Opinion

Felix Salmon

Rent-to-buy

By Felix Salmon
November 11, 2009

If Forbes writes something on rent-to-buy schemes in March and then the WSJ puts up a blog entry in November along similar lines, even the stretchiest blogger might have difficulty discerning a trend. But that doesn’t mean it isn’t a good idea. In fact, it would be great if we saw much more of it in this country.

Rent-to-buy means lots of different things to different people. Often, it’s a simple lease with an embedded option to buy the property at a set price on a set date — an attempt to give the buyer a bit of time to scare up a downpayment, and to give the seller an income stream. Typically the option is purchased for cash (1% of the purchase price seems to be standard) at the same time that the lease is signed; generally if the option is exercised, the price of the option is deducted from the purchase price.

Alternatively, rent-to-buy schemes can increase the rental price and apply rent payments to the purchase price: here the price of the option is likely to be embedded in higher rent payments rather than being an explicit up-front payment.

Both schemes, however, essentially just kick the can down the road: at some point one or three years hence, the purchaser still ends up getting a conventional mortgage and buying the property in question. If property prices fall significantly over the length of the lease, then you don’t exercise the option, or you go back to the seller and renegotiate. But if property prices fall after you buy the house, you can still end up owing much more money than the house is worth.

Then there’s a scheme I’ve heard of in Germany. Essentially it takes banks and mortgages out of the picture altogether, and sets up a long-term contract between the buyer and the seller. The buyer pays rent monthly, the house is essentially placed in escrow, and the buyer ends up owning the house after a set number of years paying rent. I like this scheme because it involves buying a house without any debt — and the buyer can even move house and sublease the property, so long as she continues to make rent payments to the seller.

The downside for the seller, of course, is the lack of a big lump-sum payment. But lump-sum payments are overrated, especially if you’re not buying a house yourself. Anybody downsizing from a two-home lifestyle, or intending to rent themselves in future, might find this kind of scheme very attractive, since it provides a steady income and they don’t need to worry about how they’re going to invest the proceeds of the sale.

Buying a house slowly, over time, is a great way of building equity without taking on debt — and it’s also a great way of making sure that you’re spending what you think it’s worth to live in a house, rather than speculating dangerously on future property prices. It’s also a great way of giving renters the same kind of emotional equity in their home — and the ability to make changes and improvements — that are generally the domain only of homeowners. Right now, when a lot of motivated sellers are looking to any possible way to move their properties, might be a very good time for these ideas to gain traction.

Comments
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“Essentially it takes banks and mortgages out of the picture altogether, and sets up a long-term contract between the buyer and the seller. The buyer pays rent monthly, the house is essentially placed in escrow, and the buyer ends up owning the house after a set number of years paying rent. “This is more or less how an Islamic mortgage works, although the title stays with the “lender” until all the payments are made.

Posted by Ginger Yellow | Report as abusive
 

“Then there’s a scheme I’ve heard of in Germany. Essentially it takes banks and mortgages out of the picture altogether, and sets up a long-term contract between the buyer and the seller. The buyer pays rent monthly, the house is essentially placed in escrow, and the buyer ends up owning the house after a set number of years paying rent.”You do know that a version of this happens in some places in the US too, structured as a loan? Seller-financing, details vary by state (I presuppose, haven’t lived in all of them)

Posted by SP | Report as abusive
 

These schemes mostly seem like ways for the seller to delude themselves that they aren’t actually lowering the sales price. What for example is the true value of an option to buy? 1% sounds pretty low.

 

Felix, you must have dropped your normally clear-sighted glasses in the sink this morning (and put on the rose-colored ones instead?). You’re talking form over substance. If the “transferee” (I’m being cautious here) can keep or walk away, he’s got non-recourse debt. If he is liable to pay whatever the value, he’s got debt. You can call it Micky Mouse or Mr.Magoo. If it quacks like debt, it’s debt.

 

You’re advocating a lot of homeowners, who mightn’t have been qualified to be that, become landlords and decide on complicated real-estate transactions.Having an true sale with a lending intermediary might come at a cost (or lower purchase price), but removes much risk and complexity from the seller.In most of the examples, the seller remains a quasi-landlord, certainly takes the credit risk and has to be willing and able to foreclose. Not easy, and costly.In the U.S., courts have stopped efforts (like a pre-signed deed-in-lieu of foreclosure held in escrow to be recorded if the ‘buyer’ stops paying) that strips the occupying ‘owner’ of statutory foreclosure notices and rights. I suspect there would be similar issues with rent-to-own and Islamic leases – much more difficult than simply evicting a renter (which is not easy anyway).

 

If you set the option price low — perhaps 80% of what you expect the house to be worth 5 to 7 years from the beginning of the agreement — you can have a shorter-lived rental agreement in which the “buyer” is likely to have a significant amount of equity on the line as soon as the option is actually exercised. If you create a cash-out value for not exercising the option — say $10,000 — it’s even more likely that the buyer would, in the event of exercise, have equity on the line (or they wouldn’t have chosen to buy the house). In each case, you’ve recreated the forced-savings component of a mortgage, which seems likely to me to be a significant part of any causal reason homeowners have more wealth than renters.http://deansdough.blogspot.com/2 008/12/home-ownership-for-poor-and-bound edly.html

 

Hi, I’m a landlord in the UK, and I’m finding our rent to buy properties are flying out! We are literally getting more people looking for properties then we have houses for! I think its a great scheme, and it helps people to get on the property ladder, in times when banks and the government are just not helping much! thanks for posting a great article!

 

These days more families are thinking to buy their first house in this scheme. As you said it is the way to buy a house slowly, over time.It is a great way of building equity without taking mortgage now and for some people it matter.

 

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