How does rent to own work?

Question

I have a property in Worcester, MA that I could sell for about $250,000.  It's a three family.  Someone in the neighborhood, a contractor/remodeler wants to rent to own the whole three floors.  Usual rent is $1,100 each unit.

How would rent to own work?  Also, is it a deal for a seller?

My plan for most of the money is to invest it for retirement in stocks and bond funds.  I'm not intending to use more than $40,000 for something other than that.

I just want to know how it works.  Thank you very, very much to anyone who can enlighten me!

Brian J Allen · Answer

Now is a great time to sell in Worcester.  if you can get $3300 a month then you should be able to get $275k-300k for the 3 family unless you need things like a roof and windows which could drop the price.  i agree with Wes on the lease option side where they get an option to purchase the house at a fixed price for the term of the tenancy.  it is much easier and cleaner to sell.  That being said, you may have tax implications you have to address and perhaps need to do a 1031 exchange so as not to pay the taxes on the depreciation and the capital gains.  Renting would allow you to avoid dealing with those things for a while.  if you are still trying to manage your property and collect rents and plow/shovel all of those issues go away with a sale.

Wes S. · Answer

@Kate B. I believe you're thinking about the "lease with the option to purchase," or just "lease option." The tenant pays an amount up front, and you give that person the option to buy the house over the next X number of years at a fixed price you decide at the beginning. Sometimes the tenant's rent can go towards the overall amount owed.

Keep in mind that the lease option means that during the length of the contract, you cannot sell to anybody else. You can read more about it here on BP, as it can be a good exit strategy.

Dave Foster · Answer

@Kate B., I know you're starting out shallow but this could turn into the deep end of the investing and 1031 pool real quick.  A lease option can be a great opportunity to not only secure your buyer to then start the 1031 but also to give you some flexibility in timing which is so critical in a 1031 situation.

However, be very careful when doing a lease option and have it vetted carefully with your legal team.  An option to purchase combined with a reduction in purchase price from rent is a recipe for that tenant to claim they have an equitable interest in the property.  And then if things go south you're not evicting a tenant - you're having to foreclose a property owner in the eyes of the law.

On the other hand a rent to own can be great to do with someone who is not lendable but is a good stable tenant.  The problem from a 1031 perspective is that the rent to own creates a situation where your 1031 starts but you have no funds to complete your purchase.  So that can be problematic.  Most rent to own situations forgo the 1031 route and treat it as an installment sale.  But then all gain is taxable.  It's just spread out.

Erin Zamarro · Answer

A true “rent to own” is probably not necessary in this market. Lease with option to purchase is definitely the better way to go; however, you should have a real estate attorney help you with the terms. There could come a time where you do want to sell, but that tenant’s option could tie you in knots if not done properly.

But - if this person wants the property, why can’t he buy now? And what’s going to change in the future where he will be able to buy? Not to mention - if he is leasing the whole building, he is then subleasing to the other floors. Do you want to lose control over who moves into the building?

Lots of potential for mayhem, IMO! Is it worth it on a 3-family?

Kate B. · Answer

Wes, your information is exactly what I needed to learn.  Thank you!  It helps me weigh the merits of doing something like this.

Kate B. · Answer

Brian, thank you for the suggestions and perspective.  I don't know much about 1031 so I started a different topic to learn about it.  I think I can see the advantage of doing that with a lease option to buy.  Thank you!

Kate B. · Answer

I don't have a mortgage.  I paid cash in an estate sale four years ago.  What I net depends on whether I involve anyone but my lawyer.  I am in contact with my lawyer to learn some things but he -- a real estate lawyer -- is very conservative so I'm looking for lots of viewpoints.  I'm curious if it can be a win-win for both sides.

Jim Pellerin · Answer

Normally rent to own is for motivated sellers and is not the best for the seller/owner, which is you. You didnt say how much you would be netting from the sale of the house and what your monthly payments are or what the monthly income would be. Just at a glance I would sell and invest your money in higher return investments. There are lots of people on this site that are looking to pay high interest rates for cash.

How does rent to own work?

Most Popular Reply