Podcast: Rent to Buy Schemes – What Investors Need to Know | Ep. 253

Posted by Ed McKnight on 22/05/20
Rent to Buy Schemes What Investors Need to Know 001
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Show Notes

What's Covered in the Show?

In this episode, we discuss Rent to Buy schemes and how they have the potential to benefit and harm both the vendor and the potential purchaser.

In a Rent to Buy property-purchasing structure, a vendor will agree to sell a purchaser a property for today's price, but the purchaser does not have to pay for the property for a number of years (e.g. 5 years). Over that time, the purchaser will pay market rent to the vendor, plus an additional amount, which counts as part of the deposit.

The benefit to the vendor is that they will usually sell the property with a margin (i.e. it won't really be the market rate on today's market). And if the purchaser decides not to settle, the vendor gets to keep the additional rent.

That can make rent to buy schemes incredibly risky for purchasers, especially lower income purchasers who would typically be targeted by these schemes.

We also mention our property investor quiz, which after answering 7 basic questions will give you a yes, no or maybe answer about whether you are in the position to invest.

Transcript

Transcript of the Podcast

Ed McKnight: Hello and welcome along to the Property Academy podcast, I'm your host Ed McKnight, and I'm Andrew Nicol, and today on the show, we're talking about rent to buy schemes.

Now we are seeing more of these become or more rent to buy schemes being talked about in the public. And I believe the government actually has floated the idea for kind of lower socioeconomic families who want to be able to purchase their first time, but we also know that more developers are talking about these as well, and essentially what a rent to buy scheme is, is where you'll pay a higher amount of rent and then at an agreed future date, you have the option to purchase the property for an agreed purchase price.

Andrew, just walk us through how these tend to work and what's in it for the vendor and what's in it for the buyer.

Andrew Nicol: Yeah, so these are quite interesting. And I remember seeing a lot of them prior to the GFC, prior to 2007, there were a lot of companies that were kind of offering these to people.

I was very wary of them, particularly because of the type of people that they would tend to attract, and so I distanced myself from them, and rightly so because they came crashing down a few years later. So, let me just talk about how they work in concept. So say you've got a house at the moment worth a $450,000, just for ease of numbers.

And, you might say that you'd agree to sell it to someone for, well, actually, let's just say $500,000. You agree to sell it for $500,000 today, and the rent would be $500 per week.

What then I do as a developer or a vendor is I do an agreement for sale and purchase to buy that in five years time for $500,000 so the upside now for a purchaser is that I'm getting today's price, which usually it is a bit of fat in there, you know, it might actually be with 480, but they were agreeing on 500, but I get that in five years time and hopefully the property might be worth say 600,000 in five years time, for example.

What then you have to do as the purchaser of that property is you have to pay an above market rent.

So if the rent's $500 a week, you pay $700 a week, you pay your $700 in total, 200 kind of gets parked, and the idea that in five years time, you have saved 200 a week times, 52 weeks times five years, roughly $50,000 so in theory, you have a 10% deposit.

Now, banks are very dubious about them, and BNZ I think it was BNZ at the time would only lend 50% LVR on them. And so the challenge was or where people came unstuck is $700 a week might be more than your family can potentially afford.

Now if you stretch yourself and make it work, and then three years down the track, you can no longer sustain that and you have to move out of the house and go and rent somewhere else, you lose the $30,000 that you've paid thus far being three years of $10,000.

And so the person, the vendor, the owner of that house, ends up collecting a far higher rent than what would be normal, because they tend to target people who aren't actually able to save enough money.

And that's how, you know, they ended up winning. And then of course, if you are the vendor of one of these properties, you can go to the bank and say, well, I've got a really good yield on this property. Will you lend me more money? And so of course I saw more of these come unstuck than I saw them successfully go through.

Ed McKnight: And the other interesting thing just in terms of talking about what's in it for the vendor. Obviously we talked about the higher cash flow, but what's not within the numbers is that you've got to have a very well behaved tenant because this person, at least at the start has the intention that they are going to purchase this property, and so is going to look after it, that they might take more care to repair it and maintain the property and make sure that it's looking good because they're treating it as if it is their home and they want to maintain that because they have agreed to buy that. Obviously there's that margin on sale as well.

If you're going to sell it and initially upfront for a bit higher than it would actually be worth on the market. And obviously, of course, that extra money for when it comes through.

So generally we are saying be a bit, yeah. Cautious about these sorts of schemes. I know I've seen a couple of investors talking about them as well in terms of tenants approaching them for these types of schemes.

While they can tend to be profitable, I can also anticipate that you could come across a couple of disputes as well down the line, Andrew, depending on how these contracts are written, to make sure that you don't have a tenant challenging some of the language within those contracts.

Andrew Nicol: Yeah. Well, one of the things that I remember seeing come unstuck was a guy who was selling a property to a family who were diligently putting their extra money aside, paying the hydrauliced rent.

What happened was he ended up being put into liquidation by his bank, and so of course they sold off all his assets, and they had no recourse and all they could do was file against him, but he had no money to recover. And so of course, that money had already been spent and he was screwed. The poor family, weren't able to recover any of that money.

And so you have to be very certain if you are the buyer in this instance that your landlord isn't going to keep leveraging against that property and then not be able to release it.

For example, if there was a lending criteria change or that go get into financial trouble themselves or borrow more money against it and then not be able to fulfil that contract.

And whilst again, you might have a legal case against that person, if they've got no money to chase, then there's no point even going down that path because you might be one of many people that they owe.

And that can become a real issue because you might've put aside 30 $40,000 extra and not have any ability to recover that and, you're kind of stuffed at that point.

Ed McKnight: And just walk us through Andrew, is there any situation where a rent to buy scheme might be appropriate for particular people, when might this sort of scheme be appropriate?

Andrew Nicol: I think the only time that I would feel comfortable with it would be if it was a family type of arrangement.

So if mum and dad had a rental property that the kids wanted to buy, then maybe what you would do is you would have the rent payment go into one account and you'd have the deposit payment go into another account and you'd structure it with someone that you trust and you know is going to honour the agreement later on, that you know is going to be in a financially able position to be able to fulfil that obligation at the end.

And if you did run into trouble in five years as the buyer and not be able to get finance, they're not going to say, I'm sorry, but that $50,000 that you've saved towards the deposit has now gone this now my money.

That would be the only time that I would say it's an appropriate mechanism. In the past, I've just seen so many people get burnt by them, that you have to really, really tread with caution.

Ed McKnight: Yes. I think with some of these more complex financial arrangements and contractual agreements, you do have to be a little more wary about them because if you don't fully understand them, there is that risk of, I guess what's called asymmetric information, where one person knows more about an agreement than the other party on the other side of the table.

And if you are walking into one of these agreements, but don't really understand your obligations around them or some of the things that can go wrong, that is where things have the potential to go wrong and had you known about that, you might not have walked into that arrangement in the first place, but let's wrap it up there, but please don't forget to rate, review and subscribe to the podcast, it really does help us get the message out to more people.

And hey, if you've been listening to the show for a while, and you've been thinking, hey, I'm going to try out this property investment thing. Then why not check out our property investment quiz?

I'm going to drop a link to this in the show notes, but in just seven questions, it will tell you as a first time investor whether you're in a position to invest, you might be in a position to invest or you're potentially not in the position to invest right now, so I'm going to drop a link to that in the show notes, or you can check it out at Opespartners.co.nz.

Thanks for listening to the Property Academy podcast. I'm your host, Ed McKnight and I'm Andrew Nicol, and we're going to be back again tomorrow with even more daily strategies, tactics, and insights to help you get the most out of New Zealand property market.

Until next time.