Lease To Own – Get Quality Long Term Tenants And Higher Cash Flow Via Purchase Option (Part I)

As a rental properties investor, the most important thing is to have properties that are assets, not liabilities. This means receiving a good rent, keeping the house in a great condition, and having a good tenant. While it seems difficult to achieve all of this in today’s tough rental market, it’s possible with lease to own. Our years of experience of self-managing our own remote properties, without enlisting ineffective and expensive property managers, leads us to believe that giving tenants a lease-to-own option is a great way to ensure your properties will earn you money. Even if you use a local property manager, a lease-to-own plan still makes sense when compared to a stand alone rental only terms.

A lease to own, also called rent-to-own, or lease option, gives the tenant the right to purchase the rental property at some future time. In return for this right, tenants pay an option premium, which consists of a one-time fee when the contract is signed, as well as an ongoing monthly premium in addition to rent. This onetime fee at move in could possibly be in the form of security and pet deposits. The option premium becomes all or part of down payment on the house if the tenant exercises the option to purchase. If the tenant doesn’t exercise this option, or cancels it prior to the end of the lease to own term, you get to keep the premium.

There are two types of lease to own options: short term and long term.

Short term / traditional lease to own

A short-term lease to own ranges from six months to one year. This is not what we will focus on in this article. Our goal is to have a longer term, stable tenant. Therefore a short term lease to own contradicts our goal. A short term is ideal if the seller is wishes to sell soon, yet finds this difficult to due to either the market condition or the buyer’s inability to get a mortgage. The sale price should be agreed-upon by both parties when the lease to own is signed, since the time value is diminished or very minimal.

Long term floating price lease to own

On the other hand, a long-term lease to own option expires in three to five years. This is what this article is focused on. It is a more attractive choice for both seller and buyer. Due to its long term nature, the seller is able to collect more option premium and enjoy a lower tenant turn over rate. In addition, the buyer is able to accumulate a sufficient amount of the down payment and repair credit. This arrangement really works favorably for both parties.

The purchase price, traditionally, is pre-determined at lease signing. Our Do-It-Yourself Kit: Long Term Lease To Own sets a floating price within a price range, especially if it is a long term contract. This gives more flexibility and protection to both parties.

What Are the Benefits of Lease to Own?

A lease to own creates a win-win situation for both seller (owner) and buyer (tenant). We will explain not only the benefits to the owner so you are convinced but also the benefits to the tenant so you can convince them.

Owner’s Benefits

Less tenant turn over

No landlord likes to change tenants because it involves a good amount of time, capital in advertising, and cleaning and repairing the house. The house may sit without being rented for a long time if the market is competitive. So how do you make sure this is less likely to happen? The trick is to make the tenant feel a sense of belonging. No one likes to move if its unnecessary, especially if one is a homeowner. A lease to own contract makes the tenant feel the privilege and the pride of home ownership. Tenant’s investment on the house also makes him more likely to stay put.

Quality tenant

It’ s a nightmare to dealing with or having to evict a bad tenant. Getting a quality tenant for makes stress free property management down the road. A little more time and effort in finding a quality tenant is well worth the effort. Better safe than sorry, right? Lease to own by nature filters out the unfit. Since lease to own requires option premium from the tenant, those can afford this generally are better in financial standing. Furthermore, those tend to be more responsible and reliable as they consider themselves more of a home owner rather than a regular renter.

Lower maintenance costs

It is human nature that people tend to care for their own things more than those owned by others. Since a lease to own tenant is virtually a homeowner, the sense of home ownership makes the tenant treat the house like his own. Gone are the minor maintenance requests from the tenant. The tenant is also more likely to take preventative measures, such as changing air filter and caulking.

Elimination of property manager

You are putting property management in auto pilot mode. As aforementioned, when the tenant is responsible for maintenance, you cut the cost of using a local property manager. You can even share this savings with the tenant by reducing the rent.

Higher monthly rental income

Cash flow is important to investors. With lease to own, you are able to collect more income and put this additional income into a good use. Here is a practical example. If the fair market rent is ,000, you can market the house for lease to own at ,050, and out of it is the option premium. This makes actual rent 5 (,050-), which appeals to the tenant. Yet your monthly income is ,050. That is additional cash flow beyond the fair market rent. If the tenant does not buy the house at the end of the lease term, you get to keep these premiums. On the other hand, if the tenant does buy the house, then you have received a good return on your investment.

Increase in house value

The tenants are likely to increase the value of the house. For example, they might make a nice backyard, install an expensive lighting fixture, or buy nice window drapes. This increase in value will be beneficial, regardless if they purchase the house or not. If the purchase does not happen, most likely you will be able to keep all the home improvements. If the purchase happens, the sale figure may be higher due to the improvement.

Save real estate agent fees at purchase transaction

Since you have located your buyer, you don’t have to shell out a big chunk of money in paying real estate agents for bringing you the buyer. Nor will you need you pay the seller’s agent for marketing the house. If you choose to use an agent to facilitate the transaction and paperwork, the fee will be considerably less than the full blown commission that is usually at 6% of the transaction amount. Another saving might be the elimination of home inspection if the buyer deems this unnecessary.

Tenant’s benefits

Saving for house purchase down payment

Tenant saves every month. At a month, tenant will accumulate ,500 in 5 years. (×12×5) Combined with the initial option premium, which can be security deposit, the tenant will have almost ,000 for the down payment. This savings would not be possible if not for lease to own.

Rebuild credit

Many tenants have low credit ratings, and thus won’t be be approved for mortgages, especially these days when banks are cautious with their lending practices. A lease to own term allows the tenant enough time to repair credit in order to be considered for a loan. Also, since the payment history is the most important factor of the credit score, an owner can even provide the service of reporting tenant’s payment history to the credit bureaus. This can be a huge incentive for the tenant to pay rent on time.

Possible seller financing

It is also called an installment sale. The seller can offer the buyer an alternative to bank financing by having them make periodic payments to the seller, just like a rent payment. The installment sale also provides benefits to seller in capital gain tax deferment. The capital gain taxes are partially or fully deferred over the term of the note.

Feel of home ownership

Tenant feels as if he is a homeowner rather than a renter, yet he is not responsible for many expenses that incur to a homeowner such as property tax and hazard insurance.

Continue to Read Lease to Own – Challenges and Considerations (Part II)

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