Apologize for being OT. Rent w option to buy

mtnrdredux_gwMay 4, 2011

Sorry, but I don't think there is a forum for my query. But I'm guessing there is some relevant collective wisdom on this forum.

Our former home is for sale. Homes in our market and category are not exactly selling quickly right now. We are open to renting, in part because we don't have a mortgage and the opportunity cost of our capital is low (we invest very conservatively and earn less than 3% on most of our portfolio). I will investigate the tax issues. We would not be renting because we expect prices to "recover", just to be clear. But I also do not see a lot of downside in this particular case at this particular time.

But I was wondering if anyone has experience with either side of a rent w/ option to buy deal, and what their thoughts are?

Thanks in advance, as always!

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    Bookmark   May 4, 2011 at 11:19PM
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Are you considering renting a home yourself or are you asking about having other people rent your house w/ an option to buy it?

If you are the one considering letting the other people rent with option to buy (which i think is what you are asking) there's little downside to you unless the market goes up significantly- and in that case, the only downside is that you are just getting less than what you could get at fair market value at the time. Renters who have an option to buy the property will pay more for that option and if they decide not to buy, then you'll get to keep the extra rent and if they do decide to buy, then you'll have gotten rid of the house. Plus, renters who live someplace where they have an option to buy tend to take much better care of the place than renters who are just renting.

Of course, the only downsides really would be the fact of being a landlord and having to deal with middle of the night calls when something breaks or having to deal with evicting a tenant if they don't pay (of course, if you do a credit check, you can hopefully avoid that problem).

    Bookmark   May 4, 2011 at 11:25PM
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Thanks, Beagle. I do follow the logic and implications of selling an option. We would hire a property manager and really have to size the security appropriately. It is a very large historic house and in pristine condition (some of you have seen the photos on my share site).

I had not thought about the fact that they will be better renters than just "plain renters". Fair point.

Just wondering if there are some interesting nuances to how these are structured, or if people have had any surprises.


    Bookmark   May 4, 2011 at 11:31PM
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Sorry mtnrdredux I didn't mean to make it sound as if you didn't understand the process. just started typing out advantages without thinking and didn't realize it came across that way. Stream of consciousness thinking!

    Bookmark   May 4, 2011 at 11:37PM
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I can't imagine why a renter would purchase an option to buy. A buyer already has the option to buy. What are they getting--the ability to pay today's higher price during a declining market?

You have to take the same economic factors into your decision. Case Shiller Index is still IIRC something like 15% above historic norms. Houses in low income areas may have bottomed because their prices are supported by their rent streams. Higher end houses are a different animal, and don't have that cushion, so continued decline is pretty inevitable. Just make your decisions after you do the what-ifs for selling your house a year from now for less than you could get today.

    Bookmark   May 4, 2011 at 11:45PM
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Beagles, sorry, tone is so hard to read on line. My reply was meant entirely neutrally! But I am a former investment banker so I was trying to say I don't really have a question on the financial aspects. : )

I am looking for someone who has done one of these deals and perhaps picked up some specialized knowledge and insight, that's all. You know, the hard-won knowledge.

I did also google it and get a good sense of common deal terms, etc

Thanks for your reply!

    Bookmark   May 4, 2011 at 11:51PM
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Marcolo - So true! I never really thought about it, and I won't go into it here but when I googled it they had a pretty good summary of why some people might do it ... it often is used for people who aren't actually able to buy your home and are going to use the rental period to repair credit and/or build equity (a function of the deal structure).

In this particular situation with this buyer they have an unusual relocation situation and I understand why they want to do it. Suffice to say i will confirm what looks, prima facie, to be excellent credit.

I happen to have followed the housing market for a living and let's just say it has treated me well; so obviously I am a bear.. So I am not really looking to discuss home prices, just any particular knowledge about this rent-to-buy animal.

    Bookmark   May 5, 2011 at 12:00AM
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Fori is not pleased

There's actually a real estate forum here--they might have some advice there as long as you don't get into the "do Realtors deserve their commission" debates. :)

So do cross post there if you haven't.

(I have no clue. I have a spare house too and I'm pretty sure *I* don't want to mess with renters even if it costs me. Now convince my spouse!)

    Bookmark   May 5, 2011 at 12:06AM
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LOL, Fori, I here you.

I have to get some sleep, but I may try there tomorrow.

    Bookmark   May 5, 2011 at 12:13AM
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Seems to me, best to consider the issues separately.

#1. Sell, or rent it out. Depends on whether the market rent, net of management fee, insurance, maintenance, exceeds the return you'd get from selling the house at the market price and investing the money. There are considerations of tax and selling costs, too. Simplified example ignoring taxes: If house would sell for $1MM net of costs, 3% is $30K/yr, if market rent is $60K/yr net of costs, then renting looks good.

#2. If rent, sell option? Simplest way is to figure out what the option is worth to the buyer, then charge him at least that much. Suppose 50% chance that in 1 year, the currently-$1MM house's market price will go up by $50K (+5%), and 50% chance it goes down -$50K (-5%), and the strike price is $1MM. The buyer has 50% chance of making $50K (buy a $1.05MM house for $1.00MM) and 50% of losing nothing (don't buy a $0.95MM house for $1.00MM). The option is worth $25K = 50% x $50K + 50% x $0K. So you want to be paid >$25K for the option.

I don't know tax, which may be a big deal. Also, if no broker commission gets paid should the renter exercise the option, that could be a big deal. I assume you'll hire a manager/maintenance company so there'll be no midnight ''toilet's clogged'' phone calls. Also assumes there is sufficient security held, and insurance maintained (w/ the right terms) so that you will be indifferent if the renter damages or burns down the house.

    Bookmark   May 5, 2011 at 12:40AM
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A certain amount of the good or bad of the outcomes of these arrangements is built into state-specific requirements of option-to-purchase contracts, apart from the specific bona fides of the parties to the contract and the property in question. So, do consult your real estate attorney and tax consultant, which I know you would do anyway.

    Bookmark   May 5, 2011 at 12:43AM
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The rent-to-own scenario is usually used when the buyer doesn't have the down payment (or credit) to buy yet and needs to build up capital. A portion of each rent payment is put into an account that's used towards a downpayment. You can set a price in the contract, but I've also heard of that being negotiated if/when the renter decides to buy, too. So the reason a renter would choose that option is if they couldn't buy the place now, but like it and want to build equity towards buying it. The reason a seller might choose that option is that (in theory) if the renter is going to eventually purchase, they'll be super respectful of the property and cognizant of the investment in it (and b/c the seller is in a position where they can set aside some of the payment and still pay any mortgage, taxes, etc. owed with the balance). I've heard of them working in some cases, but our realtor was really iffy on them. I think a lot depends on how well the contract is written---definitely a question for a RE lawyer.

On the straight renting side, we have several neighbors who are doing that---homes here aren't moving too quickly unless they're priced pretty low, and where we live most people can pay mortgages with current rents if they didn't buy at the absolute peak---we're at a weird point where home prices are low but rents are going up. So while they could have sold, it didn't make much sense to lock in a loss when things might pick up and they can break even or make money renting. Thus far, they've all had positive experiences (all are first-time landlords). They did screen tenants pretty carefully, though (one is renting to a friend). And of course they know us and other neighbors on the block, and we help keep an eye on both the houses and the tenants (not that the tenants have been a problem, but if they were we would let the owners know). You can deduct a lot of the related maintenance expenses, though in our city you need a business license and pay business tax on rental income (but those costs are also deductible). Whether the numbers make sense in the end will really depend on the specific situation, though.

    Bookmark   May 5, 2011 at 2:10AM
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I'm not as well versed as some of you in the financial/tax ramifications of renting/options but I decided to rent my home out without the option to buy for now. My renters who take possession mid May do hope to rent long term and buy the home. Here in Florida we can only do a one year lease. I did not want to set a price at this point since one cannot be sure what the market will be in several years. I still have a mortage but even after expenses; will still net a profit. For me, and on the advice of my realtor/friend/neighbor; we didn't see the point since the market will bear what it will bear in several years. Exactly as mentioned above, they had gotten into a balloon situation, above their heads (mortgage went up to almot 5K a month) and could not maintain it long term. If they are as good of tenants as I anticipate (fingers crosssed) and they don't recover to the point of purchasing in several years, then the home becomes an annuity and I have the option of continuing to rent it out, protect my principal, and make as much (if not more) as I would investing the sum from sale with no exposure to the principal. My son is a financial advisor and loves this option.

Sorry if this is a pretty basic response with not too much advanced financial insight but I thought I'd share my situation. Oh... my home is a basic 4 bedroom 2400 sq.ft. suburban South Florida pool home in a nice not overly upscale area.

    Bookmark   May 5, 2011 at 6:41AM
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