The complex web of rent-to-own schemes

With a whole generation struggling to conjure the savings necessary for a home deposit, some are turning to an option that has caught on in the US but is relatively unknown in Australia.

Rent-to-buy (or rent-to-own) schemes are almost as varied in their shape and form as the people using them for a foothold on the property ladder.

They are essentially a payment plan that allows the participant to move into the property they intend to buy and pay it off as if it was a rental. Many will allow the buyer to enter a standard tenancy with the option to purchase later on. 

The model is financially viable to the agent and owner as they usually charge a higher rental rate than the market, which will often go toward the final big sum if the buyer decides to go ahead with the purchase.

The buyer may only exercise the ‘option to buy’ at the end of the rental period if they can get the finance to pay the balance of the agreed purchase price and have complied with the terms of the contract.

The buyer will typically pay an initial ‘option to buy’ fee as well as ongoing option fees which are separate to the rental payments. Even though the ongoing option fees are supposed to reduce the balance of the purchase price they are not likely to be secured in a trust account.

The WA Government’s Consumer Protection department has described the schemes as: “high-risk, because your name only goes on the title of the property when you have purchased the property outright.”

“Some rent-to-buy contracts may indicate the buyer will lose all payments made and have no claim over the property if even a single payment is not made on time,” it adds.

Despite these concerns, there are still many reputable companies offering rent-to-own packages.

Ollie Salami, senior property advisor at Nicheliving in Perth, said they had seen a lot of interest in the model from first home buyers.

“We’ve seen consistently strong demand in both enquiries and take-up of this model, helped by us being one of the very few companies who offer the option due to our ability to provide various buying options as Perth’s largest affordable house and land developer,” Mr Salami said.

“We believe there is little downside as it helps first home buyers who genuinely want to get in the market but need help or further assistance with their deposit.”

Varieties abound

Each state has a different policy on rent-to-buy schemes. In Melbourne, Brisbane and Sydney, there is quite an active market for rent-to-own. However, South Australia is highly regulated, so it is much less common.

Fractional investment platform provider DomaCom has completed its first contract in Melbourne’s Moonee Ponds, while a second is going through due diligence in Brunswick West and discussions with developers are underway in Sydney for further properties that fit their rent-to-own model.

Domacom chief executive Arthur Naoumidis said their service differed from the standard rent-to-buy products requiring payment of an option fee above the standard rent, with this option fee providing the right to purchase the property at the end of the arrangement at a price fixed stipulated at the start.

“In our model, the tenant only pays the standard rental amount and we effectively gift five per cent equity to the tenant over five years as a tenant incentive,” he said.

“The tenant receives one per cent when they move in and then a further one per cent on the annual anniversary for up to a further four years if they remain the tenant. 

“The whole idea behind this tenant incentive is that in times of high vacancy risk, such as in a pandemic like the one we are in, we want prospective tenants to choose our properties when they have a choice of equal properties.

“Having a lower risk of vacancy makes our properties more attractive to investors, which is the whole point of this incentive and our recent ability to syndicate investors during stage three and stage four lockdown for properties in Melbourne is a good sign that investors like this."

Another comparable product taking root in Australia is the new built-to-rent schemes by the likes of Mirvac and Stockland. The key difference is that these properties are designed to be rented for life and the rent is usually higher than the standard rent for similar properties, arguably creating a class of permanent renters.

But wait, there’s more

All rent-to-own schemes have two components: a standard rental agreement and an option to buy.

But from there, the legal intricacies can diverge into myriad directions. Before entering into a rent-to-own agreement, it’s important to seek independent legal and financial advice.

A general expectation is that the buyer will need to save up about three per cent of the purchase price as an upfront option fee that will go towards equity. 

Some first home buyers choose to use their first homeowners grant (FHOG) towards this payment, but it’s also important to make sure the purchase is eligible for their respective state’s grants. Participants lose their FHOG eligibility after taking up a rent-to-own contract.

Inflated rent can be as much as 50-100 per cent higher than average, and in most cases only the inflated portion of the rent will go toward the equity of the house. Generally, the payments cover rent with a smaller portion going towards building equity.

Mike Kelly, principal of Sydney’s Housing Heroes, said rent-to-own offers a lot of flexibility, which is perfect for many clients who don’t fit inside the banks’ box ticking exercises. 

But his company has expressed reservations about some aspects of the rent-to-own model.

“The selling price is normally higher than the current market value, as it has to be — no investor in their right mind would wait five years to sell a house at the same price he could sell it for today and take his profit and employ it into another deal,” Mr Kelly said.

“Likewise, the market value of the home will be much higher and the investor is not allowed to access any of the equity without the written consent of the tenant/buyer, which they won’t lend.”

Insurance companies and banks are also a source of angst as the murkiness of the ownership split between landlord and tenant can lead to messy disputes, he said.

“I’m now steering people towards our trademarked product, the Deposit Layby, where we lend deposit funds to the buyer so that title transfers immediately,” Mr Kelly said.

But even then, it wasn’t for everyone. With the Deposit Layby product, the participant’s credit rating needs to be sound, whereas rent-to-own programs allow people to get the home now, and the loan later.  

Timing is key

With property prices falling in many capital cities, the urgency to get a foothold on the property ladder has diminished somewhat. 

Saving for a deposit over a couple of years may be worthwhile if prices decline over the same period. Low-deposit home loans are another option, while rentvesting is becoming a popular choice too.

As with any financial decision, if everything goes according to plan the rent-to-buy scheme can and do work favourably. However, due to the various complexities of the contracts, it can also leave buyers worse off than before they embarked on the process.