Creative prospective buyers are turning to rent-to-own agreements to step into the property market during a tough economic climate.
Rent-to-own transactions may slowly reappear on the South African property scene as prospective buyers look for creative ways to get a foot on the property ladder in a declining economy.
Such transactions are common when buying large household appliances and items, but not many people know they can apply when buying a home. However, this is changing, according to legal and property professionals.
“There has been an increase in inquiries about how to configure rent-to-own transactions, and a sudden increase in tenants terminating leases in favour of purchasing properties outright from landlords, particularly in the last month or so,” says Denoon H Sampson of conveyancing attorneys Denoon Sampson Ndlovu.
“The main benefit of rent-to-own is the tenant is able to peg the price at today’s values and defer the transfer until he/she has raised the price. Alternatively, he/she still has the choice not to buy the property,” Sampson says, adding most of the properties concerned are sectional title and priced below R2 million.”
During the market conditions experienced in South Africa and when banks are tight on credit, buyers are unable to buy homes the traditional way, so they look for creative solutions, says Rawson Property Group chairperson Bill Rawson.
“The concept of rent-to-own isn’t new, but many don’t realise it’s an option for property.” Those considering it must fully understand what they are getting into before agreeing to anything, he warns. “It can be risky for both parties, but there are situations in which it can be a viable solution.”
Rawson says the main attraction of a rent-to-own purchase agreement is it eliminates the need for a large cash payment upfront. This is helpful, considering 100% home loans are rare these days and most prospective buyers will need to budget for a deposit and the usual transfer, bond and attorney fees.
“These upfront costs can be significant – as much as R150 000 for a R1 million property. If the buyer doesn’t have the cash, the purchase can’t go ahead.” With rent-toown, Rawson says costs are spread over a longer period, making the purchase more viable for a financially stable person with limited access to immediately available capital.
“The way it usually works is the buyer and seller sign a lease agreement that allows the buyer to live in the home, like a typical tenant, but with the intention of purchasing the property at the end of the lease,” says Rawson.
“The details vary, but generally in return for first right of refusal, an additional sum is added to the monthly rental and this acts as a down payment or a deposit towards the future purchase.”
However, if the tenant decides not to buy the property when the lease ends, this sum is often forfeited. Depending on the agreement, if the tenant does buy, that sum can count towards the purchase price.
Major rental agencies say the rent-to-buy method of purchasing property is unpopular, but according to real estate attorneys from Cliffe Dekker Hofmeyr (CDH), this could be because the concept is not being marketed or there is insufficient knowledge about this option in the residential market.
“We believe there is a need for rent-to-own agreements, especially in the current market,” says CDH director Lucia Erasmus, associate Joloudi Badenhorst and candidate attorney Emilia Pablian.
“These methods may be used by low-income earners or first-time buyers unable to obtain loans to finance property purchases, or who have not accumulated enough capital to pay deposits.”
Although the prevalence of rent-to-own agreements cannot be attributed to particular types of residential areas, “we believe these agreements will become more popular in larger cities, where qualified students and young adults start earning salaries”.
Rent-to-own is also popular for self-employed buyers to get “a foot in the door” as few are aware of all the “red tape” they must comply with, says Meyer de Waal, of MDW Inc, a conveyancing attorney specialising in this method of buying. He says any type of property is suitable for rent-to-own transactions, adding his firm’s largest such transaction was a farm sale for R22m.
“Often a home loan is declined because the credit record of the buyer reflects a minor negative entry.
If a rent to-buy agreement is successfully negotiated between seller and buyer, the buyer has a few months to restore his credit report and reapply for a loan.” Meyer recommends buyers and sellers always consult attorneys familiar with the required legal documents.
Two options for rent-to-own
A rent-to-own agreement is a fixed term lease which includes an option for a tenant to buy the home at a price determined upfront at the termination of, or prior to termination of, their lease.
In some agreements a bigger than usual rental is paid to create a deposit for the purchase. In other agreements a tenant pays a set amount towards rental and an additional monthly amount towards the purchase price.
Documents must include a sale agreement introduced when the option to buy is exercised.
Pros and cons for both parties
Cliffe Dekker Hofmeyr details the pros and cons of rent-to-own.
Advantages for tenants/buyers:
● Many tenants prefer to purchase rather than rent, but do not qualify for loans because of factors such as no credit record, unstable income, lack of proof of income and so on. A rent-to-own agreement gives them the opportunity to acquire the property they are renting at a later stage. The tenant is entitled, but not obliged to, purchase the property at any time during the lease period or just before the expiration thereof.
● Because the agreement must specify the purchase price and all other terms with which the owner will sell the property to the tenant, they will have certainty regarding the purchase price and the sale terms and conditions.
● The tenant has the advantage of occupying the property for a period before having to elect whether to purchase it. This allows them to decide whether they still want to buy.
● In difficult economic times, when funding is not readily available and financial institutions impose stricter lending criteria, a rent-to-own agreement will ensure the landlord earns rental until the tenant qualifies for a loan.
● A tenant who intentionally wishes to conclude such an agreement, as opposed to a standard lease agreement, is more likely to be committed to comply with all obligations in the lease agreement.
Disdvantages for tenants/buyers:
● The agreement is more complex than a standard lease agreement.
● The landlord might want to charge for granting the option as he is prevented from selling the property to another purchaser during the lease period. This may affect the rent, or additional consideration may be payable.
● The lease agreement may contain onerous maintenance provisions and obligations, and tenants should make sure they understand the terms and conditions.
● The landlord may not accept any offer made by a third party to purchase the property until the option period – normally the lease period – has expired.
● As the purchase price must be contained in the “rent-to-own” agreement, the landlord will be bound to such price and may not renegotiate it at a later stage.
● Although the agreement may contain an escalation clause in terms of which the purchase price escalates, it is not easy to predict market conditions and the escalation may not be market-related at the time the option is exercised.