'Rent To Buy' Schemes

[JohnL]

Bad - I sometimes get calls from rent to buy owners (sellers) who try and refinance their renters and sometimes looking at their situation I can tell that they will not able to get out for many years, maybe never.

There are two reasons investors use rent to buy contracts. The first is to get a better price within a shortish time frame ie 2 to 3 yrs. So selection is important as you do want the 'buyer' to be able to get a bank loan. Selecting someone who you know will fail and then cancelling their contract is one of the unethical practices that goes on.

The second is for cash flow long term so its not so essential that they can get a bank loan. If you are willing to structure it over 25 years, they never have to get a bank loan. So bad becomes good in the second scenario (as long as they meet their payments and don't default).

John

[mortgage broker]

I have seen this both ways, good and bad. I financed a couple of clients not too long ago who had signed one of these before the big boom, when I refinanced I put them on higher prepayments than there rent to buy.

It would have been better for them to remain in the rent to buy since the seller had much better interest rates which my client could not access because of their credit history.

However they felt better knowing they owned the property and they wanted to do renovations. They gained on this deal by $100k plus.

Bad - I sometimes get calls from rent to buy owners (sellers) who try and refinance their renters and sometimes looking at their situation I can tell that they will not able to get out for many years, maybe never.

There are things that people can do to minimize these risks but with any investment there are risks. One of the main risks is that I can tell a person that if they meet this and this criteria they may be able to purchase in a few years but what if the banks disappear, what if their criteria become way way tougher.

[JohnL]

This is a cash flow strategy where the investor usually sacrifices future capital gain for cash flow. During the boom investors make a lot more money NOT doing rent to buys which is why many stopped doing them earlier on in the boom.

The WIN WIN was heavily in favour of the 'purchaser'. During the slump phase the WIN WIN favours the investor but of course over an entire cycle it probably averages out to be pretty fair to both parties.

There are a small minority of unethical investors/financiers/lawyers/accountants etc etc who use all sorts of techniques to 'screw' people by acting immorally if not illegally.

Blue Chip would be a pretty major recent example.

John

[cube]

In defence of Lease Options

Based on the education in LOs that I received from GBI:

First, they are charged an exorbitant amount of rent.

In just one typical example, a property offered by a mob called Rent 2 Buy Pty Ltd (run by a 35 year-old spiv called Troy Boldy) offers a home for rent in the Sydney suburb of Fairfield at $550 per week. The market rent is about half that amount.

Astonishingly, Boldy himself openly admitted yesterday that his rents are "double" the market rent.

Okay, so that's the first part of the rip off. Buyers pay double the market rate for their rent.

Firstly - from one point of view, BUYING a house costs far more than renting it at the moment, and the sense of ownership is important in a LO transaction. How the deal is structured is negotiated as part of the deal, and can in some cases, essentially, be expressed as market rent + credit, which for the purchaser is a far better deal than having a mortage.

Second, as well as the exorbitant rent, the "buyers" (victims) pay an exorbitant price for the home.

Sticking with the same example of Troy Boldy and the same home in Fairfield, the purchase price being asked for this home is $380,000.

Yesterday, a local agent estimated its real value at between $250,000 and $270,000.

So, on top of the double rent, the victims are also paying at least $100,000 too much for the home.

From my education, WRONG, WRONG, WRONG. The purchase price is the Registered valuation (or less) at the time the option is taken out. The price should NEVER be hydrauliced.

Yes, in the current market there is the chance of the value falling in the short term, which is why options are given for anything from 2 to 5 years plus.

The third rip-off with the 'Rent to Buy' schemes is that the buyers are not the owners of the homes they are buying. No, the homes remain in the name of the rogues running the scams.

Quite simply, this means that if the buyers pay the rogues and the rogues go broke or their companies collapse (as many do) then the buyers - who have done nothing wrong - are instantly evicted.

Duh - they haven't bought the house yet, so why should they own it. If the investor does go under, then a good contract will allow for the purchaser to exercise their option before the property goes to forced sale, or get a full refund of their option fee and credits.

Based on the hydraulicking that Jenman has found, I would say that Troy should be hung out, because he is giving the LO industry a bad name.

From my experience, the people who have take out LOs are not "poor", but actually reasonably high income earners who, either because of some youthful indiscretion or business circumstances (self employed, irregular income, new immigrant) do not qualify for a standard mortgage. People who can't afford the payments generally know this, and recoil at the extra expense of owning a house rather than renting when is explained to them.

Another point that is impressed at the course is making as sure as one possibly can that the purchaser will be able to qualify for normal financing when they wish to exercise their option - this means checking that they are doing what is necessary to clear outstanding debts, carrying out any renovations that may be necessary to lift the value of the house etc. LOs are not a 'set and forget' cash machine for investors - the value is generally only realised at the end of the process when the option is exercised.

cube

[krispedersen]

After all what if we start reading about Rent by the room landlords who are abusing their tenants because rather than allowing them the whole property for 300 per week they force people to pay $200 per room?

I know its not remotely close but any system can be abused.

Completely agree. As soon as anything is a mainstream business it will be taken up by a corporate.

Ethical investors actually need to be applauded as they actually lauch products that in onew way or another we all get to benefit from

[krispedersen]

If they don't qualify for credit reasons, then they are a high default risk, and will likely lose the RTB anyway.

banks have credit criteria for a reason you know. ;-) If rent to buys were a good risk, they'd fund them. The reason the contracts are written the way they are, reflects that the only people that would use them are a bad risk, therefore the likely owner/winner is the seller.

Enjoy the time overseas Mark.

I disagree however as from this argument you could say non-banks have no place in the market as they exploit areas that at that point in time the banks aren't willing to enter. In reality banks tend to be reasonably beauracratic organisations who operate a one size must fit all mentality (I am generalising with this comment) and so can be quite slow to move. What's actually interesting is that the non-banks actually were more protected in most of their 100% finance models and in most cases never got quite as high in regards to loan to value rations as the banks did as late in this property cycle with low-doc loans. They pioneered these loans and got market share and the banks folllowed and actually kept the boom going

In the current environment with overseas credit being so expensive (As I understand it our banks source 39% of their funds this way) the banks will naturally cherry pick the cream and decline everything else more or less the same as the finance companies who are still lending are doing.

There are some very good lease option operators who understand that NZ is really a small town and like any good business, keeping their "brand" intact is vital for future business and so realise that the only way to have a sustainable business model is to do the right thing by their clients.

There are however and always will be people who work off a win/lose or scarcity mentality where they actually believe the only way they can prosper is to drive the other person into the ground as far as possible to make a buck.

I actually wouldn't mind if there was a way of regulating or legislating lease options / wraps / rent to buys as it would get more people into homes that they would eventually own which is actually beneficial for the whole of society. I'm doing a fair bit of AUS finance currently and outside of SA and Neil Jenman i'm finding the practise in a lot more readily accepted over there.

Another overlooked point is that until recently some well known lenders were offering Lease Options in the shape of Muslim Mortgages. I know for a fact that these were about to come out into the mainstream market until the credit crunch stopped this in about March / April.

I have a large amount of clients who have studied PI in the States and vendor finance and other creative strategies have always been used there. I know this isn't the best example but Freddie Mac which was US government owned was doing lease options and well before using dodgy NINJA loans or similar strategies helped families into home ownership.

I'm pretty sure I have read on here or in Olly's book (Rascals in Real Estate - which is a very entertaining read BTW) that he and a whole lot of others have been doing this for decades.

He can possibly provide a better long term view on the strategy and the morals / ethics surrounding it

I've run the numbers and as a generalisation I can say that there are some clients that I would rather point towards a good L/O operator than for example someone like Bluestone (who has now left the country) who would have charged them significantly more to achieve a whole lot less

[tpr2]

1. The risk that they won't be able to obtain finance and exercise their option to purchase. In that case, they should get back their "deposit credit" (the $30pw in the Tokoroa example), but the extra $100pw is gone. I'm sure that there will be a lot of tenant buyers in the near future who will find that their house has not grown in value by nearly enough to enable them to refinance, especially with banks tightening up on lending.

2. The risk that the investor goes belly up.

Paul.

I agree with Kris
Just because the system is rife with Dodgy operators it does not mean the concept in itself is a bad one.

The two ponts you make Paul are relevant if that is how the agreement is drawn up but what if it was not drawn up that way?

Let me ask you this, what if you yourself were in a position to do a RTB and it was a good deal for you, how would you structure it?

I would guess from my association with you here on PT that you would remove those above risks you outline by rearranging the contract and lets just say that you were not borrowing the funds but were a cashed up multi millionaire.

Jurgs I a sure you have met people during your years of lending as I have who can not borrow due to say bankruptcy yet they are capable of servicing debt quite well due to the new careers.....

I am completely with you on the "they should see a financial planner", thats my core business after all but I still think regulate the dodgy buggers out of the industry and we get back to a concept which is fundamentally ok.

After all what if we start reading about Rent by the room landlords who are abusing their tenants because rather than allowing them the whole property for 300 per week they force people to pay $200 per room?

I know its not remotely close but any system can be abused.

[Jurgs]

Heading away to watch the olympics for a couple of weeks in a few hours, so a bit on the fly, but:

Essentially, mechanisms exist for genuine purchasers to buy without using rent to buys, which in all circumstances I have seen, have appeared to be heavily stacked in favour of the seller.

Whether it be in terms of the numbers, as with some of the previous examples (well dissected by Paul), or the terms, which are often extremely punitive in the event of default, they appear to be a vehicle that provides more benefit to the middleman than the end buyer.

I would suggest that in most, if not all cases, the buyers would benefit more from sound financial advice, and either a plan for saving a deposit, or using a 100% finance option.

If they can service the RTB option, then they can rent, save a deposit and ultimately service a mortgage. I think this will always be a much lower risk option.

If they don't qualify for credit reasons, then they are a high default risk, and will likely lose the RTB anyway.

banks have credit criteria for a reason you know. ;-) If rent to buys were a good risk, they'd fund them. The reason the contracts are written the way they are, reflects that the only people that would use them are a bad risk, therefore the likely owner/winner is the seller.

Bit jumbled, but my point is in there.

Anyway - Go the black sticks girls, and if they lose, it wasn't the goalie's fault, they got through 10 others first!

[krispedersen]

I've never seen a good rent to buy, and I know that for the 13 years I've been involved with the mainstream banks in NZ, they've always been frowned upon.

I'd be interested to hear some numbers associated with a true win/win rent to buy.

I was having a beer with my accountant the other day and he was one of the main accountants for wrap mortgages in the early part of this decade. In the vast majority of cases he saw, the end purchaser got a better deal than the investor.

The issue is is that the bad deals get the headlines and you don't hear about the cases where people have been helped.

Read Graeme Fowler's (used to post under Orion on PT) book where he outlines how to do it correctly.

There is nothing wrong with some of these schemes if conducted correctly, just something wrong with some with some of the people doing them.

[SuperDad]

What if it was 2003 and at the mount

Then the numbers might well be different - it could be the case that growth outstrips (and so compensates for) the dead money paid each week.

But that doesn't mean that a RTB would be a good idea.

When entering a RTB, the tenant buyer is taking two risks that the standard homebuyer doesn't:

1. The risk that they won't be able to obtain finance and exercise their option to purchase. In that case, they should get back their "deposit credit" (the $30pw in the Tokoroa example), but the extra $100pw is gone. I'm sure that there will be a lot of tenant buyers in the near future who will find that their house has not grown in value by nearly enough to enable them to refinance, especially with banks tightening up on lending.

2. The risk that the investor goes belly up.

Paul.

[tpr2]

What if it was 2003 and at the mount

[SuperDad]

If it were at the mount, it would be fair to assume that the numbers would be doubled.

In which case the tenant buyer would be paying $200pw simply for the option to purchase an asset that is losing value.

Paul.

[tpr2]

Hi Paul

I am with you and Mark on this but also liking to play devils advocate a little.

In muppets example the issue is actually that the property is in Tokoroa.

If the property were at say The Mount, and the property was not inflated would it now be an ok investment?

[SuperDad]

Problems with Muppett's example.

1. The numbers - the tenant is paying $130 above market rent, of which $30 is a rent credit. Thus they are paying an extra $100 per week simply for the option to purchase the house. This could instead be saved towards a house deposit.

2. The option price of $141,000 - is it inflated? It might not be in this case, I don't know. But the presenter of the recent RM LO course - John Gourley - was a proponent of inflating the purchase price. This makes it even more difficult for the tenant buyer to secure finance.

3. Proponents of LOs seem to like to point out that paying (for example) an extra $100pw over and above rent is nothing when house prices double every 7 years. Well, even if the Tokoroa house is worth $141,000 today, I doubt that it will be worth $146,200 in one years time, or $151,400 in two years. (This is the amount it would need to be worth if the tenant buyer is not to lose any of that $100 extra they are paying.)

Paul.

[tpr2]

Thanks Muppet

That looks totally fine to me.
Of course you would have to want to live in Tokoroa.

As long as the agreement that the solicitors create provides protection for the buyer then I can't see a problem.

I never ended up doing one because by the time I was able to they were so frowned upon in Oz it wasn't worth the flack that would have come with it.

Mark what do you think of the one muppet has shown?