In the few years that I have been taking on Rent to Own (RTO) real estate investments, I have learned a lot. I suppose the thing that has become most clear for me is that, there is no hard and fast rule for ensuring your Rent to Own is successful. My best advice is, try and be as conservative as you can. Sometimes that means following your gut.
1. Do Your Research
First and foremost if you do nothing else ENSURE that you are buying real estate in an area that is expected to achieve good to great appreciation over the duration of your investment. In Ontario I now stick to REIN's top 10 cities and compare that to CMHC expectations, then ask a number of realtors which are the hottest neighborhoods. I avoid small communities, unless they are a feeder to a large community.
2. Vet Your Tenants
Make sure your tenant buyers have a HIGH income in comparison to the property they wish to buy. You want them to have around $1000 of disposable income (after all expenses) a month to protect against the things in life that go wrong. Anything less and they will struggle when things go wrong and then suddenly those things become your problem.
3. Check Their Credit Activities
You want them to demonstrate that they are taking steps to improve their credit. Any action they have already taken to improve their credit is great. Watch for key actions they take….how quickly do they get you the information that you ask for? How thorough is it? If you are asking more than once it is a very bad warning sign.
4. Get A Credit Payment
Collect a credit of at least 3% of the property value up front. There is some protection for the investor in collecting it, but greater than that it demonstrates a tenant/buyers commitment. This credit payment is a reminder to the tenant that they have some skin in the game. Many advisors have focused on getting large deposits but it doesn't guarantee success, without the 3 above items you can still lose money, which has personally happened to me as well.
5. Gut Check - Integrity
Answer the question "Do I honestly see these individuals being able to purchase the property at the end of the term?" If your answer to this is no, don't do the deal. Even if there is the potential of making even more money, getting out of it is a mess and wrong if you had an idea from the beginning that they would struggle to follow through.
6. Plan For Failure
Know what the property would rent for in the event that the RTO fell through. Never set your rent lower than that because if your RTO turns into a straight rental your rent increases in Ontario will be minimal. Ensure the going rental rate will get you as close to breaking even or better as possible in the event of a failed RTO. This gives you options as to what to do with the property. This is also a bit of a warning to avoid hard to fill properties i.e. expensive properties, weird properties, pools etc.
Rent to Own's (RTOs) are difficult to find because so few people meet the above criteria. It is our job as investors to do our best to ensure our tenant buyers success. There are so many things that we can't account for i.e. breadwinner illness, death, loss of job, that to not do our best to ensure their success is only hurting our industry. Investing in real estate RTOs can reap great rewards and be enjoyable as you are helping people out at the same time. Just keep these six steps/guidelines in mind when setting up your RTO investments. Remember you can contact me anytime to learn more, or leave a comment below.
-Susan White Livermore