Scattered Site Rental Toolkit:
Business Planning for Development & Management
V.D. Lease Purchase or Traditional Rentals?
Lease purchase involves renting a unit to a household and giving them the option to buy the unit at some point in the future. Often the household’s rent is structured to include a portion that will be retained toward a down payment on their mortgage. This is usually done with households not ready to purchase a house, either because their credit needs repaired or, they have no down payment.
Lease purchase models
Lease purchase programs tend to be either short-term or long-term models. Under the short-term model a house is rented to a household for two to three years and then converted to homeownership. This gives them time to clean up their credit and/or save up enough money for a down payment on the house. Short-term lease purchase programs usually include elements to prepare tenants for homeownership such as allowing tenants to select their specific units, the contribution of sweat equity by tenants, provision of individual savings accounts (IDAs) to help tenants save for a down payment.
The long-term lease purchase model is primarily supported by the Low Income Housing Tax Credit (LIHTC) Program. The long-term lease purchase requires that homes remain as rental units for fifteen years prior to conversion to homeownership. The obvious advantage to this model is that it allows you to use LIHTC as a significant equity funding source for your project. Another advantage is that it allows you to keep affordable rental stock in your community for a longer period of time. Finally, the long-term model allows your organization to transfer significant equity value to homebuyers upon sale, making their mortgage especially affordable. The chief disadvantage of long-term lease purchase is that 15 years is a very long time horizon for prospective homeowners. Furthermore, the long-term model runs the risk when a unit reaches year15 it will no longer hold its appeal for potential buyers. Extremely thorough property and asset management must be executed to avoid this risk.
Advantages of lease purchase
There are a number of advantages to a lease purchase model. First, it offers a means to develop homeownership opportunities in a weak market. Second, it offers an incentive for households to take necessary steps toward becoming homeowners such as cleaning up their credit or saving for a down payment. Third, the financial institutions and your agency have the opportunity to see whether the household is a good risk for homeownership. If they pay their rent consistently and keep up with assigned maintenance, they are more likely to be successful homeowners. Fourth, tenants in a lease purchase program are more likely to take good care of the house and be responsible for some maintenance and yard work, viewing their effort as an investment in their future and feeling a sense of ownership even while renting. Finally, if the community sees these units as homeownership opportunities, they may be more accepting of your project.
Disadvantages of lease purchase
There are also disadvantages to a lease purchase model. First, it can take more effort to manage and structure the finances that we have somewhat of a bias against lease-purchase, particularly through the 15 year tax credit model. Second, tenants that are not paying their rent or who are trashing the place are more difficult to evict, because they see the house as theirs. Third, if you do have to re-lease a unit, the turnaround time for is often longer because the new tenant must be screened as a potential homebuyer and the house may need more work prior to re-leasing it due to unit modifications made by the previous tenant. Tenants are more likely to paint, install new flooring and make other upgrades to a unit if they see it as theirs. If they do the work themselves, it may be sub-standard and require replacement.
Fourth, it the purchase of the unit is a condition of the funding, you have the added responsibility to make sure that transpires on a timely basis. If the date for purchase happens to fall during a lean market condition and you do not have a viable tenant for a mortgage, then you may be in a position where the funder will ask for a portion or all of the funds to be returned. Finally, keep in mind that all units converted to homeownership are units lost to your rental stock within the community.
· Responsible Lease-Purchase: A Review of the Practice and Research Literature on Nonprofit Programs (2010 by Dan Immergluck and Philip Schaeffing), published by the Social Science Research Network
· Alternative Financing Models - Hybrids of Homeownership Lease Purchase Housing (2007), an Enterprise Community Partners publication by Peter Werwath. Discusses the role of lease purchase models in providing homeownership opportunities to households that would otherwise not qualify for a mortgage.
· Lesson from Ten Years of Lease to Purchase (2010 by Bill Goldsmith and Cindy Holler. Discusses a number of best practices learned through experience with lease purchase.
· Underwriting Considerations and Guidelines for Lease-Purchase Programs. This document was developed by Ben Greenberg of Community Housing Capital. Included with permission from Mr. Greenberg.