The thought of buying a rental house today and getting truly rewarded for that decision in 25 years is difficult for many - even less attractive if your age is getting away on you. After all, we can drive a new car out of the showroom with nothing down in a few short hours or even have it delivered to our door. In fact, almost anything in the world is a click away and can be delivered to our door 24 hours later. So why do we have to wait so long for wealth? Is there a quicker way?
Buying a rental house and letting the tenants pay off the mortgage in 25 years (often referred to as the buy/hold strategy) is the simplest wealth formula around and beats RRSP/mutual fund investing any day. But, there is a faster way.
By combining a long-term buy/hold strategy with a mid-term strategy, you can accelerate your wealth at a much quicker pace. My favourite mid-term strategy is the “lease with option to purchase” or more commonly known as the “rent-to-own.”
The rent-to-own strategy is often used as a way for a tenant to become a homeowner through two separate agreements. The first agreement is the “lease” (standard provincial tenancy agreement). The second agreement is the “option to purchase real estate,” which outlines all the terms and conditions of how the tenant can purchase the property. The rent to own offers the landlord, seller or investor several benefits over the buy/hold strategy:
- Reduce risk: With the buy/hold strategy, once you have found the right asset type and crunched the numbers properly, the main risk is found in the monthly variable expenses, not the fixed ones. The fixed expenses are the mortgage, property tax and property insurance payment. Assuming you use fixed-rate mortgages or fixed payments with a variable rate, the monthly payment amounts don’t fluctuate. However, vacancies, repairs and maintenance are the fluctuating variables, which can often eliminate any cash flow and turn it into negative cash flow very quickly, especially if they continue. With the rent-to-own strategy, the tenant signs a two- to three-year lease and takes care of all the minor maintenance of the property, therefore eliminating the variable expenses. As a result, your risk is reduced while your cash flow and overall return increases. Find out more about the different loan types in our compare home loans page)
- Ease of tenant management: Since tenants do not own the property as it’s often a temporary housing solution for them, they are less likely to treat the property as if it were their own. Whereas with a rent to own, the tenant’s mindset and motivation is different as they will eventually own the home. They take care of the property, often fix it up themselves and display pride of ownership; making these types of properties very easy to self-manage. Plus if they are late on rent, they can lose their opportunity to buy the home. Therefore the tenant is very motivated for good reason to pay on time with zero excuses.
- Win/Win investing: Giving someone the opportunity to own their own home with a proven plan can be very rewarding personally, especially when you hand them the keys for good. Let’s face it, buying a rental is typically all about us as investors and the numbers. We want the tenants to pay off our mortgage with the least amount of hassle as possible. Buying a rental house that someone else will eventually own through the rent-to-own strategy not only increases cash flow and reduces management; it also produces a positive outcome for both parties. Adding value to someone else’s life and being financially rewarded is win/win investing.
- Increased rate of return: By significantly reducing our ongoing monthly expenses, our rate of return skyrockets. Running a simple property analysis calculation over a two-year period using a five per cent annual appreciation on a $350K rental property shows a three per cent annual rate of return on cash. By applying the rent-to-own strategy to the exact same property with the exact same appreciation rate produces an annual rate of return on cash of 20 per cent. How significant is that? Well, $50,000 invested at three per cent over two years turns into $53,045. At 20 per cent per year, it turns into $72,000. A $16,955 difference. Over five years at three per cent, the initial $50,000 turns into $57,963 whereas at 20 per cent it turns into $124,416. A staggering $66,453 difference in just two years.
For all the reasons above, this mid-term strategy is at the top of my list. So instead of continuing to buy more long-term buy/holds and waiting for 25 years, consider adding some profitable mid-term strategies to your own portfolio. You may be surprised at how easy, profitable and rewarding they really are.
Paul M. Hecht is an investor, seminar leader, mentor, real estate agent and author of Everyday Real Estate Millionaires: How Average People REALLY Do It.
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