A Risky Venture for Tenants?
Rent-to-own agreements provide tenants who have a poor credit history with an opportunity to own a home. If they aren’t operated properly, however, the agreements can end up costing tenants their savings.
In a basic rent-to-own scheme, the seller (landlord) and the buyer (tenant) enter into an Agreement of Purchase and Sale that leaves the title to the property in the seller’s name. The buyer moves into the home after providing a downpayment and then pays a monthly amount for a fixed period of time. The monthly rent-to-own payment includes part payment of the purchase price of the home, in other words, a downpayment and the rest is the rent.
At the end of that fixed period of time, the title to the property is transferred to the buyer if he or she fulfils his or her end of the agreement and can get a mortgage from a financial institution. The title will also be transferred to the buyer if he or she pays the full purchase price before the end of the period.
“The idea is it’s their house, but the seller is holding title as security for payment of the monthly amount” says Joe Hoffer, a lawyer who specializes in residential tenancy law for landlords.
Some agreements give the buyer the option to purchase the property after a certain period of time according to the terms and conditions the seller specifies. For example, the agreement may specify that the tenant may purchase the home for a fixed price at any point up to two years after the occupancy begins. A tenant would typically purchase the home by taking out a mortgage in his or her own name; the owner of the property would then transfer the title to the tenant/buyer.
The terms and conditions a seller specifies determine whether a particular rent-to-own agreement is subject to the Residential Tenancies Act, Hoffer says.
In the first scheme described above, a buyer who defaults on the agreement may decide to make an application, declaring the buyer to be a tenant, to the Landlord and Tenant Board in an effort to avoid eviction. Most members of the Board would agree the Act does not apply.
“The deal is essentially an Agreement of Purchase and Sale, not a lease, and if the parties break the agreement, then the whole deal falls apart,” Hoffer says.
In the second scheme, where the buyer has an option to purchase the property, Board members could declare that the Act does apply since the living accommodations constitute a residential tenancy and “the Agreement of Purchase and Sale is crystallized only when the option is triggered,” Hoffer says.
In many rent-to-own schemes, the buyer lives in the property without title to it while taking care of his or her own maintenance and repairs, and paying significant expenses in a deposit, property taxes and a monthly amount, which can be risky. When the buyer goes into default, the owner evicts the person and finds someone else.
The cycle continues when buyers default and the seller charges each additional new buyer a deposit.
“People who enter into these agreements typically are people who can’t get financing through conventional means,” Hoffer says. “If it works out for the landlord and the tenant, that’s great. But this issue comes up so often because it hasn’t worked out.”
Buyers who have defaulted often apply to the Board to have their deposit returned on the basis it was an illegal deposit. If they apply within a year of having paid it – the limit under the Act – they may be able to recoup it.
Hoffer says buyers could benefit in a rising real estate market if they triggered the option to purchase the home and then sold the home for a profit. Overall, however, tenants need to be confident they have a steady source of income to meet their payments before they become involved in a rent-to-own agreement.
“If they don’t, they lose everything,” Hoffer says.
A Solid Investment for Landlords?
As noted above a tenant rents a house for say $1,000 a month, $900 is designated for rent and property taxes; the extra $100 goes towards the downpayment. Tenants also have to pay a deposit, which is credited towards their downpayment. Once tenants have paid the downpayment in full, they can try to apply for a mortgage in their own names and if they are approved they can then complete the purchase.
If tenants have to leave the city because of a work transfer, or decide they don’t want to own the home after all, they will lose their deposit.
As a landlord by working closely with a real estate representative you can assess the appreciation during say the previous three years of similar homes in the area of the home you’re planning to rent out. If a bungalow in east London, for example, appreciated by eight per cent during those three years, the landlord would then add eight per cent to the value of the property for each year to establish the final selling price at the end of the term.
Assuming that the market trends stay the same as they have for the last three years, the buyer is getting the house at fair market value and the seller is also selling it for fair market value. The negative is that it could go one way or the other for either party and they have no way of determining which way the market is going.
Thanks to Joe Hoffer
Cohen Highley Lawyers
One London Place. 255 Queens Ave. 11th Floor London, ON. N6A5R8