Rent-to-Own: What You Need to Know

In the exhilarating (seriously!) world of buy-and-hold real estate investment, one area that is consistently overlooked among investors is rent-to-own. Most of the investors I know are using a standard buy-and-hold strategy where they find a property, rent it out, rinse and repeat.

There’s nothing wrong with this, of course. In fact, it’s my favorite way to invest. However, a rent-to-own option is something that you should still consider. For investors, it’s an excellent way to make extra cash on a property if you only plan to hang on to it for a couple of years. And for renters, it provides a path to homeownership that may not exist otherwise.

A rent-to-own, also called a lease option or lease purchase, works similar to a standard rental. You find high quality tenants, and you rent your property to them for an agreed-upon amount payable each month. The difference, of course, is that they will ultimately buy the property from you and become the new owners.

When you enter into a rent-to-own contract with a tenant, there are a few elements that will be different from a standard rental agreement. An obvious one is that a purchase price will have to be set, either at the beginning or end of the lease. Some people like to lock in on a price before the contract is signed, while others may prefer to agree on a price at the end of the lease. That way, they can compare current market values at the actual time of purchase.

Another major difference is the option money, which is a one-time fee that gives the tenant the option to buy the property after the lease expires. The fee is usually non-refundable, so if the tenant decides not to buy the property after the lease runs out, they lose out on that money. The amount of option money paid is usually between 2.5% and 7% of the purchase price, and it’s up to the parties involved whether these funds are applied to the purchase price at the end of the lease. There are also different ways to set the lease option up. Some contracts are written so that the tenant has the option of buying, but is not required to. Other times, they are obligated to buy. If they cannot, the property owner can pursue legal action against the tenant.

Another feature that is found in many rent-to-own contracts is rent credit. Like a standard rental, the rent amount is determined at the time the lease is signed. Leases for rent-to-own properties usually have terms of one to three years, and the rental rate may include rent credit, which is an additional percentage that is paid on top of the rent. At the end of the lease, these additional funds are totaled and applied to the purchase.

The last major difference between a standard lease agreement and a rent-to-own contract is in regards to the maintenance of the property. In most rent-to-own situations, the tenant is responsible for maintaining the property and making any repairs. Depending on the terms of the contract, they may also be expected to cover HOA dues, taxes, and insurance.

There may be other clauses written into the contract as well, but these are the main features that differentiate a rent-to-own contract from a standard rental agreement. Before entering into a contract with a potential buyer, be sure that you consult with a real estate attorney to ensure that the wording of the agreement is correct.

Rent-to-own homes can be beneficial to both investors and renters. While it may not be an option you’ve considered with your investments before, it’s certainly one worth exploring.