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How Rent to Own Houses Work in Canada





One real estate strategy that I’m quite familiar with, but never written about, is rent to own or lease option homes.  What is a rent to own home?  It’s pretty much exactly as it sounds.  It’s where an investor, or home owner, rents out their property to a tenant, but gives the tenant the “option” to purchase the home after a certain period of time at a predetermined price.

Home owners sometime use this strategy as an incentive to get their home sold, even if it means taking payments for a certain period of time.  Home buyers with not so great credit, and low amount of savings for down payment,  may find this method of financing attractive.  It enables them to get into a home right away, while building their credit and down payment through rent credits.

For the investor, selling a house via rent to own or lease option is very similar to selling a covered call.  The tenant has to pay the investor an upfront “premium” for the option to purchase the house, this is called the “option deposit”.  At the expiry, which is negotiated between the investor and tenant, the tenant has the option of purchasing the house at a predetermined price.  The option deposit, along with any rent credits, are used as part of the down payment on the house.

How does rent to own work?

  1. House is listed as a rent to own with monthly rent at the high end of rentals in the area, and a small option deposit (1-2% of property value).  The option deposit goes towards the purchase of the home and is non-refundable.
  2. Tenants are screened for decent credit, employment and potential for purchasing home at end of the term.
  3. Tenant moves in, landlord collects rent and option deposit upfront.  A separate lease and purchase agreement is signed.
  4. A small portion of the rent, called a rent credit, is put against the purchase price of the home.  The rent credit is at the discretion of the investor.
  5. If the tenant decides not to buy, the tenant loses their option deposit and rent credits.

Investors Perspective

Benefits

  • Rents are typically higher;
  • Option deposit collected upfront;
  • Tenant is responsible for maintenance and repairs;
  • Tenant typically treats the home as if it is their own; and,
  • Guaranteed sale price if tenant exercises their option.

Negatives

  • Setting a ceiling on selling price of the house, especially in appreciating markets;
  • The initial due diligence required to screen tenants; and,
  • Tenants can walk away from the deal at any time, but investor is bound by terms of the purchase agreement.

Tenant Perspective

Benefits

  • Tenants can “test” the house and the neighborhood and can walk away from the deal at any time.
  • Tenants with mediocre credit can build their credit over the term and build their down payment via rent credits.

Negatives

  • Tenant pays premium rent for the “option” to purchase the house.  If the tenant decides not to buy, the option deposit is lost.
  • Bank financing is not guaranteed at the end of the term.

Final Thoughts

From an investors perspective, this is one way to make money via real estate, however, placing a cap on the selling price is the deal breaker.  Personally, I’d rather build equity over time and keep the property for the long term.  However, I can see this being a viable solution for home owners who are having trouble moving their home in a buyers market.

Do you have any experience with rent to own homes in your area?





12 Comments, Comment or Ping

  1. 1. Tim @ Rent 2 Own Home Solutions

    The cap of selling price does restrict you slightly, but typical appreciation for the rent to own homes is 3-5% a year.

    As an investor, this strategy is more a short term capital building one. If tenant leaves, finding another tenant and collecting another deposit is well worth the trouble sometimes.

    In our program, we put them in touch with a mortgage broker within the first 3 months so they are put on a guide to build up their credit where they need to be to qualify for a mortgage.

  2. 2. eva

    Lease to own real estate in Canada performs much like it does in other areas around the globe. Someone who has a home leases it out to a individual who desires to stay there. They perform out the renting alternatives. The two events also perform out an contract that declares that the tenant will have the choice of buying the property at the end of the rental. Usually the price of the property will be less than if the tenant had tried to buy the property to start with. However, if the tenant chooses that he or she does not want the property, then they do not have to buy it. However the proprietor of the property can choose not to offer.

  3. 3. Ed Rempel

    Hi FT,

    The cases I have seen show quite a mis-match in negotiating power. People that buy rent-to-own are usually people that cannot buy a home the normal way. That means they are either unable to get the down payment or qualify for a mortgage.

    Since the buyers usually have little option, the houses are usually sold to them at an inflated price. This compensates the seller for the risk of the house not selling and for the time delay until the house sells.

    We have had some clients thinking of buying this way, but we always managed to help them figure out how to buy conventionally. Generally, buyers should never rent-to-own, unless they have no other way to buy a home.

    It sounds like it would be profitable for sellers, but the people I know that sold this way usually did it as a way to sell a rental property that they are okay with owning for a while yet.

    Due to the legal issues and complexities, such as calculations of how much of the rent is applied to the purchase price, and shorter term nature, I have not seen any sellers do this with any volume.

    I agree with you that it’s probably more profitable for the seller to keep a rental property long term. For the buyer, they should avoid rent-to-own unless there is no other way to buy.

    Ed

  4. 4. Subversive

    It’s just such a sleazy business. You’re basically dealing with people who don’t understand finances or real estate and taking complete advantage of them in the process. It’s right up there with the payday loan businesses in the ranks of “legitimized businesses which do nothing but take advantage of those who don’t know any better”.

  5. 5. julie

    Negitives for prospective buyer – major money invested (major to them anyways, possibly all of thier life savings was used in the option payment) but they do not control mortgage or have name on title… opens them up to the following risks which I would find unacceptable and so would most business people
    1. what if the seller doesn’t actually make the mortgage payment and the property is foreclosed before the option date.
    2. What if seller, who still has title, doesn’t pay his taxes and Revenue Canada puts a writ on the property. How will title be transfered when the option comes due.
    3. Similarily, what if the seller is sued and a judgement is put on the title. Paying up front and not getting control is too risky.

  6. Great post! But it seems pretty complicated, with a lot of potential down sides to it.

  7. 7. Bryanna

    i would not rent to own as i had done this previously i had mad a agreement that what ever i put on the house i would recieve back that funds however i was paying 720$ a month utilities included that i was paying, that land lord decided to take all the credit building from the bills on top of my providing labour to the home for updates that what i spent would come off of the home. in the end i lost the home and all monies i had put into it along with the thousands of free labour that they scamed me of. Do not rent to own

  8. Here’s why rent-to-own does NOT often work out (but it can)…
    1) buyer has NO real idea what it will take to get a mortgage and that is his or her only real **exit strategy**
    2) The house **will** be appraised at mortgage time and that will set the lending value, so for all the rent-to-own sellers/investors who giggle about setting a 3-5% annual price appreciation, you are NOT guaranteed that price – more likely in the event of a low appraisal the deal crashes on the back of the buyer as it is the buyer that must make up any shortfall between purchase price and lending value PLUS prove his down payment.
    3) rent component MUST be “Fair Market Rent” and this will have to be proved at mortgage time. If rent was below market, CMHC/lenders will simply raise the rental component back to FMR and reduce the buyer’s down payment credits. To arbitrarily manipulate what is considered rent and what is down payment credits is …. yes …. mortgage fraud.
    4) the ONLY reason a buyer should seriously consider this strategy is if his/her purchase price (the strike price in option-talk) is at or very close to market price today and s/he has a market view that house prices will go up in their area. Same for FMR. Otherwise MUCH BETTER to save your down payment money in the bank and NOT put it at risk.
    5) More often than not, it is LACK OF DOWN PAYMENT that really keeps buyer’s out of the housing market. (Credit problems start with LACK of – and need to be FIXED with – yes MONEY). So when the buyer has an option to buy a $300K property, he is going to need to prove at least $15K (5%) plus $3-4.5K for closing costs (per GE/CMHC), so almost $20K one way or the other. That’s up to $1000/mo for 20 months in addition to FMR, if their initial DP is low. Plus they have obligations to pay for all the other stuff the cash-starved buyer spends their money on. Then the buyer has their first late payment and it spirals down from there.
    6) In summary, the buyer is making a bet – they are betting that before their lease expires they will qualify for a mortgage. This could be an easy bet (complete a non-contested divorce, for example) or a high-risk bet (typically any time there is more than one mortgage approval variable to fix (employment, credit, down payment, back-taxes, etc.).

    Rent-to-own can be a bona-fide program and an extremely useful strategy as a steppingstone to a mortgage when set-up correctly, with the proper safeguards, and with an extremely clear eye on the exit strategy for both sides. That means a licensed mortgage professional experienced with rent-to-own is involved from the start and is NOT a party to the transaction. (ie. check out conflicts of interest). BTW, if you think a lawyer knows how to get a mortgage, think again. This strategy is a financing play – nothing more. DIY enthusiasts can expect train-wrecks.

    IF, AS A READER OF THIS REPLY, YOU ARE CONSIDERING RENT-TO-OWN AND YOU DO NOT UNDERSTAND WHAT I HAVE JUST SAID, DON”T PROCEED FURTHER.

  9. 9. Stewart

    Hello just trying to find where I may get the paperwork necessary to use my home in rent to own?/

  10. 10. Cynthia

    I also find this method of financing attractive. You are absolutely right that tenants are screened for decent credit as they should be able to pay monthly rent and then purchase the house. You know, in theory, both sides win, the seller and the buyer. This way the seller gets his cash payments and the buyer immediately moves into the property he likes and wants to live in. But there are also some pitfalls buyers should avoid like, for example, the violation of the contract. If you violate some part of the contract, for instance, you can’t pat your monthly payment when you need to do it and pay it later, the owner can consider it like the contract violation.

  11. 11. sam

    Good Evening,

    I’m just a single girl not very much income however I own my home in Airdrie Alberta and in May 2012 I signed a 3 year lease with an investment company whom is renting out my property for me. Theubare the lessee directly and sublet the home and have the option to purchase at the end of the term may 2015 for exactly what I owe on my heloc. I wonder if you would be able to review my contract as I would like out of this contract to either sell the home now for more than I owe due to changes in the market. How much would you charge to review and advise if I can get out of it.

  12. @Sam, I would recommend that you contact a lawyer.

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