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adrw // Andrew Alexander

Rent to Own

Finance4 min read

While in university, an elderly friend of mine mentioned Rent-to-Own as an option as I wondered aloud about the steeply rising house prices in the area and whether that would be in our future.

I didn't look to closely into it until I recently stumbled across a number of videos (Rent to Own Real Estate in Canada with Rachel Oliver, Breaking Down A Rent To Own Deal , What is Rent to Own Investing in Canada with JAAG Properties, Building a Real Estate Empire of 100 Properties with Rent to Own, What if Rent-To-Own Tenants Leave?, ) from Matt McKeever digging into the model of Rent-to-Own with some RTO companies. The below is a summary of what I've learned as I've tried to better understand RTO and in what circumstances it is a good decision for a house purchaser, an investor, or when it leaves either high or dry.

In practice, a RTO deal from the perspective of the investor is an interesting combination of writing a 9x–levered covered call on the house and additionally receiving rent payments monthly for the house (as well as other beneficial terms such as offloading maintenance to the tenant-buyer).

Example

The numbers for this example have been copied from a video by JAAG Properties explaining one of their past deals. They additionally have other videos covering exit strategies if the purchase doesn't go through, and other information from tenant-buyer and owner-investor perspectives.

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Renter Case Analysis

Scenarios \ House PriceBelow SPAt SPAbove SP
Renter completes the RTO and purchases house at end of term at SP
Renter misses two rent payments and is evicted in month 24 of 36
Renter completes RTO and doesn't purchase home

Investor Case Analysis

Scenarios \ House PriceBelow SPAt SPAbove SP
Renter completes the RTO and purchases house at end of term at SP
Renter misses two rent payments and is evicted in month 24 of 36
Renter completes RTO and doesn't purchase home

Implementation Differences (Exploitive vs Educational)

In research on YouTube, it became clear that implementing a Rent-to-Own can be done across a vast spectrum ranging between exploitive and educational.

Exploitive

One video in particular from the United States advertising the opportunity to investors suggested that a primary generator of the ROI from RTO compared to managing a rental property is getting to keep the up front deposit from a 80-90% failure rate his deals have experienced of tenant-buyers not following through with purchasing the house at the end of the rental term, and thus forfeiting to the owner-investor the deposit.

Though the deal likely had this outcome explicitly stated, it left a bad taste in the mouth reminiscent of payday loans or other credit sharks preying on hopeful, down-and-out, credit unworthy people who enter the agreement with dreams of owning a house with part of the rent cheque, and leave three years later not owning the house but forfeiting most of their likely cash savings as part of the RTO deposit and monthly option consideration payments.

Extending credit to less worthy borrowers can be noble, if it allows them to responsibly start to use the wealth growth and credit worthiness improving strategies available to others to get their families out of their current low-wealth and credit-unworthy situation. When the dream of home ownership is used to bait credit-unworthy borrowers into hopeless deals (likely to fail to exercise the option and purchase the house at term completion) and maximally extract through non-refundable deposit payments, RTO seems to verge on payday loan level exploitation.

Another video from Community Legal Services of Philadelphia explained one of their cases of a naive tenant-buyer entering into a poorly documented fraudulent RTO deal, and finding out she had been burned by it when she got notice that the house she was living in and believed to be renting-to-own was being set up for Sheriff Sale (it was being foreclosed) and the owner-investor was unreachable and never to be seen again.

Surprisingly though, the conclusion of the legal case was not that the tenant-buyer swore to never trust an RTO again. Instead, the naive tenant-buyer found a new RTO deal and used the legal services to confirm that the agreement was legitimate and the terms were fair.

The persistence of the tenant-buyer to find and stick with RTOs led me to believe that though RTOs can be both exploitive and legal, or fraudulent and illegal, there are cases where the tenant-buyer is happy, thankful, and financially benefits from a legitimate RTO deal.

Educational

A different approach that other videos like found on Matt McKeever's channel or by JAAG Properties in Southwestern Ontario focuses on the relationship with the tenant-buyer family. The family comes to the RTO company with low credit and wanting to purchase a house, and the RTO company partners with them financially and educationally to help them by the end of the rental term get approved for a mortgage and follow through with purchase of the property.

Some of the RTO companies would have a mandatory personal finance education component to the deal, complete with budget review and monthly check-in meetings with tenant-buyers to provide accountability in helping them form new habits that will improve their credit worthiness including paying down credit card debt and saving aggressively to ensure future ability to make down payment on the property.

The testimonials and attitude of the RTO company with this relational and educational approach appears to be much less exploitive and more noble in extending credit and a robust, practical, and lived out financial education to a credit-unworthy borrower.

The RTO companies taking this approach also seem much more interested in ensuring the tenant-buyers follow through with the home purchase, and treat the failure to do so as a non-ideal outcome. This is born out in their results, JAAG properties for example has 163 open RTO deals (mid-term), 58 completed, and based on their video interview with Matt McKeever only 4 deals where at term the tenant-buyer did not follow through with the house purchase. Though these statistics are incomplete, not annualized or per-cohort normalized, it does appear to point to a RTO business model and approach that is in theory and in practice more aligned with the tenant-buyer's goal of purchasing the house at the end of the term.

Based on this dynamic between exploitive and educational RTOs, as an investor I would likely not feel comfortable considering any deal that was not educational, relational, and largely aligned with the incentives of the tenant-buyer.

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