I recently got a comment in my post How To Easily Calculate The Return-On-Investment (ROI) For Rental Properties and as I mentioned in my reply to the comment, this question deserved an entire post so I can answer it in greater detail. For everybody’s reference, I have reprinted the question below:
i have been following your blogs through the referral of my friend marlyn catapang. your blog is so informative and i have learned a lot especially the real estate thing….i just wonder about rent to own properties. i am contemplating to buy a property through rent to own but i’m hesistating right now because i believe that my interest as buyer is not so much “protected” i don’t know if i am right…what if i have been doing my part as lessee or buyer and have been religiously paying my responsibilities — suddenly the seller passed away, what shall be my remedies? what if at the end of the terms of our contract he is suddenly lost and has not issued a deed of sale in my favor yet…i hope you can help me sir…
thank you and sorry…here is another newbie,
I replied through a comment that one remedy would be to include a provision in the contract that the heirs of the seller shall also be bound by what has been agreed upon between the original seller and the buyer. To do this, one can include a provision in the contract to the effect that “It is understood that the heirs of the seller shall honor the contract in case the seller becomes incapacitated or passes away.”
While answering this question, another scenario came to mind. What if, in cases where the seller sold the property via the rent-to-own scheme, and the seller should be paying amortizations to the bank using in part the buyer’s rent-to-own payments, how can the buyer be assured that the seller’s amortization payments are up-to-date? This is important as there have been cases where the buyer religiously paid his installments but the seller did not pay his amortizations to the bank and at the end of the term of the contract, the seller had nothing to turn over to the buyer as the bank has already foreclosed the property.
I believe this can be addressed by adding a clause in the contract to the effect that “If the seller, through no fault of the buyer, does not have the absolute right of ownership at the end of the term as stated in the contract and after the buyer has complied with all the terms of this contract, the seller will return all the payments of the buyer with interest at X% per annum.” The provision on interest shows the seller’s good faith and somehow gives assurance to the buyer that the seller is legally binding himself through the contract.
As for the exact wordings, I strongly recommended that you consult a lawyer and have a customized document be drawn for you to suit your requirements. Always remember to seek legal advice before entering into any contract, agreement or executing any legal document.
Another suggestion would be to drop the idea of entering into a rent-to-own scheme and go for the “assume balance approach” instead. This approach is basically having the buyer assume the balance of the loan of the seller – i.e., the buyer will continue paying the monthly amortizations. In the Philippines, this would require the buyer to qualify for bank financing.
The seller will usually require a big down payment because his profit is already factored in here. You may consider this as a win-win situation since the seller gets his profit upfront from the downpayment and has no more amortizations to think about, and the buyer only needs to assume the balance of the seller, with usually low amortization payments. The catch is that the buyer should be ready with a substantial amount for downpayment.
The assume balance approach has also been used by motivated sellers wanting to avoid foreclosure, and in those cases the downpayment is usually not as big. I know a lot of people are very interested in the assume balance approach, so watch out for a more detailed post on this.
You will notice that I wrote the suggestions above mostly from the perspective of a seller that has considered the concerns of his client, the buyer. This is because as real estate investors, we will often play this role as we sell our properties. I believe that as sellers, we should do what is necessary to ensure our buyers are protected as well. This would lead to gaining their trust and a much greater chance of closing the deal. Otherwise, we might not even have a sale to begin with.
I really hope this helps all those investors out there with the same concerns. If you have any question, please feel free to leave a comment in the comments section of this post.
Update: A sample Rent-To-Own contract is now available on this post http://www.foreclosurephilippines.com/2009/04/19-free-legal-forms-and-contracts-from.html