For the past few days the news in Ottawa has been filled with the heart-breaking story of a family that lost $10,000 and was forced to move out in a Rent to Own deal gone terribly wrong. The company behind the deal is allegedly being sued for more than $2.25 million by investors who claim they have been scammed.
There are unethical operators in any industry, but Rent to Own seems to have attracted more than its fair share. It deserves the skepticism that exists in the marketplace. What is going on and what can you do to protect yourself?
One of the big issues in the Rent to Own industry is the fact that there is no professional oversight so pretty much anyone can claim to be a Rent to Own expert and put together their own deals. A quick look at online ads will reveal a plethora of people offering them. They range from groups (with no individuals named) to investors to real estate professionals to companies from other cities. So how on earth can potential Tenant Buyers know what’s real or even know where to begin evaluating the list of possibilities?
The purpose of this blog post is to arm people considering Rent to Own deals with key questions that they should be asking before they consider signing any documents or handing over money.
Question #1: Who are these Rent to Own people and what is their reputation?
These days, anyone can put up a website and offer a product or service. But who are they really? How do you know that they are credible and legitimate? The first step in evaluating a Rent to Own deal is to look very carefully at the company and the people involved. Find out who owns the company and then do a Google search on them. Here are a few things to think about when looking into their background:
- What qualifications do they have? Do they have the training and experience to know what they are doing?
- How long have they been involved in Rent to Own? Real estate investing of any kind requires expertise, knowledge and preferably experience. Inexperience can be very costly.
- Which professional organizations do they belong to? If they’re running a professional Rent to Own company then they will certainly belong to professional trade associations. Find out which and do a search within those organizations to see if there have been any issues.
- Have they written anything substantive about Rent to Own via a blog or other articles? One way to evaluate the knowledge of a professional is to see what they’ve written on the subject. Ask the owner(s) for links to posts or articles and see what you think of their positions and the information they have shared.
- What is their track record? Can you find any areas of concern?
- Can they provide professional references? That is, real estate professionals or lawyers with whom they have worked who can vouch for their credibility? Give the references a call; they may offer more insight in person or by phone.
- Have any of their deals not worked out and if so, why? Ask them about their track record. There are always challenges in real estate investing. If someone tells you that they have never had any issues either they haven’t been at it very long or they’re stretching the truth. Find out what the challenges have been and how they have resolved the problems. Anyone can look good when things are going well. It’s the challenges that tend to expose people’s true nature.
- Have they published a list of testimonials from people and professionals who have used their services? If all they have is a list of testimonials from “clients” with only first names or initials provided, then you don’t have much to go on. It’s better if they can give you professionals to whom you can speak.
Question #2: What is the buy-out price at the end of the Rent to Own term?
We see this all the time: People are so focused on the monthly costs that they pay little attention to the buy-out price at the end of the Rent to Own deal. In a previous blog post, The #1 critical question when considering Rent to Own, we looked at why the final purchase price is so important in determining whether a deal is credible or not. If the value of the house is too high, you will be unable to get a mortgage for the full value because the appraised value will be lower than the purchase price. In most cases, that spells disaster for the Rent to Own deal since few Tenant Buyers have several thousand dollars kicking around to put into the purchase over and above their deposit.
Here’s an example using real numbers to illustrate. Let’s say that a Rent to Own company states that a house you’ve moved into will be worth $300,000 at the end of three years. Three years later you turn to the bank to get your own mortgage and they in turn have the house appraised. Unfortunately, the Rent to Own company used unrealistic appreciation rates and the value of the house is only $285,000. The bank will only lend on a house value of $285,000. The missing $15,000 will have to be made up by you. Would you have that extra cash to put toward the purchase? In our experience, RTO clients are dealing with a number of credit and cash challenges, and the last thing they have is a lot of spare money. If you don’t pay the full price, the RTO company may insist that your option to purchase is null and void and that means that you’ve lost most, if not all, of your deposit and accrued savings.
First, ask the RTO company what appreciation rates they’re using and then turn to a Realtor to see if they are realistic for the house type you’re looking at and the specific zone in which you’re considering buying. Don’t use averages; insist on getting specific numbers that reflect the house type and the location. The ideal scenario is to have an area and house type that show strong, stable appreciation for the last five years. The appreciation rates used by the RTO company should be both plausible and conservative.
Most of the profit in a RTO deal comes from the appreciation in the value of the house which is why this is the number one area where unscrupulous companies will try to cram in profits. Add to that the fact that many clients don’t really question the final purchase price and you have a recipe for problems. In Rent to Own, you really want to start with the end in mind: Is the house price realistic?
Finally, you need to ask one more important question: What if the house price is actually lower than the agreed-upon price, even if the latter is conservative and realistic? This is real estate after all. Prices don’t always go up. What then? What protections are in place for you in this scenario?
Question #3: Will you qualify for a mortgage at the end and what is the Rent to Own company doing to help you?
The only reason that people look at Rent to Own is because they have credit and/or cash challenges that prevent them from owning outright immediately. If a Rent to Own company says that they can approve you for their program, that’s great but that’s only the beginning. The real question is, will you be ready to go at the end of the process? Here is a list of items that a Rent to Own company must provide to you in order for you to clearly understand what needs to be done to be mortgage-ready:
- First you need an assessment of your current situation. What are your liabilities? Do you have any outstanding credit problems that still need to be resolved? What is your Beacon score today?
- How long will it take for you to resolve your credit issues and why? What are the lender requirements when it comes to your particular issue (i.e. bankruptcy, consumer proposal, Beacon reject, etc)?
- Are there any errors on your Credit Bureau that need to be resolved? We see problems on a lot of files. This is a common issue.
- What is your affordability? How much can you afford to buy given your income and liabilities? Conservative estimates should be used for all factors in evaluating affordability and you need to ensure that you can qualify for the buy-out price.
- What will your Total Debt Service and Gross Debt Service ratios be when you buy out? Are they in line with lender requirements?
- What Beacon score do you need by the end of the deal in order to ensure that you qualify for a mortgage? If your TDS goes above a certain level, you need a higher Beacon score. Ask if this applies to you.
- What steps do you need to take to improve your credit file?
- Do you have enough credit instruments and are the credit limits high enough to meet lender requirements?
By the end of the evaluation process, you should have a clear picture of where you are today, what you need to do in the next two to three years and what it will take at the end in order to be mortgage ready. If you do not know the answers to any of the above questions then ask for more information. Ensure that you have a plan. You are responsible for executing the plan but you should have clear guidance from the Rent to Own company in order to increase your chances of success.
Also – and this is important – what process does the Rent to Own company have in place to follow up with you to ensure that you’re on track? If they shake your hand when you move in and then go silent for the duration of the term, they’re pretty much relying on you to be the expert in credit repair.
Rent to Own is about so much more than buying a house for clients. It’s about helping people repair past issues in order to get to a position of strength and independence. Yes, the client has to do the work but the RTO company should be providing a clear path to follow.
Question 4: What is the monthly rent and what does it include?
There are two key components to the rent in a RTO deal. First, there is the cost portion of the house and that calculation should be based on the true cost of the house being purchased. Use an online calculator to figure out what your mortgage payment would be if you were to buy the house today. Most RTO clients give a down payment of 5%. If that’s the case for you, assume that you’re going to be borrowing 95% from the bank, use a term length equal to the RTO term, use a 25 year amortization (i.e. currently required by lenders for purchases where the down payment is less than 20%) and use an average interest rate. That will give you an idea of what the mortgage cost would be. If you’re being charged more than that, ask why. There shouldn’t be any mysterious numbers in the process.
The cost portion also includes the property taxes and house insurance. Be sure to factor in average increases each year for both and average out the costs. The total of the mortgage plus the taxes and the insurance is the cost portion of the house.
Second, there is the savings portion. Currently, lenders require a minimum down payment of 5% plus 1.5% for closing costs. The least you should be saving within the program is therefore 6.5% of the final purchase price. If the savings portion proposed to you is less than that, you may not have enough cash to do the deal at the end.
In short, the monthly cost should include a cost portion that is understandable plus a savings portion based on real figures and the minimum requirements listed above.
It might be OK to draft up a quick one-page agreement with a family member for a small personal loan but where real estate is concerned you want to ensure that all of the documentation is thorough and professional. Here are a few documents to look for:
- Proof of deposit. Do you have a signed document confirming the amount you disbursed initially? There should be a paper trail for every step.
- Lease Agreement. This document should outline the terms of your rental for the entire Rent to Own period.
- Option to Purchase. This is the most important document of all. The Ottawa Real Estate Association provides a generic, professional document that you can use as a starting point. Ask a Realtor to provide this form. Schedule A should outline all of the clauses that protect both the Tenant Buyers and the investors. Ensure that everything is listed in detail including the amount you gave as a deposit, the amount you’re saving on a monthly basis and any other conditions related to the purchase at the end of the Rent to Own term.
Once you have gone over all of the documents and you are satisfied that you understand them, have them reviewed by your lawyer. It is important to understand your rights and obligations within the RTO program. If you have any questions or concerns, ask for more information and clarification from the company. If your gut is telling you that something isn’t quite right, listen! Call another RTO company and find out what they offer. Compare notes and documents. Above all, ensure that all of your questions and concerns have been addressed.
Rent to Own can be a powerful, effective tool for families when it’s done properly. Like any other industry, there are companies doing it well and others who are setting up their clients and investors for a big fall. It pays to ask a lot of questions and to do your homework thoroughly. Insist on working with honest, reputable companies. They do exist.