By Rachel Oliver
This is the final in a tri-series of articles on investing in rent-to-own (RTO) properties. In this final installment, Rachel Oliver explains why her "people first" strategy for RTOs generates consistent cash flow, and reveals specific personas that make for ideal RTO customers.
In the previous articles, we took a deep dive into the science behind winning RTOs and discovered the four-part screening process for ensuring your RTO tenant is a good fit. We crunched the numbers to show above-average cash flow, and identified traditional buyers who rent to own their way into homeownership.
But are RTO customers only those who are recovering from bad credit or setbacks? What are the actual personas behind these customer profiles? Why would someone need to rent to own? These are some of the recurring questions real estate investors ask us when they discover RTOs as an investment strategy. Since 2010 we’ve worked with a variety of complex buyers and have identified four personas behind winning tenant-buyers.
An RTO customer is typically viewed in terms of bad credit—as a person who has gone through a bankruptcy or consumer proposal. Although this may be the case, it is critical to identify the persona behind the person. In doing so, we learn why they are motivated to rent to own. In our experience, when there is a why, there is a way—to help them.
Desirable RTO Personas
Entrepreneurs are excellent candidates for RTOs. Often they are self-employed, and as such, their stated income must be proven over a certain period in order to qualify for financing. For people with this persona, becoming a homeowner today is challenging, as they would struggle to collect the down payment needed to qualify for traditional financing. Regarding the psychographics of this persona, entrepreneurs are customers with drive and determination. They know how to plan and move forward with an achievable target. They make exceptional RTO clients because they understand commitment and are invested in succeeding right from the beginning of the process.
New immigrants are another persona that makes for ideal RTO customers. New Canadians or immigrants display immense courage and perseverance when uprooting their families and lives to move to a new country. Like entrepreneurs, they aim to follow through on a plan, and are often good money managers. Their “why” is typically strong too: the need for stability and growth. Remember, a person with good credit in their country of origin is an immigrant with no credit history in Canada. Canadian banks don’t recognize credit history in another country. Starting a new life in Canada means that an immigrant requires time to re-establish their financial track record and to become mortgage-eligible. Although they may be deserving, they are not qualified for financing. This is a recipe for successful RTOs.
Millennials are the next best-suited persona for RTOs, did you know? Canadian Mortgage and Housing Corporation (CMHC) has reported that by 2036 the number of millennial households will triple in Canada. What this dramatic shift means for real estate investors is that we are going to see more millennials moving out of their rental apartments—currently the prevalent situation—and into single-family homes. Homeownership will be the top priority for this customer. Millennials are challenged by the rising price tags on homes, which makes it harder for them to save up a substantial down payment. The longer they continue to rent, the longer they stay out of the market, which means they’re playing constant catch-up with a volatile market. As a perpetual renter, it can be difficult to find the impetus to be a disciplined saver. RTOs are a viable option for millennials, allowing them to accelerate their savings. With RTOs, whether they have good or bad credit, millennials are on a fast track to entering the housing market within 24 to 36 months, which otherwise seems near impossible.
The Unusual Suspect
Based on our research at Clover Properties, we’ve identified another customer persona that is not typical of the RTO market. This persona is often overlooked but has the potential to be not just an ideal RTO customer but one who understands the business from the inside out. Meet the aspiring real estate investor.
As beginner real estate investors, they are, most likely, renters who are saving up to buy their first income property. They have financial goals within specific timelines in mind. They have no or low credit history and may be jointly renting a house or condo with friends or family, paying approximately $500 per month. Over 36 months, they will end up spending $18,000 on rent, money that will not go into building their equity or savings. Despite some credit challenges, this persona has a steady nine-to-five income and is assumed to be diligently squeezing in $1,000 per month in savings, with their investment goals in sight. Based on the current market, it is realistic to expect that this aspiring real estate investor may take two or three years to accumulate the down payment needed to qualify for financing, and risks being priced out of the market.
What if this aspiring investor could get into the market sooner through a rent-to-own arrangement? Let’s do the math.
Let’s take as an example John, a twenty-something professional with a steady income, and an aspiring real estate investor with savings of $16,000. After passing our four-step screening process, he starts shopping around for a property. He zeroes in on a legal duplex in a hot micro-market like Hamilton, Ontario, listed for $400,000. The property is in good condition, comes with an upper unit, a main-floor unit with open-concept living space and a decent-size kitchen, and multiple upgraded bathrooms. This duplex presents promising prospects, since John has a 4% down payment and his income supports the purchase price. Using conservative estimates, we can assume that this property will appreciate at the rate of 7% per year. So, with three years of appreciation, in 2020 this duplex will have fair market price tag of $490,000. However, through the RTO arrangement, John locks into a purchase price of $455,000. In a short 36 months, John will generate about $35,000 in equity, $40,000 in rental income, and $41,000 down payment credit. Most importantly, he will own his very first income property.
From the RTO investor’s point of view, John’s 4%, or $16,000, offsets the out-of-pocket expense of purchasing the property, thereby reducing the investment to about $79,000 after expenses and closing costs. The investor gets a monthly income of $2,800, which includes John’s $700 down payment credit. After expenses, this RTO can generate approximately $700 cash flow per month, and the estimated profit is around $67,000. In our investment analysis spreadsheet (see below), we identify that the return on our $79,000 investment hovers around 85%.
While the RTO investor leverages the tenant-buyer’s initial down payment, the tenant-buyer gains a stronger springboard to launch into their own homeownership, thus creating the potential to become an investor themselves. These are the fundamentals of a win-win RTO strategy, where we gained an understanding of John’s persona, assessed his needs and eligibility, and created a path for him to become a landlord and break into the real estate market faster than if trying to save up for it on his own.
In a Nutshell
Simply put, when thinking of including RTOs in your portfolio, the most important criterion for generating repeatable success and predictable above-average cash flow is following a “people first” strategy from the get-go.
We realized this at Clover Properties seven years ago. By putting people first, no matter what the market conditions, we engineered a lucrative RTO strategy where, first, we were creating an opportunity for more people to become homeowners, and second, we were paving the way for a 90% success rate on our investment, leaving nothing to risky speculation.
Having successfully completed 163 RTO deals through Clover Properties, we’ve proven that RTO deals are intricate procedures factoring in people, properties, the market, and changing circumstances. Over time, we’ve built an ironed-out approach that accounts for all the hidden nuances of a true win-win RTO arrangement. A do-it-yourself approach can result in expensive mistakes and precarious deals. Therefore, if you’re new to RTOs, it’s key to get hands-on training or to tap into a finessed turnkey system.