There are many uncommon and powerful property strategies, ones that can make shrewd investors a killing. This is the third blog in the KPS series and looks at the strategy of rent to buy.
In Killer Property Strategies, I looked at (1) options and (2) bridging loans. In Killer Property Strategies II, I considered (1) seller helping and (2) buy to split.
Whereas those strategies are most appropriate for investors, rent to buy is suitable for both investors and persons simply looking to buy their first home. In fact, for various reasons, it is probably more suitable for a home-buyer than an investor.
1. What is rent to buy?
Rent to buy is where you rent a property from the owner and you are given the right to buy that property within a fixed period of time for a fixed agreed price.
You will normally get the right to buy by way of an option agreement. I deal with options in my blog KILLER PROPERTY STRATEGIES
THE PERSON RENTING CAN BE AN INVESTOR, WHO WILL SUB-LET THE PROPERTY TO THEIR OWN TENANT, OR IT CAN BE A REGULAR TENANT WHO WILL LIVE AT THE PROPERTY.
2. Key features of a rent to buy agreement
The key legal elements of a rent to buy deal will normally be:
- A tenancy agreement entitling the tenant to occupy or sub-let the
- An option to purchase agreement giving the tenant the option to
buy the property for a fixed agreed price within a set time period, often between 2 and 5 years.
A key feature of an option is that it gives the right to buy but not an obligation to buy.
THE OWNER OF THE PROPERTY WILL USUALLY ASK FOR A PREMIUM OR LUMP SUM PAYMENT AT THE START OF THE TENANCY.
The premium will depend on the value of the property but you should resist any premium which is more than 1% of the purchase price.
Ideally you want this payment to be treated as part of your deposit when you come to buy. However, the owner may want to treat it as a non-refundable payment in return for offering you the deal.
What actually happens will depend on what you can negotiate and agree with the owner.
SO THAT I CAN SEND BLOGS TO YOU AS THEY ARE PUBLISHED, PLEASE SUBSCRIBE TO MY BLOG
THE DEAL WILL NORMALLY BE STRUCTURED SO THAT EACH MONTH YOU PAY THE NORMAL MONTHLY RENT, PLUS A BIT EXTRA, SAY £100, WHICH GOES TOWARDS YOUR DEPOSIT WHEN YOU PURCHASE.
The owner will normally want you to be fully responsible for repairing and maintaining the property until it is purchased. You will want the right to be able to carry out works and improve the property should you decide to do so in advance of your purchase.
3. Legal input and documentation
It goes without saying that you should not enter into a rent to buy agreement, or pay over any money to the owner, before taking legal advice.
The agreement you reach with the owner should be in writing and both sides should have their own solicitor.
A rent to buy agreement is not a common everyday legal agreement, and you should ensure that the solicitor you engage is experienced in that area of work.
It is best practice to have the property formally valued by a surveyor before agreeing the purchase price in the option agreement. If you agree too high a price you may not be able to secure a large enough loan when you come to buy.
4. Advantages of the strategy
The strategy has advantages for the owner and the tenant.
The benefits for the owner include:
- The premium (where the owner is entitled to keep it)
- The advantages of a delayed sale (financial, practical or fiscal)
- A chance to find a buyer for a tired, difficult to sell property.
An owner may have a property which is in a poor condition and not cost-effective for them to refurbish. However, the refurbishment may appeal to a buyer who is given a chance to purchase at a competitive price and has plenty of time to improve the property pending purchase.
The main downside for the owner is that the buyer is not obliged to purchase the property and may be unwilling or unable to do so during the option period.
A prudent owner will want to secure some level of protection by keeping the option period as short as possible.
If you are the tenant/buyer, a rent to buy agreement may appeal to you for several reasons.
- Your credit record may be poor when you move in and you can improve it by the time you exercise your right to buy.
- With the price being fixed in the agreement, you know the future price you must pay and therefore have certainty.
- You know the deposit you must find. You are able to save the deposit at the same time as you rent.
- By incrementally carrying out works to the property until you are ready to buy, you can improve it bit by bit, ensuring it is in a good condition when you buy and hopefully worth more than you will be paying for it.
- By having the right but not the obligation to buy, you can walk away if your circumstances change and you are no longer able or willing to buy.
If you need to walk away, you should check your agreement to see the consequences of walking away. You may lose the premium paid and you may also lose part of the deposit fund you have amassed.
At the pre-agreement stage, you should try to secure the best walk-away deal possible.
Ideally you want to get back the premium and your deposit fund in full if you choose not to buy. However the owner is unlikely to be happy with that and so a compromise may have to be reached.
5. Risks faced by the tenant/buyer
You need to be aware of the risks of this strategy if you are the tenant/buyer. If there is a mortgage on the property, you are reliant on the owner paying the mortgage until such time as you are ready to buy.
The rights of the mortgage company will be greater than yours. If, for instance, due to non-payment of mortgage, the mortgage company is entitled to take possession of the property, your right to buy will not be enforceable against them.
YOU MAY BE ABLE TO SUE THE OWNER FOR BREACH OF CONTRACT, BUT THAT MAY NOT BE PRACTICAL OR REALISTIC IN THE CIRCUMSTANCES.
If the premium is a contribution to your deposit, you should insist that it and your deposit fund are fully protected – for instance, by being kept in the clients account of the owner’s solicitors.
There is no certainty that you will be able to obtain a mortgage during the period of the option. It is good practice to try and secure a clause in the agreement that you will be entitled to the return of the premium and your deposit fund if you are unable to secure a mortgage.
If you are a tenant/buyer who will live at the property, you have the advantage of being in occupation and have a certain amount of control over the situation.
If you are an investor – a tenant/buyer who is going to put in your own tenant into the property, you will face greater risks. Not only will you have the risks mentioned earlier, you will also have risks associated with having a tenant.
If your tenant doesn’t pay the rent or you have periods where you can’t find a tenant, that will indirectly add to your overall purchase costs and may make the deal unviable.
Similarly, if your tenant damages the property or fails to maintain it in a good condition, that will also hit you in the pocket.
Rent to buy is a creative strategy which offers a tenant/buyer or investor the opportunity to buy a property in the future for a price which is agreed now. It has many attractions, but it is not a common strategy and it is not low-risk.
Before embarking on this strategy you should seek advice and assistance from a suitably qualified property expert.
If you have not signed up to get my latest blogs sent to you weekly, please do so HERE
Rebel Property Coach
My website is: www.rebelpropertycoach.com