Rent-to-Own Deals are Usually Good for Sellers, Bad for Buyers

Most people buy real estate hoping that homeownership will turn out to be a good investment. But increasing wealth doesn’t always come with buying. The same is also true for rent-to-own scenarios, where caution is also highly recommended.

The main issue with this form of home buying is that in most metropolitan areas, only about 1-to-3 percent of available housing is a rent-to-own (R2O) offering.

Here’s the reason that’s a problem: The vast majority of wealth earned in real estate comes from long-term ownership. If in that small pool of R2O offerings you don’t find a property you really feel good about, yet you still enter into that deal, this is more likely to result in you not owning it long term, because that home was not what you really wanted in the first place.

Bottom line: You probably won’t increase your net wealth as a function of buying that property.

In addition, most people trying to do a R2O deal are trying this strategy because they’re not creditworthy enough to qualify for mortgage financing. If you can’t qualify, the bank is telling you that they have concerns that your financial picture may lead you to default on a mortgage loan.

My advice? Please, take their advice! Work on your creditworthiness. Get some credit counseling from a reputable non-profit credit counseling organization. Get your financial house in order. You are most likely better off saving your pennies and working on your creditworthiness so you can buy that perfect home with low interest rate, fixed long-term financing a few years down the road.

Also, many R2O deals are offered by investors who bought the property and are selling it to you so they can make money! Many of these investors ask above-market prices for the properties because they assume you have no other option.

Additionally, many times the “rent” is above the comparable market rent. So market rent might be $1,500 but you are paying $1,800 with that additional rent to be credited (termed “rent credit”) for your downpayment. But if you aren’t able to purchase for any reason, including the chance you can’t secure bank financing, you don’t get that extra rent credit money back. So the seller keeps it. You lose.

Of course, all terms are 100 percent negotiable, so if you try one of these R2O deals, feel free to negotiate all terms to your advantage, and good luck.

I know people want to own real estate to earn wealth, and I’m the biggest proponent ever, since this can be a great way to earn long-term wealth. But doing a rent-to-own deal is unlikely to increase your wealth and more likely to end up costing you money via forfeits of those additional rent down payment when you move out.

Oh, did I forget? It’s estimated that only about 10 percent or less of renters in R2O deals actually are able to close the purchase. So at the end of the day, you’ve paid above market rent to someone else. I’m sure they appreciated your increasing their net wealth? But for you, the better route would have been leasing a normal rental and saving money. That’s a more solid strategy for building wealth.

If you want to earn wealth on real estate, you need to buy that near-perfect property for all the right reasons — which is because you want to own real estate for a long time. That’s my philosophy, and it should be yours, too!

Leonard Baron, MBA, CPA, is a San Diego State University Lecturer, a Zillow Blogger, the author of several books including “Real Estate Ownership, Investment and Due Diligence 101 – A Smarter Way to Buy Real Estate.”