How to Structure a (real) Rent-to-Own Agreement

In today’s economic climate where renting is becoming more prevalent, and homeowners are renting out their homes instead of taking losses, I have seen an uptick in rent-to-own interest.  A true rent-to-own structure can be a powerful tool to help a renter become an owner, and to help an accidental landlord sell their property.

A good rent-to-own structure should provide a real incentive for the renter to overcome the obstacles that are getting in the way of ownership.  For most renters, the obstacles are either lack of a downpayment, bad credit or both.

I think the following structure provides a fair rent-to-own structure for both the tenant and landlord.  I call it the 50/50 match. Simply put, this structure allows the tenant to rent the property at a premium, which premium is held in an escrow account for the tenant to use as a down payment. In order to provide a strong incentive to the tenant, the landlord matches the monthly premium. If the tenant purchases the property, then the escrow funds are dispersed to the tenant for use as a down payment. If the tenant does not purchase then the escrow funds are forfeited to the landlord.

There are four things that have to be defined and clearly outlined in the escrow agreement:  1.  Market Rent, 2. Rental Premium, 3. Landlord Matching, and 4. the Length or Term of the agreement.  There are many other provisions as well, such as the conditions under which the funds are forfeited, etc.  Consult an attorney to learn more about other provisions that should be considered.

Market Rent

Find some comparable properties that have rented recently in your neighborhood.  Seek the input of a realtor, or do some research to determine an estimate of the market rental rate.  There are many resources that can be used to determine the market rental rate, for example http://www.zillow.com/local-info/

A word of caution when using Zillow:  Zillow indicates average rents by neighborhood according to the number of bedrooms.  I recently rented a 3 bedroom condo in Wicker Park for $2700/mo.  When using this as a benchmark to compare Zillow data, I realized that Zillow does not hold data for Wicker Park; they lump Wicker Park in ‘West Town’ which indicates an average monthly rent of $2,100 for a 3 Bedroom.  Conversely, the zillow ‘z estimate’ of market rent for a 3 Bedroom property in Albany Park is $1,787…this is too high.  Zillow might be a good starting point, but definitely find some comparable properties that have rented recently in your neighborhood.

Rental Premium and Landlord Match

Figure out how much the tenant needs to save every month in order to purchase the property. For example, if the tenant needs to save $6,000 to have an appropriate downpayment, then he should be socking away $500 month to have the downpayment saved in one year.  The rental premium + landlord match needs to be at least $500 a month.  At a 50/50 split, the rental premium is $250 and the landlord match is $250.

Length or Term of the Agreement

This can be a real sticking point in the negotiations.  The landlord needs to exercise patience, and the tenant has be comfortable with some risk of losing the rental premium. If it will take one year for the tenant to save the downpayment, then the term needs to accommodate enough time beyond one year for the closing to take place.  In this case a term of 18 months to two years might be appropriate.

Example:

Let’s say you are trying to sell a 3 Bedroom Condo in Albany Park.  You’ve had it on the market for several months at $215,000 with zero interest.  You are ready to move on, and now you are considering renting the property.  A rent-to-own might be a good structure to consider to increase the likelihood of a sale in the near future.

Zillow indicates a market rental rate of $1,787 a month, but you find some comparable properties that have rented for $1,500-$1,600 a month.  You market it for rent at $1,500 a month, and you indicate a rent-to-own option is available, and after a few days a potential tenant emerges that is interested in the rent-to-own option.  You walk him through the 50/50 match structure, and he is excited to move forward.  The tenant applies for the property, and the credit check reveals a low credit score, but he has paid off all collection accounts and he says he is working with a credit repair company.  The candidate believes his credit score will be high enough to get financed within 18 months, but he needs a down payment of 5% and he has no savings.

You and the tenant agree to a strike price of $190,000 for the property.

At $190,000, the tenant needs a 5% downpayment and approximately $4,000 in closing costs for a total of approximately $13,500.  Since he has no savings, he needs to accumulate $13,500 in 18 months, or approximately $750 a month. You both agree to a rental premium of $375/month with a landlord match of $375/month, and a lease term of two years lease.

The tenant pays $1500 + $375 = $1,875 a month in rent + premium, and you deposit $750 of this in an escrow account every month.  After 18 months the tenant will have a sufficient down payment, and the rent could then drop to the market rent.

After two years the renter risks losing $6,750 if he does not go through with the purchase.  If the tenant does not move forward, then you will gain $6,750 which is arguably appropriate compensation for essentially selling a put option on your property for 24 months.

I have had tenants push back on the idea of losing the rental premium. If you encounter opposition, then explain that an option is very valuable.  Anything can happen in 18 months.  The property values could go up significantly, in which case the tenant will benefit from the appreciation, and they could go down significantly, in which case the tenant can walk away and avoid the loss.  The tenant also benefits from living in the property for an extended period of time with obvious benefits.

It is critical that both parties seek the advice of an attorney when entering into such an agreement!  Absolutely critical.  I am not an attorney, and this advice is no substitute for sound legal counsel, but feel free to contact me with any questions.  I’ll be happy to share my experiences.

Chicago School District Property Searches

For parents moving to Chicago, there is only one way to guarantee that your children are accepted into a good elementary school:  live in the attendance boundary of a good neighborhood elementary school.  There are numerous magnet schools that accept children from all over the city, but these schools have an application and/or lottery process that does not guarantee admission.  For those families with the financial resources, there are also several private school options in Chicago.

Given the importance of neighborhood elementary schools to some buyers, the lack of resources to search by school district is surprising, both for consumers and real estate agents.

Imagine you are a buyer, and you have decided to focus your search within Sauganash school district because not only is Sauganash Elementary a great school, but also the public transportation options are awesome, and the area is very affordable.  You find a realtor with whom you are comfortable, and you give him or her your marching orders:  please show us everything available in Sauganash School District.  You also conduct your own search on various websites, and you are frustrated by the lack of resources to search by school district in Chicago.  Most ‘school searches’ actually search within a radius of the school itself, or within the same zipcode.

Fortunately, your agent has access to the MLS (Multiple Listing Service: a database of all properties for sale in a given region), and an elementary school district search returns 17 homes for sale in Sauganash school district as of 01/14/12.

The thing is, there are actually 40 homes for sale in Sauganash School District!  Why the discrepancy?  It’s the classic ‘garbage-in, garbage-out’ phenomenon…..the elementary school search described above relies on school district input provided by the listing agent, and unfortunately listing agents do not always input correct data, if they enter the data at all.

Sophisticated agents can conduct a map based boundary search in the MLS which will return more accurate results.  This type of search is not only time consuming and prone to errors (the agent must trace the exact school district boundary), but also occasionally not possible because a boundary search will allow exactly 15 vertices before the loop closes.  For complicated school districts, such as Beubien, where the outline has more than 15 vertices, it is much more difficult to see all the properties available.

So if you are using an agent, make sure you ask what method they used to find the homes for sale in your specified school district!  Livebytransit.com has a true school district search that is based on the latitude/longitude of the property, and we do not rely on the input of listing agents.  We also publish a ranking of all public neighborhood elementary schools, and links to each school on the CPS website. We are in beta mode, and some users have made us aware of a few bugs on the site.  We will be pushing an updated site very soon!

Mechanical Turk and my first Ruby job

Many people have asked how I compiled all the data for the livebytransit website.  The answer is that I wrote rake tasks to get the data from various CSV and XML files.  A lot of the data was available publicly, and for the data that wasn’t, I used Mechanical Turk to build the data in Excel.  Mechanical Turk worked out ok for me, but watch out for two things:  1.  You pay up front for the work, and if no one does the job then the refund policy is this:  after 2.5 years you get a refund in the form of Amazon credit.  WTF?  2.  My jobs were repeatedly spammed by people from all over the world saying they completed one of my tasks.  The problem with this is if someone says they complete a task, then after 2 days they automatically get paid!  I had to police the site everyday to reject submissions from spam artists.

All that said, it worked out fine, but I may have gotten lucky because out of all the spam emerged only one person who was legit, but wow did she do a good job.

I recently had another reason to post a job, and I explored Elance as an alternative.  In the process of exploring I found a job posted that I thought I could do with my newly found Ruby Skillz.  In fact, I did the job and it took me under an hour.  The job was to take an excel file and convert one field with a full doctors name and credentials into two fields, one with just the first name, the other with just the last name.  There were over 2,000 entries, and they were suggesting that someone would do this by hand for $200.  Below is my solution.  It is probably not the most elegant code (or even close), but I welcome thoughts from programmers who can think of a better, easier way to do this task.  I am always looking to improve.  Feel free to email me for the original spreadsheet.

desc “doctor excel”
task :doctor

require ‘csv’

first_names = []
last_names = []
CSV.foreach(‘doctor.csv’, :headers => true, encoding: “UTF-8″) do |row|
full_text = row['Name']
full_name = full_text.split(“,”).first.split(” “)
first_name = full_name[1]
c = full_name.count
d = full_name.slice(c-1)
if d != “III” && d != “Jr” && d != “JR” && d != “II” && d!= “IV”
last_name = d
else
last_name = full_name.slice(c-2)
end
first_names << first_name
last_names << last_name
end

first_names.each do |first|
puts first
end

puts “LAST NAMES”

last_names.each do |last|
puts last
end

Why Craigslist Sucks for apartment finding

3 reasons why cragislist sucks for finding an apartment in Chicago:

1. Rental Brokers
2. Rental Brokers
3. Rental Brokers

Rental brokers have their place in the market….they are there for landlords who are unable or unwilling to handle apartment showings on their own.  With the exception of this scenario, I believe rental brokers should not be in the mix.  Rental brokers use craigslist as a lead generation tool, blasting the same listings multiple times a day in hopes of capturing a renter client.  Renters end up with seriously diminished negotiating power by using the rental broker’s “free” service, and Landlords end up paying millions in unnecessary leasing commissions every year in Chicago.  Craigslist is a problem.

Livebytransit.com is an exclusive place for landlords to post listings for rent.  What does exclusive mean?  It means we exclude rental brokers from posting!  Renters are empowered to negotiate and deal directly with landlords.  Renters also benefit from cool search functionality, like search by train station and search by school district.  Landlords can also use this tool to manage their inventory.

Livebytransit.com is in beta mode….please take it for a spin and provide comments.  With your help Livebytransit might just replace craigslist as the go-to site for finding an apartment in Chicago.