|Investors - How To Buy a House For Your Rent To Own
First and foremost, this article is for investors. As an investor, you should not (must not) have
any emotional ties to any of your properties. You are in this business to make a fair and honest profit,
and you will sell your home(s) when it makes sense to do so. Your goals should be to buy low
and sell high, generate a positive cash flow while you own the house and use as
little of your own money as possible. OK, so now how should you go about buying a house for your
rent to own inventory of homes?
Location: Stay in your comfort zone. If you are not familiar with the laws and regulations in
other states, stay in your home state. If you must "touch and feel" (see) your properties, stay within
a comfortable driving range. If you are not comfortable with certain types of neighborhoods, whether
it be an urban blight area or upscale posh area, don't go there. There are plenty of opportunities in
your comfort zone. All you have to do is find them and BE PATIENT.
Buy low: The best way to do this is to find a motivated seller. Here are some obvious (and
some not so obvious) ways to find that seller:
1. Search the MLS listings in your preferred location(s) for properties that have been listed for
more than 90 days.
2. Check public records for foreclosures and/or tax delinquencies.
3. Read the obituaries in your preferred location(s). There might be a house in the estate that must
4. Check public records for divorce filings. Many times a house must be sold to satisfy a Judgment.
5. Advertise in local newspapers and on the web (for example, place a free wanted ad on
JSC Rent To Own Homes).
6. Look for a high growth area where builders are extremely active. You will discover there will be
people who are unable to sell their home because the builder incentives are capturing all the qualified
buyers. These neighborhoods are usually very desirable, and there are motivated sellers unable to
sell. That sounds like an opportunity, doesn't it? Here is your advantage. The person that you will
try to find to rent the house after you buy it probably is not a qualified buyer to the builder.
Builders want bank qualified buyers. Typically, people who are seeking a rent to own opportunity
do not qualify for a mortgage with a bank. All you have to do is have a good renter/buyer lined up
to move in to that desirable neighborhood.
7. Let your good renter/buyers find their own rent to own home. If you have a good prospective
renter/buyer that is asking for your help (and you will if you do your job properly), give them the
opportunity to find their own rent to own home. You have to set the ground rules, and they will think
you walk on water. It is strongly suggested you develop a relationship with a good realtor who will
follow your ground rules, take your renter/buyers on showings (most homes are listed anyway) and save
you the time of doing this yourself.
Bottom line - If you find a motivated seller, you should be able to buy the property below appraised
Sell high: In this scenario, sell high refers to the option price you will set with your
renter/buyer. Keep this in mind - If your renter/buyer was able to qualify for a mortgage today,
he/she would probably not be your renter/buyer. He/she would simply buy a house without your help.
Furthermore, the renter/buyer is probably a frustrated renter who wants to be a buyer. In other words,
you have a motivated prospect, and that prospect should understand that you are a business person who
is entitled to a FAIR profit in exchange for the risk you will take to help them. Bottom line - your
prospect is probably not very price sensitive, and he/she will probably accept any fair number. In my
opinion, a fair option price should be the current appraised value (not necessarily what you paid for
the property) plus an amount equal to the average annual rate of increase compounded annually for
each year of the option term. Allow me to explain by way of example:
First, try to keep all of your option terms to one year. It's to the seller/landlord's advantage. So,
assume you own a house with an appraised value of $150,000 and prices have been increasing an average
of 8%. For a one year contract, you should set your purchase price at $162,000 ($150,000 + 8% of
$150,000 or $12,000); a two year contract, $175,000 ($162,000 x 1.08 = $174,960).
Positive cash flow: Cash flow is defined as the amount of money you receive per month minus
the amount of money you spend per month. Obviously you want that to be a positive number.
1. First let's look at how to minimize the amount of money you spend per month:
Your mortgage loan: You could put a large amount down to minimize your monthly payments, but that
would not be wise. The best thing you can do is find a good lender who is willing to work with you.
They are out there. A good lender will realize that you will bring in many deals, and most up front
fees should be greatly reduced if not eliminated. Ideally you should be able to borrow up to 90% LTV
amortized over 30 years without having to purchase mortgage insurance. You should avoid high interest
fixed rate loans. You plan to sell the house in a short period of time so a 30 year variable rate loan
with a fixed interest rate period of 3 or 5 years will be much better. In our example, we borrow
$135,000 at 5% amortized over 30 years. That is approximately $725 per month (principle and interest)
Furthermore we use an additional $300 per month for taxes and property insurance.
The lease: Your tenant is not just a lessor. Contractually he/she has the right to become the owner
of the home. As such the tenant should develop a "pride of ownership" attitude and be responsible for
most of the minor maintenance issues that arise with any home.
Ownership: Get a good real estate attorney and an accountant. They should be able to explain the
advantages/disadvantages of personal versus LLC ownership including liability issues. This will help
you determine the extent (and cost) of insurance you will want to have.
2. Now, let's look at how to increase the amount of money you receive every month:
Here's a little known fact - Over 90% of all people who enter into a rent to own agreement fail to
exercise their option after one year! Do you remember I said to try to keep all of your contracts to
one year? Besides maintaining better control of your investments, this little known fact can be hugely
advantageous to you, the business person. Now, PLEASE keep this in mind; if you have a GOOD tenant who
is unable to exercise his/her option, WORK WITH THEM. You should renegotiate a second year to your
advantage, but not one that would force a good tenant to leave.
OK, here's what you should consider (by way of example).
Using the above example, a reasonable contract might stipulate an option consideration of $8,000
(to be fully applied toward the down payment upon exercising the option) and a monthly rent of $1,100
per month of which $100 will be applied toward the down payment providing that monthly rent payment
was made on time. After one year, assuming all rent payments were made on time, the tenant/buyer will
have accumulated $9,200 in credits ($8,000 plus $100 per month). One can view the actual monthly rent
as $1,000 assuming the option is exercised. If the tenant/buyer fails to exercise the option for any
reason, That $9,200 is forfeited by terms of the contract.
To increase your cash flow, offer the tenant/buyer greater credits in exchange for a higher monthly
rent. For example, in exchange for $1,300 per month, offer the tenant a $400 rent credit for every
on-time payment received. Now, it can be viewed as a monthly net rent cost of $900, and the total
equity built would be $12,800. If you present this properly, you can let the tenant negotiate for
higher rent payments! You will have a much better cash flow, and there will still be a nice profit
if the option is exercised provided you properly purchase the house. If the option is not exercised
(90%+ odds it won't be exercised), you keep all the rent monies paid. But, again, PLEASE keep this in
mind; if you have a GOOD tenant who is unable to exercise his/her option, WORK WITH THEM. You should
renegotiate a second year to your advantage, but not one that would force a good tenant to leave.
Use as little of your own money as possible: With diligence and patience, you will be able to
buy a home for less than appraised value. Rather than buying the house at the reduced amount, pay the
appraised value and take the difference as an allowance for, say, remodeling. Take this money in the
form of a bank check. Using the above example, assume you are able to negotiate a purchase price of
$140,000 (this is possible, in fact, doable if you do your homework). Tell the seller you will pay
$150,000, and they must give you a bank check for $10,000.
Now you will finance 90% of the purchase price of $150,000 which equals $135,000. You need a down
payment of $15,000. Your actual out of pocket cost is $5,000 because of the $10,000 allowance.
Summary: We will assume the tenant/buyer takes advantage of getting additional rent credits,
makes all rent payments on time and the option is exercised after the first year. Using the above
example (which is based on a composite of actual deals) and not accounting for miscellaneous costs
(for simplicity purposes), here is the deal:
1. Cash spent - $17,300 ($5,000 out of pocket down payment plus $1,025/month P.I.T.I.)
2. Cash received - $23,600 ($8,000 option consideration plus $1,300/month rent)
3. mortgage obligation: $135,000
4. Received from sale - $149,200 ($162,000 minus $8,000 option consideration minus $4,800 rent
Profit from cash flow = $6,300 ($23,600 minus $17,300)
Profit from sale = $14,200 ($149,200 minus $135,000)
Total profit = $20,500
$20,500 profit divided by $5,000 out of pocket = 410% RETURN IN ONE YEAR!!!
If the tenant does not exercise the option, it can only get better.
Bob Pappas is an associate of JSC Rent To Own Homes, a
unit of JSC Investments LLC. Bob acts as an investing third party in certain situations where either a
renter would like to purchase a new house or the house he/she is currently renting, or a seller wishes
to sell his/her property through a lease purchase agreement.
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