Two options to prevent tenant defaults

December 1, 2009

We wanted to take the time to address some very realistic concerns investors and tenants have identified in recent months about the future purchase price of their property at the end of the rental term.

In the last 12 months, Canadian real estate has experienced a significant valuation decrease and increase. The variance observed in the real estate market could only be characterized as a valuation roller coaster. For most of our deals, the future purchase price agreed upon in the Occupancy Agreement will reflect the market value of the property.

However, there are markets that remain somewhat depressed and as result, the purchase price does not reflect the home’s current market value. This has raised a considerable number of questions.

Mortgage companies will not lend on an inflated property value and will most certainly conduct an independent appraisal prior to close. Tenants might also become skeptical about buying a property above market value. This could potentially increase defaults, and leave certain investors holding the property they believed their tenants would purchase at the end of the rental term.

We  realize this is a serious problem, which is why we wanted to take the time to explore 2 very creative ways of solving this issue.

Option #1 – Extend the Rental Term

At the end of the rental term, your tenant will have amassed some equity in their property, anywhere in the range of 5-10%. If they don’t purchase the property from you at the end of the rental term, the Occupancy Agreement states they are in default and their security deposit, along with the monthly option credits they’ve amassed, are forfeited to you.

Because tenants are significantly invested at this point, they do not want to compromise the equity they’ve established. So in order to avoid default, and as a way to provide tenants with the ability to purchase the property at a price that reflects its value, we suggest extending the rental term by 6 months to a year. For you as investor this is quite beneficial.

One, it guarantees your tenant will be in a position to purchase the property at a price that reflects the value, and thus they will be inclined to execute the purchase and not leave you with a vacant property. Two, it affords you the ability to collect premium monthly rents for another 6 months to a year (depending on the extension period). This will contribute greatly to the overall return on your investment and net profit at the end of the transaction.

Option #2 – Agree to a Lower Purchase Price

Another option for you, the investor, if extending the rental term is not a choice and you need to discharge the property as soon as possible, is to work with your tenant to arrange a lower purchase price at the end of the rental term.

We understand this is not an ideal arrangement because it goes against the principle of having signed the Occupancy Agreement with the expectation of honoring its arrangement. However, as mentioned, this is only an ideal situation if  Option #1 – Extending the Rental Term does not work, and you need to discharge the property as soon as possible.

If you require any more information or would like to talk about these options please feel free to give me a call or send an email.

You can also leave a comment below as well.  We would love to know what you think.

Regards,

Alex

Posted by alexkluge | Filed Under Uncategorized 

Comments

  • renttoowninvestor
    Sorry I accidentally deleted this comment. I am re-attaching it below.

    "I like an idea rent to own but I am new in real estate investing business and my concern is:
    If I buy property in the city that I don't have any idea what vacancy status is and it located far away from my place of living in case that tenant refuse to buy the property at the end of the contract what I would do in this situation?
    If some one can share their own experience ???!!!!"

    Roza Kovalenko

    kovalros@hotmail.com
  • alexkluge
    Hi Roza,

    That's a great question. Speaking from my own personal experience, I purchased my first 8 properties within an hour's drive of where I lived. Once I felt more comfortable with owning properties from a distance, I bought my next 7 properties in a completely different province. I surrounded myself with a great team (where I own these properties in Alberta) should anything go wrong. Having said that if you feel apprehensive of investing from a distance, you should look at buying your first few properties close to home.
  • Your welcome Lisa. I love your outlook. While the goal is to make money, at the end of the day, it's about helping people become homeowners and sometimes some sacrifices might need to be made to accomplish this.

    As you state, you don't want to lose money, but if you can still make a great return and your money and help the tenant, then its still a win-win.

    We hope to attract more people with your outlook. :-)
  • Lisa Kember
    At the end of the day, while we hold property, we are in the people business. So I would suggest the option you work out with the tenant should accommodate the tenant to some degree, as long as you don't lose money. Nice summary of a real concern and possible solutions. thanks.
  • andy
    Sorry, changed numbers have way through and forgot to change them all, so don't laugh at my math, haha.
  • renttoowninvestor
    No laughing Andy. Appreciate you taking the time to add a comment.
  • andy
    Another option frequently done in RTOs is to simply give a vendor take back mortgage (2nd to the banks) on the property at fair interest for the difference between sale price and appraised value
    .
    For example, if property sale is $200,000 but bank appraisal is $170,000 (and will only loan at 80% of appraised value) then bank mortgage is $120,000 and you could give VTB to the tenant for other $25,000ish that they don't have, or give an even higher vtb to make it easier on the tenant.
  • admin
    Thanks Olev. I believe that is what Jon was referring to on option #1. If for some reason, the home in that particular neck of the woods didn't appreciate as anticipated, then yes modifying the contract makes sense for both the investor and the tenant.
  • Olev Maimets
    My suggestion is to modify the contract to make the sale more likely to go through. i.e a Lease to Buy agreement.
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