By Alejandro Lazo
Washington Post Staff Writer
Saturday, November 22, 2008
Justin Sprinzen took a chance on an abandoned Capitol Hill townhouse last spring, despite the faltering housing market.
The 34-year-old novice developer saw potential profit in the vacant District-owned property on D Street NE, about a dozen blocks from his home.
So he bought it from the District in March and went to work gutting and refurbishing. He knocked down walls; added bamboo floors, modern lighting and new appliances; and installed a small backyard patio. He put the property up for sale on July 4.
It went nowhere.
At least two serious buyers were not able to get financing, Sprinzen said. After four months, with the economy getting worse, there were still no viable takers. So he began searching for alternative ways to sell.
The house was advertised on Craigslist with the headline: "Rent/Lease/Option to Buy." Sprinzen said he will consider tenants who are committed to buying the house but cannot buy just now for whatever reason -- shaky economy, bad credit, not enough for a down payment, no longer able to qualify for a mortgage. These arrangements are often known as rent-to-own.
"The name of the game is to stay above water," Sprinzen said. "If I can break even and cover my mortgage and get through this, I am open to it."
Renting to own, also known as renting with an option to buy or a lease-purchase agreement, had practically vanished during the days of easy money. Now real estate professionals say the practice is reappearing as sellers grow increasingly desperate and buyers with damaged credit scores find it harder to secure mortgages.
Glenn Kelman, chief executive of the Seattle-based online brokerage firm Redfin, said he has seen a spike in requests from buyers looking for listings with rent-to-own arrangements. He said his agents are telling him that homeowners are also increasingly willing to consider such requests.
"Normally, sellers will tell you to pound sand if you ask them for an option to rent," Kelman said. "But now because the sellers are in a vulnerable position, they are more likely to do it."
However, several real estate professionals said they remain skeptical of the practice. A volatile market could lead a buyer to lock in a price that is higher than what the property will be worth at the end of the term. That can be bad for both seller and buyer if a bank is unwilling to make a loan. In a world of falling real estate values, the homeowner can be foreclosed on, leaving a potential buyer high and dry. And if a potential buyer cannot secure a mortgage now, then there is no guarantee that he or she will be able to do so in the future.
"There is substantial risk for buyer and seller that the other won't be able to perform given the volatility of the real estate market," said Mark E. Simon, a real estate lawyer with Village Settlements in Montgomery County. "Each side should look at each partner carefully on this."
Sprinzen said that despite the risks, he would prefer to strike a rent-to-own deal with a potential buyer rather than just rent out the property. Allowing somebody the ability to own gives him a sense of pride, he said, and homeownership is an instrumental part of the urban revitalization of the District, which Sprinzen said he feels a part of.
"I am covering my mortgage at the same time they are gaining some equity . . . so I feel it is kind of a win-win for everybody."
And, he said, "It helps stabilize an area that could have taken more of a bath than it did."
Typically, a rent-to-own agreement is a contract between owner and tenant that gives the tenant the option to buy the home at the end of a stated period of time. A nonrefundable deposit is sometimes asked for by the seller to ensure commitment on the part of the tenant. The monthly rent a tenant will pay is typically higher than the prevailing market rent for similar properties, as the tenant is also paying for the right to purchase the home. This premium can be used as a credit toward the purchase, potentially making it easier to get a mortgage.
Because rent-to-own deals are a hybrid of renting and selling, they can be difficult, said Steve Wydler, a lawyer and real estate agent who is co-principal of the Wydler Brothers team at Long & Foster.
"In my experience, I have had a number of people who have tried to put together rent-to-own deals and not once have we been able to close," he said. "When you try and do a rent-to-own, you have the complexity of combining the two."
Striking an initial rent-to-own deal is the start of a long-term relationship. And with time, hearts can change.
A buyer could discover down sides to the property, such as: "I didn't realize the traffic noise was so bad or the commute was so bad or the house was built so poorly," Wydler said. "There are all sorts of things that can come up once you are living in a home."
Thus, many important things should be worked out upfront. The option value, how much time a buyer has to exercise that option, the terms of the rental agreement, who will pay for major repairs and the purchase price -- or at least a method of determining the purchase price when it comes time to sell -- should all be determined before a deal is signed, with both sides represented by legal counsel, real estate experts said.
Simon, of Village Settlements, said an escrow company should be used to hold the portion of the monthly payments that will ultimately go toward a down payment. Simon also said a potential buyer should hire a title company to research the property and find out how much the owner owes and whether the property is worth as much as the mortgage on it. If a seller's loan is underwater, then the bank would probably have to approve a short sale, he said, complicating any transaction.
Once a deal is struck, a lawyer can record a memorandum of option, a public document that gives notice that someone has entered into a contractual obligation to buy the property in the future, Simon said. This can prevent a buyer from taking additional mortgages out against the property, Simon said, but none of these steps is foolproof.
"You can protect yourself some, but not completely, in a long-term relationship," Simon said. "From start to finish, the longer there is, the more chance there is for bad things to happen, and especially with the economic climate that we are in right now -- with recession, job losses and falling home prices -- it is a perfect storm for things to go wrong."
Teresa Cunningham, 51, of Springfield, learned this the hard way. Twice she entered a rent-to-own contract with the same couple for two separate homes in Woodbridge, beginning in 2004. During this time, she paid $200 a month into an escrow account on top of rent. And both times, the homes went into foreclosure.
"I found out about the [first] foreclosure with a notice tacked to the door. It was from the sheriff's office. It gave a date of lock-out," she said.
Cunningham never recovered her money, and she is now in a third rent-to-own home, which she found through http://RentToOwnMarket.com. She said she is confident that she will ultimately be able to own the property she is living in now, a split-level brick home with a big back yard inhabited by foxes, flying squirrels and other critters. This time she had a lawyer review the terms of the deal before she signed it -- but she said she learned from her past experiences.
"As a purchaser, don't be afraid to ask questions," she said. "And don't be afraid to walk away if you have that gut feeling that says 'no.' "
Because rent-to-own agreements often put buyers on the line, only those truly willing to purchase a home should consider them, said Todd Huettner, president of the Colorado-based real estate brokerage firm Huettner Capital.
"Assume you are buying the property," he said. "Don't just do it on a whim. Be serious."
If a buyer is entering a rent-to-own agreement because he or she needs time to repair his or her credit, then working with a counselor and devising a plan on how to improve that score is wise, Huettner said. Buyers also need to keep abreast of any developments in lending standards and adjust their strategy accordingly if things change, he said.
There are risks involved for a seller, too. A depreciating market could mean that a bank will not make a loan against an agreed-upon purchase price. A rising market could mean that a home will be worth more than what was initially agreed to. A potential buyer might not be able to get his or her credit together during the time of the agreement. The sputtering economy could hand either side job losses or reduced hours, making it harder to abide by any deal.
A key thing for a seller to know about a buyer, Huettner said, is why that buyer cannot purchase the property now.
"I truly want to understand where this guy coming is coming from. Why is he a good buyer? Why is he going to qualify in two to three years?" he said.
Sprinzen said he understood these risks when he put his Capitol Hill property on Craigslist. He said he is willing to negotiate with any potential buyer, but he said he will ask for a deposit of about $5,000 to $6,000 to ensure that he gets somebody who is committed. He said he wants to devise a method of settling a purchase price at the end of the term, not at the start, to avoid the complications of price swings. And he also hopes to strike an agreement whereby someone will buy within six months to two years, not in the hazy future.
"I want somebody who is really serious," he said. "I am not just looking for a renter."