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.