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Rent To Own


Newsflash - Rent-to-buy is back in vogue for selling property

Rent-to-Buy is going mainstream in Western Australia - Mirvac advertising rent-to-buy to sell apartments at Claremont Ova (Perth).

What's interesting is how they are structuring the Rent-to-Buy, using (you guessed it) a Lease Option. This is how it works:

The buyers pay an up-front option fee of 2.5% of the price for an option to purchase and enter into a two year lease paying fortnightly rental instalments equivalent to loan repayments. After two years they must purchase the property with external finance. Because they are tenants, and so do not pay Council Rates or Strata Levies and so the rent is all they pay.

The buyers receive a full credit of the 2.5% option fee and a full rent credit for the rent they pay. If my arithmetic is correct, the credits will add up to about 10% of the price (+ stamp duty), leaving 90% to be financed externally.

Significantly, the buyers must prove their ability to pay the fortnightly rental instalments and qualify for a pre-approval for the mortgage finance they will need to take out after two years to buy the property.

The apartments are priced from $495,000 for a 1 bedroom 1 bathroom apartment.
9 May 2019

What is Rent to Own?

Rent to Own is a variety of vendor finance.
In Rent to Own, the seller helps the buyer by allowing the buyer to rent the house for a while, until the buyer builds up enough equity to qualify for a bank loan and own the house.

How does Rent to Own work?

Rent to Own is a two phase contract made directly between a seller and a buyer.

The first phase is the Rent phase when the buyer is living in the house and is making the regular payments.

The second phase is the Own phase when the buyer has enough equity to qualify for a bank loan, which they use to cash out the contract and transfer the house into their name.

What questions do buyers ask?

  1. How quickly can I move in?
    You can move in immediately and start the
    rent phase once your home application form is checked out favorably, you pay the documentation fee, you sign the contract and make the up-front payment.
  2. What do the payments go towards during the rent phase?
    The up-front payment goes towards building equity. The ongoing payments are mainly rent payments, with some going towards building equity.
  3. What are the payment amounts during the rent phase?
    The payment amounts are higher than the market rent because they consist of not only rent payments, but also the to own payments.
    The to own payments go to build equity and to pay house expenses such as Council and Water Rates and Home Insurance.
    How much the to own payments will be depends on what you can afford and the time frame agreed for building equity.
  4. How long does the rent phase last?
    The rent phase lasts until the buyer has built up enough equity in the house to finance with a bank. Five years is a very rough guide.
    Building equity can be achieved by making regular to own payments and by renovations.
    In terms of payments, for some buyers it is to build up 10% of the pre-agreed price, for other buyers it is to build up 20% of the pre-agreed price. Self-employed buyers usually need to build up 20%, but if they are handy, can build up some of that 20% with renovations.
  5. Can you speed up the rent phase?
    Yes. You can save up extra if you receive a pay rise, you can reduce expenses by paying off a car loan or a personal loan, and can use the extra towards building equity.
    If you renovate wisely, by building a carport or a pergola, by landscaping, by installing a new kitchen, by painting, etc., then you will be able to build equity by increasing the value of the house.
  6. What do you do when you reach the to own phase?
    Once enough home equity has been built up, you obtain finance from a bank. Using a mortgage broker is best. Because the purchase price is agreed and fixed up front, it is easy to work out how much you need to borrow. You will need good financials and a good credit rating for a loan.
  7. What happens at the to own phase?
    While you are in the rent phase, you are not recorded on the title as owner. During the rent phase, your interest in the property can be protected under the Contract, by living in the property and by registering a Caveat on the title of the property.
    At the to own phase, the bank loan pays out the Contract and the title is transferred into your name.
  8. Where do I find a house to buy with Rent to Own?
    You need to keep an eye out for signs on properties, adverts in the local newspaper and on the internet. If you are a tenant and the landlord is interested in selling to you, you could ask the landlord if he or she would consider a Rent to Own.
  9. What is the paperwork for a Rent to Own?
    There are two different kinds of paperwork that can be used for a Rent to Own, depending on which State in Australia the property is in, and depending on the seller’s tax position.
    The paperwork starts with a Heads of Agreement, which the seller and buyer complete, which is then handed to the seller’s property lawyer for Contract preparation.

    Click here for a sample Heads of Agreement. Contact us for a more detailed version.

    Click here for a list of property lawyers. Use a property lawyer who practices in the State where the property is situated.

Example of a Rent to Own

A house is ‘sold’ as a Rent to Own at a price of $300,000.

The paperwork will contain these items:

  • pay an up-front payment of $10,000
  • move in immediately
  • pay $50,000 of the price by 250 instalments of $200 per week in just under 5 years
  • pay rent of $300 per week (including rates) over the next 5 years
  • at the end of 5 years, borrow $240,000 (which is 80% of the price) and pay the outstanding amount due to the seller
  • be able to add a carport, a pergola, landscaping, a new kitchen to improve value and possibly refinance faster
  • look after repairs and maintenance

What steps do I need to take in order to buy a house with Rent to Own?

  1. Look on the web, on street signs, on flyers for houses which are advertised as ‘Rent to Buy’ or ‘Rent to Own’ or ‘Vendor Finance available’. This website is an information website – it does not advertise Rent to Own houses.
  2. Save up your up-front money – as a guide 3% of the price.
  3. Choose a Rent to Own house, contact the advertiser and fill in their home application form.
  4. Consult mortgage broker to look at your financial situation and to work out a plan to refinance with a bank down the track when there is enough equity in the house and your financials can support a bank loan.
  5. You are chosen to buy the house and pay the documentation fee. You select a property lawyer to advise you on the Contract.
  6. Complete the direct debit authority for the payments from your bank account.
  7. Sign the Contract.
  8. Pay the up-front payment (less the documentation fee paid).
  9. Collect the keys and move in.
  10. Look after the house, pay the payments on time, and down the track refinance or sell.

Can an Option to Purchase be used to buy a house or a home unit?

Buying as you are renting a house or home unit means that a tenant holds an option to purchase their rental property.

Coupling an option to purchase with a lease has been used in commercial leases for many years.

In a recent decision: Le v Phan [2016] NSWSC 632, the Supreme Court of NSW has upheld the validity of a combined option to purchase and a residential tenancy.

We will now review the decision and the form that the option to purchase should take when combined with a residential lease, to make a rent to buy transaction.

What form should an Option to Purchase take in rent to buy transaction?

Options to Purchase provide a pathway for residential tenants and residential property investors to control a house or home unit, initially without taking out a bank loan or paying a traditional deposit.

Over an agreed term, the tenant or investor, can either build up a deposit and obtain a bank loan to take title to the property, or sell the option at a profit, or relinquish the option.

This is the form that the rent to buy transaction should take:

  • An option to purchase (a call option) and a residential lease are entered into at the same time. That is why the transaction is commonly known as a Lease Option.
  • The residential lease is entered into at market rent, in the standard form prescribed by the Residential Tenancies Law.
  • The option to purchase (a separate document) specifies the option fee payable and how it is to be paid, the fixed purchase price payable and the option expiry date.
  • The amount of the option fee payable and the option expiry date are set by reference to the expected loan availability at the end of the option term. For example, if the tenant can expect to qualify for a loan of 90% of the price, then the option term will need to be sufficiently long for the option fees to be paid to amount to 10% of the price. As a fall-back, often there is provision to extend the term if the loan qualification becomes more difficult during the term. The term of the residential lease mirrors the option term.
  • The option fee is paid by instalments. Part of the option fee is paid on the entry of the option. The rest of the option fee is paid during the term, by instalments, usually when the rent is paid. For example, the rent might be $400 per week and the option fee might be $200 per week. And so, the total weekly payment might be $600 per week. The rider is that the weekly payments of $600 per week need to be affordable to the tenant or investor, as if affordability was assessed under responsible lending guidelines.
  • The price is a fixed price which is set when the option is granted.
  • The price represents 'full market value' of the property. The price will be higher than the cash price, because payment terms are offered. How much higher depends on prospects for capital growth and the term.
  • The option to purchase can be exercised at any time.
  • The title to the property remains in the name of the owner, and the existing property loan remains in place. If the option is exercised, then at the time when the price is paid, the property loan is repaid.
  • The tenant/buyer can protect their interest under the Lease Option by registering a Caveat over the title to the property.

Do the courts recognise Lease Options as valid?

In Le v Tran, Associate Justice Harrison of the Supreme Court of New South Wales upheld a Lease Option which took the above form.

The house was a standard 3 bedroom house. The other facts were somewhat unusual - the option fees payable were lump sums payable on certain dates; and the court's task was to determine the validity of the termination of the Lease Option, as opposed to enforcing the Lease Option.

And so the decision, which centred upon the tenant/grantee's default, the termination of the option and the lease, and orders for possession and payment of arrears of rent and option fees, is not relevant for our purposes.

However, relevantly for our purposes, the court upheld the validity of the Lease Option documentation. These were the observations made by her Honour:

  • “The option agreement provided that Ms Tran would be granted an option to purchase the property for the price and in accordance with the terms of the Contract for Sale attached to the option agreement in return for an option fee, comprised of an upfront option fee and ongoing instalments. The option fee was to be credited against the purchase price of the property. ... Although the option agreement appears to be expensive, the benefit it conferred on Ms Tran is that she had the right to purchase the property and the payments made by her were credited to the sale price.”
  • “The residential tenancy agreement is a standard form agreement in accordance with the Residential Tenancies Regulation 2010 (NSW) Schedule 1 clause 4. .... the term of the agreement is two years. The rent is $550 per week. A rental bond of $550 was required.”

What are the legal, licensing and stamp duty issues for Lease Options around Australia?

Lease Options are legal throughout Australia. Each State and Territory has their own standard form Residential Tenancy Agreement, but they are similar. Each State and Territory has their own laws for property options, which means that they can be considerably different.

The failure to use the standard form Residential Tenancy Agreement and to strictly comply with the property option laws can lead to the documents being invalid, and therefore legally unenforceable. It is therefore essential for these documents to be prepared by a lawyer / conveyancer.

In South Australia, the use of Lease Options is limited – they cannot be longer than 6 months, and the option payments are limited to 4 in number. No other State or Territory has this restriction.

In Victoria, Lease Options are liable for stamp duty as if they were a purchase, when they are entered into. No other State or Territory imposes stamp duty on entry of a Lease Option.

Entering into Lease Options is a real estate activity. If the Lease Option is for an owned property, as a one-off, then it is unlikely to be considered a real estate business activity – it is a private activity. But if a person engages in Lease Options as a business, then it needs to be done through a licensed real estate agent. Of course, the alternative to using a real estate agent is to obtain your own real estate licence!

Lease Options are not credit contracts. No credit is given in a Lease Option. Paying rent is not the same as paying interest. Therefore, an Australian Credit Licence is not required.

Sandwich Lease Options

There is an interesting twist to this decision, which is that the grantor of the option, Mr Le, was not the registered owner of the property.

Mr Le had taken an option to purchase the property from the owner, Ms Phan. Mr Le's option was to purchase the property at a fixed price.

To pay the option fee, Mr Le agreed to pay Ms Phan's home loan instalments, as they fell due, together the land rates and water rates. He also paid for the home insurance.

This form of option is known as an 'Assumptive Option'.

Together with the Assumptive Option, Mr Le was given a residential lease of the property, with the right to sub-lease.

He was appointed the attorney of the owner (under a Power of Attorney) to deal with the property.

When an Assumptive Option and an Option for Purchase are used together, they are known as a 'Sandwich Lease Option". Of course they are accompanied by a lease and a sub-lease.

Their attraction lies in the fact that someone in Mr Tran's position can put together a Sandwich Lease Option to control the property without needing to expend any of their own money - figuratively, they can 'Buy a house for $1"!

Why is no financial outlay necessary? The reason is that payments made by the tenant/grantee of the Option to Purchase exceed the property loan and other payments that need to be made under the Assumptive Option.

Sandwich Lease Options are not for beginners. It is recommended that Options to Purchase be mastered first, and then the more difficult Assumptive Options can follow.

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