Wednesday, February 3, 2010

A faster way to home ownership

RTOs or Rent-To-Own transactions can bring you closer and faster to home ownership.

Some people may have a bad credit rating but yet are committed to the road of financial independence. They would like to own a place rather than rent. Although their income would qualify them for a mortgage, the credit record won't let them. They even have some money to put down but the mortgage is out of reach. For such people rent-to-own may be the way to go.

Others may have no credit record, because they never borrowed money in Canada. For them, it may be a significant waiting time before they qualify for a mortgage as well, even though they have sufficient funds for a down payment. Rent-to-Own may help. Finally, there is a group of people who have some money saved towards a down payment, but not enough to their liking or to the liking of their bank. Here rent-to-own may help as well.

The RTO transaction is a way to speed up your dream of home ownership and a forced savings plan all-in-one. Rent-to-own, means you rent the place you would like to own but which is out of reach for the next year, two years, or three years. You find an investor who is willing to buy the house for you with you having the right to buy the house at the end of your rent term, say 2 years from now at a pre-set price.

So we're dealing with two contracts a) a long term lease contract (1 - 3 years) which is a normal rent contract and b) an 'option to buy' contract or a 'post-dated' purchase contract set to go into effect at the end of the lease term. The rental contract is a normal tenancy contract outlining the (market) rent payable, a safety deposit (which goes towards your down payment) and the other standard clauses.

The second contract outlines the terms of purchase at the end of the lease, and the creation of a savings account where your down payment accumulates. This account holds an initial deposit, say $3000 to $5000 or more if you want to. It could be an interest bearing savings account, although in today's economy the interest accumulation won't amount to much. When you make your monthly rent payments, you also commit to pay ,say a minimum of $200, extra that goes towards your down payment account. That way, you are building up your down payment to the desired level by the end of the lease term.

The 'down payment' is the security for the investor/landlord in case you decide to walk away. He bought the house for you after all and if you don't buy it at the end of the term he will be stuck with it. This way the 'down payment' account is for the benefit of both. So rent and down payment are out of the way.

Next is the purchase price. Typically, this is negotiable, but the investor does not buy your house out of the goodness of his/her heart. He/she wants to make a return on investment. Usually, the investor supplies the down payment and a mortgage to finance the remainder. Thus he can use leverage to increase his returns.

The investor's first goal is to have positive cash flow on his rent - in Calgary that is usually difficult to achieve so, the investor may be happy with $200-300 per month. (Positive cash flow is the money left-over from the rent after deducting property taxes, mortgage payment, advertising, condo fees, etc.)

Another source of his return is the appreciation of the property. In Calgary, properties over the long term appreciate around 6% per year. So if the house was bought for $200,000 it would appreciate by 6% or $12,000 per year on average. Now, part of the reason you, the Renter-to-own, are interested is that you would like to enjoy that appreciation as well. So you split kind of the appreciation: rather than taking all the investor would take 4% and leave you with the remainder of the appreciation.

In return the investor can sell the house for a preset price to you. In our simplified example, over a two year lease of the $200,000 house that would be 4% of 200,000 = $8,000 dollars for the first year plus 4% of $208,000 = $8,320 for the second and a total profit of $16,320. A nice return on the investor's down payment of say $40,000.  Also, the mortgage has been paid down somewhat over the 2 year lease term; say $3,500 and that goes to the investor as well.

For you, the Rent-to-Owner, there are rewards too. Because you get the rest of the appreciation.If the property value actually increased by 6% you would have made approximately 2% of $200,000, or $4000, in the first year and another 2% over $204,000 or $4080 for the second. You had a minimal down payment, say $5000 plus your monthly payments toward the 'down payment' account of $200 per month leased. So you invested on average $5000 plus 24 months/2 times $200 = $7400,00 and made how much profit? $8080 in other words you doubled your money. If the actual market in Calgary went up by 8% over those two lease years you would have done even better.

There is risk, more for you than the investor whom you guaranteed the purchase price. But higher risks give higher returns. What is your risk? The risk is the same as for any other home owner, namely that the market value of the house goes down rather than up. That definitely happens from time to time. But guess what?  At the end of the lease term the house maybe less than your guaranteed purchase price, but you're there for the long haul. You are going to stay there for at least another year or three so the market will have time to recover and you will still be doing fine. Real estate is for the long term (5 to 10 years).

Rent-to-own deals are examples of a win/win transaction. If you are interested in this type of investment, let me know, you can e-mail me at
Just another idea!

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