Tier One Real Estate

Rent-To-Own Programs, How Do They Work?

There are many and varied programs available for rent-to-own (RTO) properties. In each RTO program there is a negotiation between the Buyer and the Seller where each party negotiates concessions from the other party to complete the transaction. The intent of this blog post is to briefly explain only two major methods to structure the overall RTO transaction.

Basic Option or Lease to Own Option

In order to understand a RTO or Lease-to-Own transaction one must first understand what an option is in a real estate transaction. An Option is where the buyer offers money (consideration) to the Seller to make a future purchase of the property within a specified time frame and for a specified amount. The Buyer secures the right to purchase the property for the specified amount within a certain time frame or lose the option money to the Seller. The Seller agrees to withdraw the property from the market and wait for the buyer to exercise the option or the Buyer forfeits the option money. Here are some examples of how to use a real estate option.

Option Money Paid in Advance of Occupancy

The first step in any option negotiation is an agreement between the Buyer and the Seller on the purchase price. This price is determined at the signing of the option paperwork as well as a time frame for the option to be exercised.

The next step is for the Buyer and Seller to agree on an option amount. Although there is no exact formula to calculate an option amount, the Seller needs to feel comfortable that the amount is sufficient to cover the costs of taking the property off the market in case the option is not exercised by the Buyer. The Buyer must understand that the option money is non-refundable so that if the Buyer determines not to purchase the property the Buyer will lose the option money.

As the end of the option period approaches, the Buyer notifies the Seller of intent to purchase or withdraw the option. In the purchase option, the Buyer finances the purchase and the Seller is paid the agreed to amount with the option amount paid towards the total purchase price.

Option Money Paid Monthly During Occupancy

This option is used when the Buyer doesn't have sufficient money upfront to make a substantial option payment. In the case, the Buyer and Seller agree on the value of the property at the start of the option period and also the value of the property at the end of the option period. Most option period are for a minimum of one year but can be extended on a year by year basis. Many investors prefer not extending the option period past three years.

Once the current value of the home is agreed to, the option amount is agreed to and paid monthly over the option period. The amount of the option normally equates to the estimated value of the property at the end of the option period. In periods of normal appreciation this amount is 5% to 7.5%. In periods of less than normal appreciation the minimum amount many investors will accept is 4% to 5.5% to make the investment worth their time.

For example, a property worth $200,000 at the beginning of the 12 month option period would be worth $210,000 at the end of one year if the option rate was 5%. This amount becomes the agreed to purchase price between the Buyer and the Seller when the option is exercised in one year.

The rental price is calculated so that the $10,000 option price is paid as part of the monthly rental rate and accumulates over the option period. The Buyer gets a monthly credit towards the purchase of the home or a credit towards closing cost for making payments on time when they exercise the option. If the option is not exercised, the monthly credit remains with the Seller. In this case too, the option money is non-refundable if the Buyer fails to exercise the option.

In either option case, RTO offers and additional sale option to the Seller and it offers the Buyer a chance to own a home and build savings or credit to purchase a home of their choice. Both can be benefited from a rent-to-option to purchase a property.

For further information on RTO forms, rent calculation spreadsheets, and ROI numbers for seller please send me an email.