In the world of real estate investing, rent to own – also known as a lease option or purchase option – is one of the many investment strategies to make money from real estate. Essentially, rent to own homes are real estate investment properties which property investors rent out to potential buyers, giving them the opportunity to make the purchase after a set time period (usually 1-3 years).
This investment strategy is kind of similar to the buy-and-hold strategy, in that both involve renting out the real estate investment property to long-term tenants. However, the difference is that tenants of buy-and-hold investment properties don’t have to purchase the rental property after a set time period.
In other words, investing in rent to own homes involves a signed contract (lease agreement) between the real estate investor (property seller) and the tenant (potential property buyer) in which the tenant has the ability to keep renting the real estate investment property before actually buying it after a set time period. Upon signing the contract, real estate investors can’t place their rent to own homes on the market for rent or sale during the set time period, and tenants have to buy this rental property after the duration of the contract expires.
The Many Advantages of Rent to Own Homes
As you could probably tell from the definition of rent to own homes, this real estate investment strategy yields many benefits for property investors. Although there are a few disadvantages, the advantages definitely overweight them, which is why many property investors find this real estate investment strategy very rewarding.
Option Money Fee
When singing the contract for rent to own homes, the tenant of the investment property is obliged to pay the real estate investor a one-time, non-refundable option money fee. There’s no standard for the size of this fee, but it typically ranges from 2.5%-7% of the purchase price of the real estate investment property.
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When investing in rent to own homes, the option money fee is actually beneficial to the both real estate investors and the tenants of the investment property. To the real estate investor, this fee allows him/her to make a profit when the tenant first moves in the rental property! In addition, since this is a non-refundable fee, tenants can’t legally ask for a refund if they decide not to buy the rental property.
As for potential buyers, paying the option money fee makes it easier for them to purchase rent to own homes in the future. In the rent to own contracts, property investors consider all or some of the option money a portion of the investment property’s purchase price. Thus, if the purchase price of a real estate investment property is $200,000, for example, and the tenant has to pay option money fee that is 7% of the purchase price, then only $14,000 has to be paid up front! This is a lot less than the $40,000 (the size of the standard 20% down payment) which buyers have to pay in a traditional real estate transaction.
The second advantage of investing in rent to own homes is that during the set time period, real estate investors receive a rental income in the form of monthly rent collected from the tenant. The amount of monthly rent is specified in the option lease, which is good for the real estate investor as it allows him/her to predict his/her income and plan his/her finances ahead before selling the investment property. In addition, monthly rent for rent to own homes is slightly higher than for regular rental properties. For a property investor, this acts as compensation for taking the real estate investment property off the market.
In some cases, a portion of the monthly rent (called a rent credit) is applied to the purchase price. For example, say the tenant pays $1,200 as monthly rent, and 25% of that is credited to the purchase price. If the purchase is after three years, then the tenant will earn $10,800 rent credit to apply toward the rental property’s purchase price ($1,200 x 0.25 = $300; $300 x 36 months = $10,800). We can say that even though monthly rents are slightly higher for rent to own homes, this is actually beneficial for potential buyers as rent payments act as down payments on the rental property!
Typically, real estate investors are responsible for covering taxes and insurance costs as they’re still the owners of the rental property. However, a real estate investor is allowed to include in the contract that tenants of rent to own homes are responsible for maintaining the real estate investment property and paying for any repairs such as mowing the lawn, raking the leaves, and cleaning out the gutters. Tenants of rent to own homes usually take good care of the rental property. After all, it’s ultimately going to be their future home! This is beneficial for property investors because they can deduct some of their expenses. Moreover, they make sure that their tenant is not going to damage the real estate investment property.
The last benefit of rent to own homes is that property investors guarantee to sell their investment properties after the set time period expires. Thus, rent to own homes benefit a real estate investor in two levels here: financial and emotional. The emotional level is that real estate investors have a sense of security over their real estate investment. The financial level is that when the time comes to sell rent to own homes, property investors are not required to hire a real estate agent to find potential buyers! This further eliminates the extra fee which a real estate investor would otherwise have to pay to the real estate agent.
The Few Disadvantages of Rent to Own Homes
Just like any other real estate investment strategy, investing in rent to own homes also has some risks. Even though the advantages certainly overweight these disadvantages, they are still worth mentioning.
Breaking the Lease Option
The first risk would surface if tenants of rent to own homes find themselves financially incapable of buying the rental property after the set time period has expired. In case this happened, the real estate investor would have to start the process of finding another tenant or potential buyers of the real estate investment property. However, the real estate investor would still have the right to keep the option money and the rent credit paid until that point, which is obviously catastrophic to the tenant.
Risk of Missing Out on Better Offers
The second risk is due to the fact that upon signing the contract, property investors of rent to own homes can’t place their real estate investment properties on the market for a while. As a result, if other potential buyers come along offering a better price for the rental property, the real estate investor is legally not allowed to sell it. Not only that, but real estate investors could end up selling their rent to own homes for a price lower than their actual value.
Final Thoughts on Rent to Own Homes
In the world of real estate investing, many real estate experts consider rent to own homes a “win-win” real estate investment strategy – if conducted successfully and neither party broke the contract. The advantages certainly overweight the risks for both the property investors and potential buyers!
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