Rent-to-Own Real Estate

Mortgagenomics Canada

I think it's safe to say that every single detached home in Vancouver is priced over $1M. In fact as of Feb 2021, the average priced single family home in Greater Vancouver shot up to $1.83M (the third highest monthly figure, ever!). And here is the major disconnect of the entire real estate equation (for Metro Vancouver)...the median total income of households sits at only $72,662 - you don’t have to be a mortgage broker to know that this income will not qualify for a $1.83M purchase, in fact, a $72,000 income will net you a mortgage of just under $400,000.

So where do we go from here?

Knowing that the minimum down payment required to purchase a property over $1M is 20%, the entry barrier to owning a single family home in Vancouver is sky high. For many, unachievable...impossible. More people actually qualify for a $1.83M purchase, than those that actually have the required down payment to fulfill the qualification (this is the bigger problem). For example, the annual income required to qualify for a $1.83M Purchase (with a 20% down payment) is ~$220,000. But the qualification milestone is only realised upon your $366,000 buy in (the 20% down payment) - this is where many prospective homebuyers falter. So, unless you come from wealth or were fortunate enough to have stepped on to Vancouver’s property ladder in the early 2000’s, the outlook for home ownership for many in Vancouver is bleak...it’s a tough pill to swallow for many.

BUT, we must forge ahead. We must continue to explore and exhaust ALL avenues for solutions. What we cannot do is, stand still. People will continue to migrate to Vancouver and demand for housing will continue to increase...we need to explore new ideas and concepts on how we can purchase real estate, and in the same lens, we need to tweak lending guidelines, accordingly. And this leads to my topic for this week's newsletter - What about Rent-to-Own?

The Rent to Own concept has been around for awhile, but it has never been an off-the-shelf-main-stay type of product. In my 17 years as a mortgage broker I have only ever completed one and am currently working on another. The two successful ones that I have under my belt don’t make me an expert on the topic, but the several others that I’ve experienced and that were not successful is where I can share some valuable insight.

What is a Rent-to-Own (RTO) Contract?

A RTO contract mimics a car lease structure in that it enables the buyer to occupy the subject property for a fixed period of time (typically 3-5 years) while making customized payments towards a specified down payment at the conclusion of the term (kinda like the balloon payment that’s outstanding at the end of your car lease). The monthly payment within a RTO is configured to account for the market rent obligation to the landlord/owner and simultaneously pieces off a specified amount that is set aside for the cumulative pre-agreed-upon downpayment at the completion of the contract. At the completion of the RTO contract, a mortgage is then secured to close out the transaction and secure ownership to the buyer.

Rent-to-Own Contracts are generally comprised of two agreements; a standard Lease Agreement, and an Option To Purchase agreement:

• The Lease or Rental Agreement:
• Throughout the lease agreement, the title of the property remains with the landlord until the tenant exercises their option to purchase the property
• The Option to Purchase:
• This agreement grants the tenant the option/right to purchase the subject property within a specified period of time. As all contracts are unique, it is important for a tenant to be aware of the consequences if they choose to not exercise their option to purchase. Do not assume that there is a built in refund clause in the agreement.

Some risks and hardships associated with RTO Contracts:

• Far less banks participate in RTO purchases than those that do
• There is no guarantee that a RTO-participating bank today will remain a RTO-participating bank in 5 years
• There is high potential for BUYER AND SELLER remorse as markets may evolve throughout the term of the contract in ways both the seller or buyer didn’t expect
• Finding a willing seller to commit to a RTO can be challenging. Typically, RTOs are far more prevalent in depressed market segments and regions, but they are also present in stronger active markets

Can both parties win in a Rent-To-Own transaction?

Landlord Perspective

• As RTO contracts are typically 3-5 years, this could appeal to the owner/landlord as it solidifies the tenants commitment to be on time with payments and take extra care of the home (as they aspire to become owners of it). Worst case scenario...in the event the tenants do not qualify for a mortgage, the landlord has gained another 5 years in equity pay down and could potentially retain the entire sum that was held in trust for the down payment (depending on the terms and conditions of the contract)
• As most RTO transactions act independently (without the services of a real estate agent), sellers can avoid listing agent fees.
• Sellers can also benefit from the basic principle of supply and demand. In some markets and regions the demand for RTO properties can far outweigh the supply of willing landlords.
• A potential downside for the landlord could be the unilateral nature of the contract, itself. The landlord is contractually obligated to sell the house to the tenant, however, the tenant is not contractually obligated to purchase the house. Furthermore, the landlord is bound by the agreement to not sell the house to a third party during the tenancy and option period.

Tenants Perspective:

• A good option for a tenant who would like to purchase a property, but due to recent credit issues or lack of down payment resources cannot qualify for a mortgage at present time
• The option of not proceeding with the purchase could also be an appealing feature as the outcome will not result in foreclosure proceedings, nor would it impact the tenant’s credit history. However, the tenant could stand to lose the upfront deposit and likely all (or a portion) of the cumulative equity payments throughout the term (depending on the unique terms and conditions of the contract).

And finally, to bring closure to this long overdue transaction comes the qualification for the mortgage. Easy peasy, right? Not really. As RTO agreements are not a common method of buying or selling real estate, it never really cemented itself as an ongoing way of transacting real estate. It's always been a niche thing and lenders have always teetered on and off the RTO bandwagon in favourably adjudicating them. But, I can tell you although there are not many lenders that are open and willing to participate with RTO transactions, there are enough that will - you just gotta know who they are. There are two that I currently know of and whom I have successfully closed a few transactions with...here are the key guideline points to be aware of which ultimately must be worked into the RTO agreement:

• Make sure there is a clause in the contract that states you will receive a partial or full refund in the event you do not qualify for the mortgage...the few lenders that will consider these arrangements, will likely demand this clause
• Some lenders might also demand that the negotiated monthly rental fee be capped to match the accumulation for a minimum down payment (5 or 10%) so as to discourage unreasonable and unsustainable monthly rent payments.
• All participating lenders will require bank statements provided by the seller to confirm regular deposits of the down payment portion and balance.

So to conclude, I’ll leave you with these three very important points:

1. Do not assume that all lenders will mortgage your RTO transaction...many will not.
2. When drafting the RTO Agreement, begin with the end in mind. Educate yourself on the lenders qualifying guidelines and be sure that your RTO Agreement complies with them.
3. Call around and look for a lawyer who has experience in RTO transactions to draft the agreement

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