Wednesday, September 19, 2007

Rent to Own (Lease-Purchase) Real Estate

I've been struggling lately to sell 2 of the properties that I purchased this year. One a fixer-upper wholesale flip hasn't had a bite for 6 months, the other is a nice rehab that I am trying to sell at the upper end of it's neighborhood price range. The first property is in Buffalo, the second within a mile of Buffalo.

The first house that I purchased for investment in this area was a 1.5 story brick cape in the town of Lancaster. Lancaster is the fastest growing suburb of Buffalo. We purchased the house for $80k. The basement was full of water and it had sat on the market for nearly a year. We spent about $19k rehabbing it with about $8k going to drain tile. Since our cash flow was very tight I couldn't let it sit on the market for long, I decided to try to sell it as a lease-purchase.

I had learned about lease purchase primarily from a course I purchased through Ken Preuss. For this property I put up one sign in front that said "Rent to Own". This sign generated over 500 calls last year and we quickly leased the property to a family. Rental rates are quite low here and a typical home rents for ~$900 per month. We were able to get $1050 and a $2500 non-refundable option payment. The lease agreement specified that the tenants pay the first $200 of repairs, so my maintenance for last year was $0 and the property generated a positive cash flow of $300 per month.

The tenants took care of the property and actually made improvements (installed a new bath room floor and a nice ceiling fan in the kitchen) at their own cost. In the end they decided to buy another house and have moved out leaving me with their option money. We put our "Rent to Own" sign out again 2 weeks ago and were again flooded with calls. This year we have a $3000 option payment and raised the rent to $1075. The option amount is for a sales price of $139k and we give the tenants $500 rent credit towards a down payment if they pay by the first. We quickly found another tenant.

For a rental property this method really seems to work well. The advantages:
  • the rent we get is about 20% above current market rates
  • the rent credits really motivate the tenants to pay on time (I used to have to chase tenants down in my previous days as a land lord)
  • the upfront money we get seems to motivate the tenants to take care of the property
  • we don't have to worry about the nitpicking small maintenance items that used to get me out of bed at 2 am
  • the selling price is higher than what I think I would get by putting the property on the market

The one disadvantage has been that I cannot get my equity out of the property, although I was able to recover all of my down payment and rehab costs by getting a HELOC type loan on the property.

The concept does have it's limitations. For starters,we are at the upper end of the rental market here and I don't think I could do this for my Cheektowaga home. I would need to rent that one for $2000 per month just to break even and I have never seen any houses advertised for that rate here (although there must be some available through re-lo offices of local Realtors). Preuss also talks about getting $5k to $10k as option money, but that is too high for our area. $3000 seems about right. The rent and option money really drops the number of qualified people significantly (95% self-eliminate when they find out the terms) at the price range I am charging.

The courses I have taken talk about focusing on "bread and butter" homes. It seems that this house is such a house for our area. The other 2 are either too highly priced for their location or the location is so bad no one wants them. Modifying my house buying criteria might help me turn a very negative year around next year.

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