Rent to Own to smokers and other due diligence

[TangoWhiskey]

My wife is handling three RTO houses as her first foray into RE investing. She seems to have already lined up two sets of tenant buyers. One of these are a couple with two kids, but both adults smoke.



Prolonged smoking in a house is extremely costly to repair in paint and odor/stain blocker. The upfront deposit she's negotiated is 5K. If the tenant buyers don't work out then the 5K would disappear into fixing smoke damage at a minimum.



What do you do in this situation? Put super draconian rules that they sign accepting that any sign of interior smoking will result in loss of deposit? Or increase the deposit substantially? This would knock many candidates out of consideration as 5K seems to be something of a ceiling for ready cash for a deposit for this tenant profile.



Mark, Adam, others with RTO experience - how do you handle this particular risk? And what about pets and pet damage?



thanks for all replies

 

[kfort]

I would never allow smoking in a home that I own. And 5k seems awfully low unless this is a very cheap property.

 

[Thomas Beyer]

[quote user=TangoWhiskey]What do you do in this situation?
Smoker or not, increase deposit substantially.



The risk of damage exists for non-smokers too, and the only way to protect yourself in any case is a higher deposit and assessment of their ability to make the agreed upon monthly payments until they buy. I am doing a RTO right now for $535,000 with 3% upfront and a monthly payment that is 2x the rent of $2500, with a goal to have them qualify in the second year with roughly 10-12% accumulated so they can qualify for a new mortgage.

 

[Sherilynn]

We have had clients with initial option payments of $60000 on a $366k house. Yes, you will find a LOT of people with only $5k, but there are good prospects with more money out there. If people can't manage to save more than $5000, then I would argue that they are not ready for home ownership.



I will accept $5k cash along with other security. For instance, for one client we have a $20k irrevocable direction to pay on the sale of their house in another province.

 

[Sherilynn]

Oh, pets I allow with no special rules. A large option payment greatly decreases your risk.

 

[TangoWhiskey]

[quote user=Sherilynn]A large option payment greatly decreases your risk.


What as a percentage is a good rule of thumb to require as the non-refundable deposit? My wife is generally shooting for a 4 - 5 000 $ deposit on a purchase price of 206 K with an annual appreciation rate of 5 % for a two or three year option contract. So not much more than 2 % down as it were.



Expressed in those terms it does seem very small. She's been looking for approx 1 month now for tenant buyers and has had maybe 100 inquiries to her kijiji ad. Two of these seem likely to develop into tenants buyers so how much should we be asking? And how much longer will doubling the upfront deposit add to the search and marketing period to find that more exclusive/lower risk tenant buyer?



How do these numbers seem to people, both for financial side and also the relative response rates and success of the marketing campaign.

 

[MarkTorgerson]

A couple of questions;

• Do you already own the property or is this going to be a new purchase? This has a very large impact for my deals regarding the option deposit. I'm much more flexible on my terms for property that I have already owned for several years. Possibly 5k option deposit. If it is a new purchase, I wouldn't consider anything less than 5% of purchase for an option deposit, and more likely 10%. This mitigates the risk and also helps ensure the deal closes when the contract is due since the tenant/buyer will be coming in with a strong deposit.
• What is the monthly lease payment from the tenant/buyer?
  Where is the property located to be justifying a 5% appreciation rate? Seems a bit aggressive.

 

[TangoWhiskey]

Answers:

- we just closed on them, avg price was 174K for three 6 yr old semi detached 3 bed 3 bath in a row in a newer subdivision (they come from an overleveraged investor who went bankrupt)

- monthly rent payment is 1200 and purchase credit of 200-300/month for a total of 1400-1500 on top of which they pay water and their utilities

- sub-market of Halifax, the 5 % appreciation rate is one of the negotiables, (we have had one tenant buyer couple push back on this rate and we reduced it to 3 %)



Generally there seems to be 4 financial variables to play with to make a situation work: 1 - up front deposit; 2 - monthly purchase credit amount; 3 - entry and exit prices 4 - rates of appreciation during the rental period (which is really the same as 3).



Are there any other variables to play with financially?



In total we're in to each house for about 50-55K with repair and appliances purchases on a 75 % open mortgage expecting to refi in 1 yr and pull most of the cash out before the tenant buyer purchases them. Using RTO the underwriting is we expect to make about 5-6K/yr in cashflow before the refi and about 30K per house after taxes on a successful exit in 2-3 yrs.



Do these numbers seem ok? My concern is how much of an upfront deposit should we look for given the added holding and vacancy costs that that will mean??



Thanks for the rapid and valuable responses from all the RTO pros.

 

[MosaicRentals]

If it is costing you $5000.00 because of smoking you are either getting shafted or you are exaggerating the cost. I believe it is the latter. I can do a lot of renovations to a home for $5000 whether they were smokers or not.



I think you are losing a sizable client pool by fear mongering with these exaggerated claims. With the money an RTO pays every month and the high deposit they make will far out weigh the painting and cleaning costs. According to the RTA in Alberta the expected life of a paint job is 4 years or even less depending on which DR officer you talk with. So that means you should have to paint anyhow, smoker or not.



And for those that consider the home still theirs with a RTO occupant in it I think you should change that to RMSY... "Rent Mine so I can Screw You". RTO, the O would suggest they own the home just like anyone else paying a typical mortgage. So why would you have the right to dictate what they legally do in the home?



To make the most of your RTO you should choose a client who most likely would succeed at the end of the term instead of putting someone in that you already assume they will not, make certain they carry enough insurance at all times , monitor the maintenance of the home, sit back and shut up.



But I guess because of that approach you wouldn't keep making excessive rents and deposits from RTO's you know won't qualify at the end of my term.



Is it obvious my opinion of RTO is a negative one?

 

[MarkTorgerson]

These numbers seem ok. I try to put deals together that have the tenant/buyer having a minumum of 10% for deposit at the end of the contract. We have found numerous times that 5% simply isn't enough and we have had to extend the contract. It is ok to be a little aggressive on the backend purchase price. You can still sell it for the appraised value if it comes in less. As long as you are making a good return, don't let greed get in the way.

 

[Sherilynn]

[quote user=TangoWhiskey]What as a percentage is a good rule of thumb to require as the non-refundable deposit? My wife is generally shooting for a 4 - 5 000 $ deposit on a purchase price of 206 K with an annual appreciation rate of 5 % for a two or three year option contract. So not much more than 2 % down as it were.


Our minimum in a major center is 3%, so your numbers aren't much different. ($5k is pocket change in central Alberta.)



When you tell people that the more they have, the better, because you can be more flexible on the final price, suddenly they may find an extra $5k.