Recently “rent-to-own” real estate has become trendy among the real estate community in Ontario. The rent-to-own model essentially involves a tenant/buyer agreeing to pay a lump sum to the landlord/seller up front as an “option price” in order to secure the right in the future to purchase the property at an agreed price. In the meantime, they are a tenant and must pay monthly rent which is higher than the market rent. The portion above market rent is then
credited against the eventual purchase price of the property. The agreement states that the tenant/buyer is only a tenant with an option to purchase the property. Typically, the length of the term ranges anywhere from one to five years.
Agreement for Sale vs. Option to Purchase
Unfortunately some tenants/buyers enter into these agreements with the notion that they have purchased the property and are paying the purchase price over time, which is not the case. There is an important distinction at law between an “agreement for sale” and an “option to purchase”. In an agreement for sale, which is generally used in the western provinces and not Ontario, the buyer makes monthly payments to the seller. Title to the property remains in the seller’s name until the entire purchase price is paid. Title is then transferred.
An option to purchase is quite different. Under an option, the “buyer” is not really a buyer, rather only a tenant of the property. Some rent-to- own agreements stipulate that the tenant’s option is terminated immediately upon any default of the tenant. Furthermore, virtually all rent-to-own agreements state if the full purchase price is not provided by the closing date, tenants/buyers forfeit the ability to purchase the property, all the money which they have paid towards the equity in the home and the rights to any improvement they have made to the property.
- The following benefits and risks should be considered prior to entering into a rent-to-own agreement:
- It appeals to tenants with a poor credit, yet with enough money to pay for the option.
- Real estate investment firms advertise annual returns of 20-26% to investors who purchase the properties and rent them to tenants.
- The purchase price is fixed, which is beneficial for the tenant/buyer in a rising market.
- Since the downpayment is spread out over time, home ownership is easier to achieve for tenants/buyers on fixed budgets, while benefitting from occupying the home of their choice immediately.
- There are no standardized rent-to-own agreement forms accepted by the real estate industry, and the commonly-used forms are poorly drafted.
- Determining the purchase price for a transaction taking place anywhere from one to five years in the future is problematic. If the price is too low, the landlord/seller will try to walk away for potential additional profit and if the purchase price is too high the tenant/buyer will attempt to back out of the transaction.
- Tenants/buyers generally pay “above market rent” in order that each month some money will be credited against the purchase price. However if the tenant/buyer backs out of the transaction at the end of the option period, they will lose the option fee, any monies credited against the purchase price, and the rights to any improvements made to the property.
- Tenants/buyers may encounter dishonest sellers or unlicensed real estate agents. There have been instances of rent-to-own operators who rented homes from desperate sellers, subleased them to tenants, pocketed the rents without making mortgage payments, and left the tenant/buyer to be evicted by the mortgage lender.
- It may be difficult for the tenant/buyer to obtain financing with a conventional lender when they are trying to obtain mortgage financing to pay out the landlord/seller. Some banks will not recognize the past payments as part of the down payment. If the tenant/buyer cannot satisfy the bank’s requirement with respect to a further downpayment, he or she will not be able to obtain a mortgage, which in turn means they cannot exercise the option and they lose their investment.
- The Landlord and Tenant Board has ruled that if a tenant/buyer defaults under the agreement it does not have jurisdiction to evict a defaulting tenant/buyer who has an option to purchase.
- Power of Sale or foreclosure proceedings cannot be used against a defaulting tenant/buyer. Landlords/sellers must commence a lawsuit against defaulting tenants/buyers to evict them and terminate the option agreement.
Rent-to-own transactions involve a significant amount of risk for both the landlord/seller and tenant/buyer. It is not for everyone. Persons wishing to participate in these transactions must fully understand the legal implications involved, the associated risks, and only deal with licensed real estate agents and real estate lawyers familiar with this concept.