Having a rent-to-own agreement with a tenant can be both profitable and charitable, as it gives a chance for homeownership to someone who would traditionally be overlooked. While many perks can come along with rent to own for real estate investors, that doesn’t mean it’s without risk. If you need to learn how to evict a rent-to-own tenant legally and safely, read on.
Evicting a rent-to-own tenant isn’t a straightforward event as it’s dependent on the laws of your state. Consult a real estate attorney for the specifics of your area and secure your assets by creating an option contract that is separate from the rental agreement. By having an option contract, you’ll be able to revoke the option for your tenant to purchase the home, thereby allowing you to begin the eviction process.
But rent to own isn’t all doom and gloom; it can actually be quite profitable. Let’s dive into what a rent-to-own agreement means and some tips for how you can have it work for your investment strategy.
What Does “Rent-to-Own” Mean?
Rent-to-own properties are similar to other homes that a real estate investor owns. These are properties that are held with the goal to eventually flip them for a profit.
However, the way they are sold differs greatly from other investment strategies like fix & flips or wholesale properties. Rather than being sold outright to a buyer, these homes are instead rented to the potential buyer for a fixed amount of time. Once that time limit is up, the renter then purchases the property from the seller outright.
What is the Appeal of a Rent-to-Own Property?
While you, as the seller, would be the property owner longer in a rent-to-own agreement than you would another method of real estate investing, that doesn’t mean it’s not worth the additional time.
For one thing, having an interested party already occupying the home means that you may have less of a hassle flipping the property for a profit. By having an active renter become the owner, the work you’d typically have to do fixing up the property, listing it through a real estate agent, negotiating contracts, etc., are pretty much removed.
Another reason is that it’s very common for the renter to be responsible for all maintenance and upkeep of the property, even while you’re still the owner. Having a rent-to-own agreement gives you the ability to be hands-off on the care of the home while still having the equity.
What’s in it for the Renter?
Why would someone want to take responsibility for a property without owning it outright? It boils down to what’s known as “Pride of Ownership.”
Pride of Ownership is a term that refers to the psychological benefit a renter receives in a rent-to-own agreement. Quite often, the renter cannot get approved for traditional mortgages due to poor credit history or unstable income history, so rent to own gives them an avenue towards homeownership that was previously unavailable.
Are Rent-to-Own Properties Good Investments?
Rent to own properties can be good investments for real estate investors who have trouble flipping a property for whatever reason. Not only will your tenant be the one in charge of repairs and upkeep, but you may be able to increase your profits in a way that traditional flipping wouldn’t.
It comes down to capturing the appreciation of a home while it’s renter-occupied. This is contingent on the contracts you have with your tenant, so have a real estate attorney guide you through this. Essentially, you may be able to reap the benefit of the marketplace heating up throughout your rental agreement.
In addition, rent-to-own may be able to pad your profits thanks to higher monthly payments you can charge. Let’s say that a standard rental agreement for a property like yours would run around $1500/month. In a rent-to-own agreement, you may be able to charge $2000/month by agreeing to put that extra money as a credit towards their eventual purchase price. Having that additional $500/month now can go towards more investment properties and grow your portfolio much faster.
Things to Consider Before Starting a Rent-to-Own Investment
While there are many upsides to running a rent-to-own agreement for a property, that’s not to say you won’t be susceptible to risks that are unique to this business model.
For one, you might end up leaving equity on the table if your contract doesn’t take into account changes in the marketplace. If your property appreciates without your contract accounting for it, your renter may get an incredible deal that leaves you with less profit.
In addition, if you’re looking to expand your cash flow, then a rent-to-own business model might not be for you, as you’ll have to constantly replace your inventory which can create instability in your budget.
Lastly, and most unfortunately, rent-to-own agreements rarely mature into purchase contracts. This is rarely due to any fault of your own and is mainly caused by your tenant being unable to get financing due to the very reasons they weren’t able to buy in the first place. Unfortunately, old habits die hard, and if your tenant has been unable to improve their credit scores or show a more stable income history, you may be on the hook for the property you had assumed would be out of your hands.
How to Ensure Maximum Profits with Rent-to-Own Contracts
While you may not avoid financing issues your tenant faces, there are ways to get around the appreciation problem.
It comes down to the terms of your contract. Again, please consult an attorney for the details for doing this, but essentially, you may be able to base your contract on the appraisal value at the time of sale. To do this, you’ll need to stipulate that the purchase price is based on a formula that factors in:
- The appraisal value at the time of sale
- A discount on that value (I usually say around $10,000)
- A hard limit which the price will not go under
By having this set up in your rent-to-own agreement, you’ll be able to entice your tenant by offering them the agreed-upon discount while not leaving tens of thousands in equity on the table.
How to Evict a Rent-to-Own Tenant
If you come upon the unfortunate event where your renter cannot get approved for a mortgage, you’ll need to make some tough decisions for how to evict a rent-to-own tenant. No one wants to be in the position where they have to evict someone from a home, but sometimes these things have to happen.
Evicting your tenant is a tricky situation as each state has its own set of rules for eviction procedures. However, one way you can help reduce your legal exposure is by having an option contract.
Option contracts should never be part of a rental agreement; they should always be separate agreements. Having them as a wholly separate legal agreement will help reduce confusion if the need arises.
An option contract works like this: If your tenant is not making payments on their rental agreement, then the option contract stipulates that they lose their option to purchase the property.
Again, consult an attorney about how this works in your specific state to ensure your legal documents are all in compliance.
Rent to own properties can be a great way to hold ownership of a property that creates not only profits but goodwill. Creating an opportunity for someone to become a homeowner when it was previously out of their reach is not only a great feeling, but helps improve your local community, too.
But it doesn’t always work out the way you hope it will. When that happens, make sure you’re prepared with legal agreements that protect you and afford you the ability to evict a non-paying tenant and start anew. Give a few of these tips a try and let us know if we missed any by leaving a comment below.