If you’re thinking of starting a real estate investing career, then you must be filled with questions. One of the many questions beginner property investors ask is which investment strategy is best to start off? Truth is, there is no one-size-fits-all when it comes to real estate investment strategies. The answer really depends on a number of factors such as the location and type of the investment property. Therefore, what might work for one real estate investor might not necessarily be the best option for another. However, one investment strategy that real estate experts seem to recommend to beginner property investors is rent to own homes.
Before you go ahead and invest in rent to own homes, you should first learn more about them! Keep reading as we explain what exactly rent to own homes are, why they make a smart investment strategy, and what beginner property investors should keep in mind to succeed in real estate investing with rent to own homes. So, without further ado, let’s jump right it.
What Are Rent to Own Homes?
In the world of real estate investing, rent to own homes – also known as a lease option or purchase option – are rental properties which the owner or real estate investor agrees to lease to someone for a specific period of time (usually 1 – 3 years). After that time period, the renter has the option to buy the investment property for a predetermined amount.
This investment strategy is kind of similar to another one – the buy-and-hold investment strategy. Both involve renting the real estate investment property to long-term tenants. However, the main difference is that renters of buy-and-hold rental properties don’t have the option to buy the rental property after a set time.
In addition, investing in rent to own homes involves a signed contract (lease agreement) between the real estate investor (seller) and the renter (potential buyer) in which they agree that the renter will keep renting the investment property before actually buying it after a set period of time. Upon signing this contract, property investors can’t place rent to own homes on the market for rent or sale, and the renter is obliged to buy the rental property after the duration of the contract expires.
Just like everything in the real estate investing business, rent to own homes come with a set of benefits and potential risks for the real estate investor. Nonetheless, after reading all about them, you’ll notice that their advantages outweigh the disadvantages, which is why rent to own homes are highly recommended to beginner property investors.
Pros of Investing in Rent to Own Homes
Option Money Fee
Before leasing rent to own homes, renters have to pay the property investors an upfront, non-refundable fee in addition to the security deposit – Option Money Fee. There isn’t a set standard to the size of this fee, but typically it tends to be 2 – 7% of the purchase price of the investment property.
This option money fee allows the real estate investor to make a quick profit when the tenant first moves into the investment property. In addition, it’s also beneficial to owners of rent to own homes because – seeing as it’s non-refundable – renters can’t legally ask for a refund in case the lease is broken or if they decided not to make the purchase at the end of the lease term.
Furthermore, renters of rent to own homes benefit from the option money fee as well! This fee is a portion of the purchase price of the investment property and a credit to renters if they complete the sale. Thus, the option money fee makes it even easier to buy the rental property at the end of the lease term.
The second advantage of investing in rent to own homes is the rental income and cash flow that the real estate investor receives in the form of monthly rent collected from the tenant. Investors typically lease rent to own homes at market rates with an additional fee tacked on each month. That fee varies, but it’s usually anywhere from 10 to 15% of the monthly rent and it should be specified in the option lease.
For instance, a rental property that would rent for $1,200 on the open market may cost a rent to own renter $1,350 per month, with the $150 difference put aside in an escrow account. Any funds collected in the escrow account are usually used toward the purchase of the investment property if the tenant decides to complete the sale. Otherwise, the owner has the right to keep the funds at the end of the lease term. In our example, this would result in $5,400 collected over a 3-year lease period, which the renter could put toward closing costs or as part of the down payment on the investment property.
As for property investors, this additional fee acts as compensation for taking rent to own homes off the market. Therefore, although monthly rent is slightly higher for rent to own homes, this actually benefits both owners and renters planning on buying the investment property.
Typically, property investors are responsible for covering property taxes and insurance seeing as they’re still the owners of rental properties. However, when investing in rent to own homes, a real estate investor is allowed to include in the contract that the tenant is responsible for maintaining the real estate investment property and paying for any repairs.
Renters of rent to own homes usually take good care of the rental property. After all, it’ll be their future home! This benefits beginner property investors as they can deduct some of their expenses and ensure that renters won’t severely damage their rental properties.
Property investors have the right to include in the lease option that they can evict the tenant, even if that tenant is planning to purchase the rental property down the road. Doing so safeguards the real estate investor in the event that renters stop paying rent or the need to evict for other reasons arises before the end of the lease period.
The last benefit of investing in rent to own homes is that property investors are guaranteed to sell their rental properties at the end of the lease term. Thus, rent to own homes benefit beginner property investors both financially and emotionally. Emotionally, property investors have a sense of security over their real estate investment. Financially, is the fact 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 that the real estate investor would otherwise have to pay to the real estate agent.
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Potential Risks of Rent to Own Homes
As you can see, rent to own homes are a win-win for both beginner property investors and renters if they stick to the option lease’s terms and conditions and complete the sale at the end of the lease term. However, just like any other real estate investment strategy, investing in rent to own homes also has some potential risks that property investors should know.
Breaking the Lease Option
The first risk would surface if renters of rent to own homes find themselves financially incapable of buying the rental property after the lease term. In this case, property investors would have to start the process of finding another tenant or potential buyers of rent to own homes. There are stories of tenants who were responsible for repairs and maintenance but then walk away from the deal without taking those duties seriously, leaving the owner in hot water.
Nonetheless, as a real estate investor, you would still have the right to keep the option money and additional funds in the escrow account until that point, which is obviously catastrophic to the tenant but beneficial to you.
Risk of Missing Out on Better Offers
The second risk is due to the fact that property investors of rent to own homes can’t place their rental properties on the market during the lease term. As a result, if potential buyers came along offering better prices for the rental property, as a real estate investor you legally can’t accept it.
In the real estate investing business, many consider rent to own homes the best investment strategy for beginner property investors. The fact that their advantages outweigh the potential risks further proves this. Would you consider investing in rent to own homes? Let us know in the comments!
For more information on anything real estate related, make sure to keep reading our blog which includes up-to-date information, step-by-step guides, and tips for actual and future property investors.
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