Market forces change

With houses sitting, some sellers turn to rent-to-own agreements.

Posted: August 12, 2007

It's a sprawling Arts and Crafts house, with a brand-new kitchen, a brand-new master suite, and vintage details like leaded-glass windows in the built-in china cabinet.

Last fall, David and Elizabeth Rubin put it on the market for $475,000. Now they're asking $439,000 - a price that reflects a loss on the $100,000 they've spent on remodeling.

With no takers, they're now offering the house on Milwaukee's east side for sale one month at a time: If a qualified buyer is amenable, the Rubins will consider offering the house on a rent-to-own basis.

They'd rather do that than lower the price.

"It's like the stock market: You don't sell at the bottom," Elizabeth Rubin says.

As houses sit, and sit, and sit on the market, some fed-up sellers are turning to rent-to-own, a tactic that all but disappeared from the market when home loans were easier to get. Also called lease-to-own, the arrangement appeals to would-be buyers who are stuck because of the same market dynamics: They want to buy, but their down payment is locked up in their own house that won't sell.

Rent-to-own is fraught with pitfalls, say lawyers and real estate brokers. It's harder than it looks to construct a fair contract, and sellers don't always get what they want: an easy, automatic sale.

"It's filled with potential problems on both sides," real estate lawyer Jeff Patterson says. "There are all sorts of situations that the parties can't anticipate."

Typically, a rent-to-own agreement stipulates that part of the monthly rent check is held in escrow for a down payment if the renter buys the house at the end of the lease. If the renter doesn't buy the house, the seller gets the escrowed money.

The title is held by the seller, who usually is responsible for paying taxes. The rest of the details are up for negotiation: who pays for maintenance and repairs; how much money is held in escrow for the sale; security deposits; and tenant behavior and use of the property.

Too often, sellers are relieved to get someone - anyone - into the property, says Barbara Nichols, author of The No Lawsuit Guide to Real Estate Transactions and a Beverly Hills real estate broker for two decades.

But sellers need to treat the deal as though the sale is imminent, she says. That means doing a credit check, ensuring that the buyer qualifies for a mortgage, and ordering an inspection to document the condition of the house.

What if somebody else wants to buy the house before the lease is up?

"The seller is out of luck. It does tie up the seller's property," Nichols says.

If the renter decides to buy, the house still has to be appraised, financing arranged, and the transaction completed.

Nasty surprises sometimes emerge, says Paul A. Maranan, a lawyer who often handles real estate transactions. If a prospective buyer doesn't keep up with the rent payments, the seller might not be able to make the mortgage payments, and the house might teeter into foreclosure.

A long-term rental might violate the mortgage if it contains a clause requiring it to be paid when the house is sold, he said. And buyers need to make sure that owners don't run up liens against the property, such as home equity loans.

If the renters continue to rent, the sellers might find themselves running afoul of the requirement that the house be their primary residence for two of the last five years to qualify for favorable tax benefits, Patterson notes.

Of course, the whole point of rent-to-own is that it's a temporary arrangement for everyone.

The Gillespie family is moving from Michigan back to the Milwaukee area and isn't having any luck selling its four-bedroom bi-level, asking $153,000, Erin Gillespie says.

"We're going to rent until the house sells," she says. "We don't even want to write a contingent offer. It's too scary."

They want to rent where they'll eventually buy so their children won't have to switch school districts.

So far, the Gillespies have looked at two rent-to-own deals offered by sellers who have already purchased their next houses.

"But it makes me nervous," Erin Gillespie says. "What if the houses sell," forcing her family out?

A more appealing option, she says, would be for a full year's lease offered by an owner who is moving and doesn't want to put the old house up for sale until the market rebounds. That would give the Gillespies a year's respite from the pressures of the market.

Everyone else, she says, is begging, "Please take this house off our hands."

Real estate lawyers note that there are several matters to consider before embarking on a rent-to-own arrangement.

For sellers/landlords: How will you put the house back on the market if the renters don't want it, especially before their lease expires?

Who will tend to and pay for routine maintenance? Repairs?

What are the costs of setting up and managing an escrow account for the portion of rent allotted to the down payment?

Will you manage the property yourself, or hire an agent? (Chris Muellenbach, owner of My Dwelling, a Milwaukee residential-leasing firm, says the fee for managing a single-family house ranges from $100 to $300 a month, depending on how much attention is demanded by the house and landscaping.)

For buyers/renters: How much of the rent is going to the down payment?

How much flexibility is there to extend the lease if you don't want to buy the house but want to continue living there?

Will you feel pressured to buy the house by the owner/landlord?

If the house is put back on the market before your lease expires, will you be expected to keep it in ready-to-show condition, and comply with expectations of the owner or real estate broker?

Do you hope to strengthen your credit rating by paying rent on time, and if so, will the owner report your good habits to credit bureaus?

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