the seller side, "you have many willing to do this but you don't have a clue that they are" until you bring it up, she says.

For many practitioners, the alternative for their seller clients who can’t find a qualified buyer is to rent the house until the market improves, but that's not a solution anyone is excited about, Patton says. The sales associate gets a small rental fee, the seller very likely can’t get a rental rate sufficient to cover the entire mortgage, and the buyer accumulates nothing that can help make future homeownership more likely.

What to Keep in Mind About These Transactions

Yet for all its attractiveness in today's tough climate, the rent-to-own transaction isn't something to be jumped into lightly. Structuring a deal in a way that benefits all parties takes patience and an understanding of arcane details, including realizing that:

1. Not all sellers are good candidates for rent-to-sell. For example, sellers who are in financial trouble and facing a good chance of defaulting on their mortgage are not ideal candidates. If they should default and go into foreclosure, what happens to the rent-to-own buyer?

2. Not all properties are good candidates. The governing associations of some condos, for instance, have rental caps. In such cases, structuring a deal in which the buyer comes in as a renter for the first year or two won’t fly.

Also, you'll want to consider the following questions when you work on rent-to-own transactions:

● How many ways can you structure these deals? For example, how long should the terms of a rent-to-own contract extend? How much of the monthly payment should go to the purchase? What safeguards do you put in place to make sure payments are allocated appropriately each month?

● What are the different ways practitioners can get paid? How much should practitioners ask for up front, how much each month, and how much once the property finally changes hands?

●What are wholesale options all about in the lease-to-own niche?

● Can a deal be made to work when the monthly rental rate generates negative cash flow? Can such a deal be made to work with the help of a money partner? What's the role of such a partner?

Notwithstanding issues like these, the niche opens up a large swath of the market that would otherwise be limited to rental transactions, so it makes sense to at least try to understand whether the transactions can work for you, Furniss and Patton say.