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Supercharge your portfolio with ‘rent to buy’

By MoneyQuest
In Home Loans, Investment

Sometimes dismissed as a riskier investment strategy, rent-to-buy deals are becoming more popular with tenants who are squeezed out of home ownership by the banks’ tight lending criteria. Investors are also benefitting from the high rental returns on offer, which could transform a negatively geared investment into a top money earner.

In its simplest format, a rent to buy deal is a win-win arrangement between both the renter/buyer and the investor, says Peter Doherty from Alternative Home Ownership Company.

“People may have heard about the rent to buy strategy, but most don’t really understand it,” Doherty says.

“There’s a lot of negativity surrounding it, but we’re looking at it in a little more depth and utilising it in a different way for everyone’s advantage. It’s a flexible model and it can be a great investment tool for property owners.”

As far as renter/buyers are concerned, this strategy gives them an opportunity to buy a home when they may not ordinarily be able to. Perhaps they can’t get a bank loan as they are new immigrants, are recently self-employed, have a small blemish on their credit file, or they don’t have a large enough deposit.

“People in these situations are excluded from the property market at the moment, because they can’t get the funds,” he explains.

“Under a rent to buy agreement, they don’t need a bank loan upfront, so this gives them time to get a few things in order in the meantime. Usually rent to buy arrangements run over a minimum of three years, and they can range to up to 10 years. The agreement is for them to stay in that property for that period of time, and at the end, they must settle the purchase with a regular bank loan.”

The benefit to the renter/buyer is clear: they have the opportunity to buy a home and live in it as if it’s their own, even before they officially take ownership. They can settle in without fear of eviction, paint the walls, and even start to renovate, with the owner’s approval.

On the other side of the equation is the investor, who legally owns the property until it settles at the end of the agreement. Under a rent to buy arrangement investors generally achieve a significantly higher rent, and because the purchaser treats the property as if it’s theirs, the tenant takes care of expenses such as council rates, maintenance and insurance.

As a result, the investment will be positively geared, allowing the investor to enjoy monthly profits that can support other negatively geared, high capital growth properties.

“As an investor in this sort of arrangement, your motivation isn’t capital gain, it’s income on a regular monthly basis. Many property investors think in terms of one strategy, which is all about capital gain, but we take a broader based view,” Doherty says.

“If you’re heavily negatively geared, you expose yourself to a lot of risk. The whole idea of investing is to make you more independent, not financially dependant on your employer, so we encourage you to look at diversifying and looking at your portfolio so that you develop a safety net.”

What are the risks?

This type of strategy is not for everyone, says Nathan Birch from BInvested.com.au. While his investment philosophy purports that “there’s no right or wrong strategy, as long as you make a profit,” Birch believes that rent to buy ventures often fail to maximise your investment potential.

“You’re dealing with people who are normally knocked back for finance. They represent a bigger risk, so they may not be able to settle the purchase of the property at all,” he says.

“But the bigger problem to me is, you’re selling the asset. You’re going to the bank and getting the loan, doing all of the work to get into a deal, and then you go and sell the asset? It doesn’t seem like it’s worth it for all of the effort involved.”

Doherty counters that the effort involved is minimal and the risk really lies with the buyer/tenant, as the property owner stands to lose little from a financial perspective.

“The property always remains in your name, so if the purchaser takes off, the property reverts back to you. In the meantime you’ve had a higher income stream and your mortgage paid for a period of time, so you’ve come out ahead anyway,” he says.

“We then just go back to the drawing board and evaluate our families who are waiting for a home, and match up the right fit with your property.”

This may minimise the financial risk, but in Birch’s view, it misses the point of helping you achieve your broader investment goals.

“People tend to think small, and the bigger picture is building a property portfolio that delivers wealth for years to come – not making a few dollars a week,” he says.

“The biggest profit in property is capital growth. You need to hold it for 10 years to make any real headway, and on-selling it straight away for a small profit of say $20,000 doesn’t make sense to me.”

Michael Yardney from Metropole Property Strategists agrees that by selling the asset, you’re also failing to build your long-term wealth potential.

“People get involved in property investment for wealth creation and to create wealth you need to own assets. Rent to own is a cash flow play at best, but not an asset play, as cash flow won’t make you rich,” he says.

“In fact over the years, I have never seen anyone get out of the ‘rat race’ using rent to own strategies. Yet, I have seen many investors develop significant property portfolios and substantial asset bases by using tried and tested techniques of buying well-located properties at a fair price, and holding them for the long term. Over the years the value of their properties goes up, as does the rent, allowing them to buy further properties and eventually build themselves a cash machine.”

Rent to buy… as a cashed up investor

If this type of investment fits with your risk profile and your investment strategy, then it’s worth investigating a rent to buy deal if you wish to add a positive cash flow deal to your portfolio, Doherty says.

“Many investors in the current market simply want a regular income – they are sick of the return they’re getting on their investment properties and right now, because the market is so flat, most investors wont break even on their property if they sell,” he says.

“That’s why in a flat market, a rent to buy strategy is a good way to go. If the market is really roaring ahead, you might be balancing your portfolio in a different way but in this flat market, rent to buy offers a great opportunity to build your income stream.

Depending on how you structure the deal, Doherty says its possible to enjoy profits of up to $1,000 per month, after all ownership expenses have been paid, although the norm is closer to $150 per week.

“If a house normally rents for $350 per week, it will rent for around $550 per week as a rent to buy. A portion of this, say $40 per week, will go towards the renter/buyer’s deposit, but as the investor, even if you gain a 100% loan, your rental income will still more than cover it,” he says.

You can attempt to set up a rent-to-buy on your own or partner with company such as Alternative Home Ownership Company, which will take a percentage of your profits in exchange for matching you up with a quality renter/buyer. They also manage the property on an ongoing basis.

“As licensed real estate agents, we manage it ourselves – we like to keep our finger on the pulse of what’s happening in each property and also, the incentive program in a rent to buy attracts a different type of tenant,” Doherty adds.

“They have a vested, financial interest in the property and they’re going to look after it. It’s not your normal rental situation so we like to be involved every step of the way.”

To discuss this article or anything to do with your finances, please call our office today and we will be happy to assist you.

 

MoneyQuest
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