Several of us have had properties that were scheduled to be fixed and flipped and are now fixed and… well let’s just say not flipped. These often turn into rentals and the best rental is one with a tenant that will buy the house in a year or two (a lease option). Here are 5 steps to help get your tenant buyer closed:
Price the property correctly
The biggest issue I see is that investors get greedy and price their property higher than it will appraise for. Even if you think the house is going to increase in value you want to price it at least close to what other houses in the area are selling for. You’re kidding yourself if you think you tenant does not pull the flyer out of the neighbor’s yard sign to see what it is listed for. People are smart and they will look around at other options before they close on the house they are living in and no one wants to feel like they were taken advantage of.
Shorter option contracts
I have found that the longer the rent to own term, the less likely the tenant is to buy. They must feel that there is plenty of time so they don’t work on the issues they need to in order to qualify for the loan. By the time they need to start worrying about it, something in their life has changed and they need/want a different house. Since they don’t own this one it is easy for them to leave. If possible you should make the term a year and never make it more than 2 years.
Make sure the tenant has something invested
The fact that people move every few years is a problem to get tenants to exercise their option to buy. One of the key ways to have them stay is to make sure they have something invested in it. If they are allowed to decorate and make changes this will help but the best way to be sure they feel committed is cold hard cash. If you get less than 2 percent of the purchase price as an upfront commitment your tenant will probably not buy the house. The goal is to get somewhere between 3 and 5 percent total. Most of this should be up front but some can be collected over time with additional payments above the normal rent amount.
Another way to accomplish this goal is rent credit. This is a portion of their rent being applied to lowering the price or other credit towards the purchase. The larger the monthly credit the more they feel invested and the more likely they are to buy.
Monthly rent payment is critical
If there is going to be a large increase in the tenant’s monthly payment when they get a loan, the chances of them actually doing it are close to zero. This makes it very difficult to rent to own larger more expensive houses in my opinion. The nicer houses rent for a fraction of the mortgage payment. For example a $350,000 home might rent for $1,700 or $1,800 (It could be more depending on the area) but the payment on that house with taxes and insurance will be $2,200 to $2,300 or more. In this case I think it is essential to find a tenant buyer that is willing to pay above market rent to get closer to what their payment will be with a loan. You can offer large rent credits to compensate for the higher monthly rent.
The lower priced homes will work better. For example a $150,000 house might rent for $1,100 or $1,200 but the payment with taxes and insurance will be $900 to $1,000. Remember that taxes and insurance are cheaper on a cheaper house. In this example the tenant’s payment will actually go down when they buy it so there is a lot of incentive for them to do that.
Interest rates are really low right now but they may not be when your tenant is ready for a loan so please keep that in mind.
Working with the tenant
I think this is essential if you really want them to buy but it is not necessary if you are ok with them buying or not buying. My belief is that you should do as much as you can upfront with your tenant to get them in a position to buy and then leave it up to them to do what needs to be done. If you do it this way, they may not do what needs to be done and you could get the house back. Getting a house back is not always a bad thing. Hopefully it is worth more and you will keep all the money that was given to you by the tenant. Some people will say this is setting up tenants to fail but I don’t see it that way if you did what you could for them at the beginning.
Because this article is teaching you how to increase the likelihood of your tenant buying we are going to talk about working with your tenant. If you stay in touch with them asking them how things are going and what they are doing to improve their situation they will be more motivated to do it. They will see you as really trying to help them and will not want to let you down. I would say send them at least one letter every other month and maybe a phone call three or four times a year. You will also want to send them articles and tips on how to improve their credit if that is their issue.
It is also a good idea to work with a mortgage broker who can look at their situation and help you coach them on what needs to be done. Have the mortgage broker reassess them every six months.
Tenant buyers are truly a great way to go and it is even better when they close on the deal and you get paid. Take these five steps into consideration on your next lease option.