Rent-to-own: These are the risks and benefits 

Owning a home is seen as prestigious and a measure of one’s success in many societies, and is, therefore, a goal for many people.

But the process can be taxing. From scouting the property, and checking other factors such as security, location and amenities, to securing finances, it can be overwhelming. Not to mention having to decide what approach to property acquisition to take.

According to the Kenya National Bureau of Statistics, only 61 per cent of Kenyans are homeowners. Of this, 93 per cent built their homes, three per cent bought their houses, and three per cent inherited the property.

When buying a home, the most preferred approach is taking a mortgage. Sometimes, however, this is not always an option, or the mortgage one qualifies for is not enough. That is where alternative means of property acquisition come in, and one such option is ‘rent-to-own’ homes.

These homes can be a great option and can have many advantages over traditional home buying.
To elaborate further on this kind of investment, DN2 Property enlisted the help of Stephen Waweru, the Clients Relations Manager and Head of Learning at Centonomy Limited.

Rent-to-own property acquisition is a real estate arrangement where a tenant rents a property for a set period of time, typically a few years, with the option to buy the property at a predetermined price at the end of the lease term.

The agreed monthly payments will be lower than the market rate rent, but it will still be more expensive than your average monthly rent payment. 

During the rental period, a portion of the rent paid by the tenant is set aside as a down payment towards the purchase of the property and is called the option fee. This fee is non-refundable but it is negotiable and will range between two and six per cent of the purchase price of the house.

Rent-to-own contracts typically involve a lease agreement, an option agreement, and a purchase agreement. The lease agreement outlines the terms of the rental period, the option agreement set for the purchase price and other conditions of the sale, and the purchase agreement is executed when the tenant decides to buy the property.

Lease option: There is an option of buying the house once the lease agreement expires. The seller is obligated to sell the property to the buyer at the end of the rental period, but the buyer is not obligated to purchase the property. If you change your mind, you can always move to another house with no obligations to the landlord.

Lease purchase: It is a legally binding contract where you are obligated to buy the house at the end of the lease whether you can afford it or not. It is usually hard to get out of this type of contract.

To enter into rent-to-own property acquisition, you will typically need to find a property owner who is willing to sell their property using this method. Alternatively, you can work with a real estate agent who specialises in rent-to-own transactions to help you find a suitable property.

Once you have identified a property, you will need to negotiate the terms of the lease, option agreement, and purchase agreement. It is recommended that you work with a real estate attorney to ensure that the terms of the agreements are fair and legally binding.

The seller states the price of the house either at the start of your lease before you sign the agreement or when the lease expires. The price of the house is based on the home’s current value. A house could either appreciate or depreciate by the time you are ready to purchase it.

Most buyers will want to decide on the purchase price before they move into the house to know what they are working with and to avoid paying more if home prices in that location rise.

When signing the contract, you agree on the amount of rent to pay each month. Your rent will be slightly higher than the other tenants because a portion of it, which is referred to as rent credit, will go towards purchasing the home. Make sure this amount is clearly defined in the agreement.

Rent will be 25 per cent to 30 per cent more compared to the usual rent price of that area. Fine-tune these details beforehand to avoid having any misunderstandings with the landlord as time goes by.

Landlords are usually responsible for taking care of the property. But in a rent-to-own agreement, some will transfer the maintenance responsibility to you because technically you will end up owning the house. Because rent to own is a unique situation, the contract needs to state who does what in terms of maintenance and making payments such as property tax and insurance.

When the time comes to buy the house, mortgage financing can go a long way towards paying off the balance of the house. A mortgage adviser will inform you of the different options available and explain how the mortgage application process works.

When you sign the lease option contract and the lease expires, there is no obligation on your end to purchase if you happen to change your mind. Unfortunately, you will lose the option fee and any money paid up to this period.

Before making a decision, it is important to note the pros of rent-to-own home acquisition. 

Ability to build equity: Since a portion of the rent paid is typically credited towards the purchase price, it allows the tenant to build equity in the property while renting.

Time to improve credit score: Rent-to-own agreements typically have a long rental period, which gives the tenant time to improve their credit score and financial standing so they can secure financing to purchase the property at the end of the lease.

Opportunity to test the property: Renting before buying not only allows the buyer to test the property but also the neighbourhood, to ensure they are a good fit before committing to the purchase.

The option fee is less than the down payment: The option fee paid upfront is generally less than the down payment required for a traditional home purchase, making it more accessible for buyers with less funds.

Less competition: Rent-to-own properties are not as common as traditional real estate, which can mean less competition for the property and potentially lower purchase prices.

Fixed purchase price: If the purchase price of the property is agreed upon at the beginning of the lease term, then it is not subject to market fluctuations and can protect the buyer from market volatility, which is highly likely in the real estate industry.

Higher purchase price: The price of the property is usually higher than the current market value at the time the option is granted, which results in the buyer paying more than the property is worth.

Non-refundable option fee: This fee which is paid upfront is non-refundable. If the buyer is unable to secure financing at the end of the lease term, they will lose the option fee as well as any rent credit paid towards the purchase.

Risk of losing the property: If the buyer fails to make timely rent payments or breaches any other terms of the agreement, they risk losing the option to purchase the property and may be evicted from the premises.

Maintenance and repair responsibilities: Depending on the terms of the agreement, the tenant may have to bear the repair and maintenance costs during the lease, which results in additional costs.

Limited inventory: These properties are not as common as traditional real estate transactions, which can limit the inventory of available properties for buyers to choose from.

Limited negotiating power: The terms of the lease, option and purchase agreements are usually set by the property owner. This can limit the buyer’s negotiating power when it comes to the terms of the agreement.

Risk of housing market downturn: If the housing market experiences a downturn, the buyer may end up overpaying for the property.

All the terms and conditions of the rent-to-own agreement should be put in writing when you get into one.

This document will serve as a reference for both parties throughout the duration of the rent-to-own agreement.

The following are some items that should be considered before signing a rent-to-own agreement:

The amount of rent that is due each month, the amount of down payment, the length of the time period for rent payments before becoming eligible to purchase the property, the interest rate on the purchase price and when it is payable, who pays homeowner’s insurance, property taxes and other related costs, any special clauses or conditions that need to be met in order for you to become the owner. 

Rent-to-own property acquisition can be a great option for those who want to buy a home but do not have the funds for a down payment. It offers flexibility and allows you to take your time before making a decision. 

However, it is important to weigh the pros and cons carefully before deciding if rent to own is right for you. Before you commit to this type of investment, doing due diligence and researching the landlord or seller puts you in a better space and gives you the right information to make an informed decision. Find out how long they have owned the property and if the title deeds are readily available.