Will “try before you buy” succeed in residential real estate?
Would you like to rent a home for a year or more to decide if you really wanted it? You can.
Many companies will allow potential customers to try their products for some period of time before the customer buys it. If the customer doesn’t like the product, the customer may return the product and pay nothing. If the customer does like the product, then they buy it. Surprisingly enough, people can do this with residential homes as well.
After the housing bust, institutional money flowed into residential real estate for the first time. These companies bought REOs and rented them out, often to those who lost their homes in foreclosure but wanted to stay in the neighborhood. These renters were not creditworthy enough to buy due to their recent foreclosure, so they were forced to rent whether they wanted to own or not.
One of the pioneers of this industry was Waypoint Homes. Early on in their marketing, Waypoint Homes touted a program where they would sell the house to the tenant if the tenant wanted it. At the time very few took them up on the deal, and Waypoint finally dropped this offering from their website. Since most early renters had poor credit, and since the recession wasn’t providing opportunities to save for a down payment, the timing wasn’t right for this program.
Once institutional money entered this asset class, many smart people started looking for other profitable ways they could invest. The “rent to own” concept initially floated by Waypoint was further developed by others who now offer this program nationally.
For institutional money to get involved, they need to know both that they can make money and that they can put a great deal of money to work. The challenge with these programs is to structure a deal that both parties want to participate in. If the deal is too favorable to customers, investors won’t fund it. If the deal is too favorable to investors, customers won’t participate in large enough numbers to satisfy the investors.
The deal for customers
One of these investment groups is Home Partners of America.
The deal offered to customers is enticing. They allow the customer to pick the house they want from the MLS just as if they were the buyer. Home Partners will buy the house, make any necessary improvements, and rent the house to the customer with a one-year lease renewable at the customer’s option. If the customer renews, the rent does go up, but only by a small amount, and these rental increases are known for up to five years, providing the customer with stable home costs.
The customer is under no obligation to buy the home, but if they do decide to purchase, they know in advance what the purchase price would be because it’s based on the amount Home Partners had to spend to acquire and fix up the property. The purchase price also increases each year, but the increase is small, so the customer gains some assurance that they won’t be priced out in the future.
If you could pick out the house you wanted and live in it for a year before you decided to buy it, wouldn’t you consider it? I would.
The deal for investors
Investors like this structure because they obtain a regular cashflow from the rental rate, they have a tenant who will care for the property, and they know they can sell for a profit later on.
In the real world, less than half of lease-to-own renters ever execute their option to buy the home, so the investors do have some risk of selling for a profit later on, but assuming the housing market is stable now, this risk is minimal — or at least low enough that investors are willing to fund these deals.
The risks and returns to investors are much like investing in mortgages or mortgage-backed securities. Investors in mortgages don’t know how long the mortgage will be active before the borrower refinances or sells, and investors in these houses don’t know when or if the customer will buy. Investors in mortgages have risk of loss based on the value of the underlying collateral, but their risk is reduced by the loan-to-value limits. Investors in houses have risk of loss based on the value of the homes, but the keep more of their money at work because their investment is not reduced by principal repayment, and their returns are generally higher.
The boomerang buyers that are yet to materialize in significant numbers are potential customers, and so are Millenials that may not have the savings they need to close the deal. The timing may be right for a program like this.