Building for the Single-Family Rental Market

In a housing market inundated with potential buyers who can’t qualify for mortgages, some builders are offering a rent-to-own option on selected single-family homes. Rent-to-own (also known as lease-to-own or lease-purchase) can be a good source of supplemental income for builders. It also reduces carrying costs on unsold inventory and helps convert more homes to sales.

Some builders have a separate division to handle the rental side of their business, while others prefer to work with customers on a case-by-case basis. T&M Building Co. of Torrington, Conn., and Classic Communities Corp. of Harrisburg, Pa., are two examples. 

“There are situations where we recognize that the sincerity of the buyer is such that if we have tools to help them out, in the long haul it will help us out as well,” says Greg Ugalde, president of T&M. “They become short-term renters until they can pull everything together and close.”

Renters sign a use-and-occupancy agreement that allows them to live in the home until they can refinance it and take T&M out of the equation. “The beauty of doing this on an ad hoc basis is that we can tailor it to the customer’s needs,” says Ugalde. “It also keeps pressure on the customer and the bank to get the deal done.”

In most cases, customers are able to purchase their home after renting for one year. Occasionally it takes two years. Ugalde says there have been no defaults or evictions. Customers can also elect to sign a conventional lease, but they always have the option to buy, he says. At press time, approximately 30 people were renting T&M homes and another 10 were in various stages of a use-and-occupancy agreement.
Classic Communities Corp. in Harrisburg, Pa., is willing to negotiate with customers who have tarnished credit but enough income to pay rent.

4 Tips for a Successful Rent-to-Own Program

• Provide top-notch customer service to renters, just as you would to homeowners. Depending on the size of your rental portfolio, you may need staff dedicated solely to servicing those homes.
• If applicable, make sure that the rent includes homeowner’s association fees.
• Be flexible, but protect your assets. Make sure renters understand their responsibilities about making modifications to the home.
• Avoid “payment shock.” The last thing you want to do is let customers rent for $600 a month knowing that the mortgage payment is going to be $1,500. Payment shock is reason enough for a bank to deny a loan.

“We work with them to establish a sales price on the home they want, and then draw up a full contract,” says Marc Hargraves, director of sales for Classic Communities. The monthly rent is equivalent to what the mortgage payment will ultimately be, Hargraves says.

Most customers are either working to repair their credit or recently relocated to the Harrisburg area and haven’t been able to sell their existing home, he says. First-time buyers saving for a down payment are also potential candidates. “We look at each situation individually and try to decide what would be most helpful to that customer,” says Hargraves.

Catering to the Rent-to-Own Client

The Mungo Cos. of Irmo, S.C., manages its leasing program through a subsidiary, Palmetto Residential Rentals. “Typically, we pick a few homes from our new-construction portfolio and co-market them for rent,” says Palmetto’s Kym Farrell. “It’s usually based on what we have in terms of standing inventory in various subdivisions.” A nonrefundable deposit is required (typically 1-2 percent of the home price, depending on the client’s credit history). That deposit is applied to the sales price when the client buys the home.

“We have a surcharge that basically doubles when the customer is ready to complete a purchase,” Farrell says. For example, the tenant might pay a $75 premium in addition to their monthly rent. Palmetto matches the premium every month the rent is paid on time. The premiums accrue and are ultimately credited toward the price of the house.

Luxury production builder T.W. Lewis maintains a 110-home rental portfolio, 95 percent of which is currently leased and about 40 percent is structured as lease to buy.

Monthly rents are generally in the $1,200 to $1,500 range, and the minimum lease period is two years. No changes can be made to the home other than cosmetic ones, such as painting walls. “If they don’t purchase the home at the end of the lease period, they’ll be charged for any changes they make or will be expected to put the home back into its original condition,” she says.

Palmetto has its own maintenance technician to handle service requests on rental homes. “Renters don’t deal with Mungo at all,” Farrell says.

Luxury production builder T.W. Lewis of Tempe, Ariz., started its rent-to-own program in 2008 when the housing market went south. Owner and CEO Tom Lewis formed a separate company to buy homes from the for-sale side of his building operation. Over the last few years, his rental portfolio has grown to 110 homes around the Phoenix area, including 10 recently purchased field models. Lewis upgraded the homes (some as large as 5,000 square feet) with swimming pools, additional landscaping, and other amenities attractive to renters.

Leases range from two to four years and monthly rents from $2,000 to $3,400. A security deposit equal to one and a half times the monthly rent is required for a straight lease. Those who sign up for the lease-purchase program pay a small down payment, with 25 percent of their monthly, on-time payments credited toward the home purchase.

Rental manager J.D. Dwyer says 95 percent of the homes are currently leased and about 40 percent of those tenants have chosen the option to buy. “We prefer to do lease-purchase because there’s more of a commitment from the tenant,” says Dwyer. “They generally take more pride in the house. But we have no issue with signing a straight, two-year lease.”

Like T.W. Lewis’ buyers, renters “know what they want and are willing to pay for it,” Dwyer says. “They’re accustomed to nice houses and nice neighborhoods; they just need time to repair their credit.” Some clients have always wanted to own a T.W. Lewis home but would like to test-drive it first. Requests for modifications to a leased home must be submitted in writing and evaluated by the builder. “We don’t want people tearing out cabinets, but if they want to make some changes to the backyard or paint a few walls, we’re not opposed to that,” says Dwyer.

Renters get the same customer service as homeowners, Dwyer says. Lewis has an around-the-clock emergency hotline, a dedicated customer-care representative in the office, and three field managers. There’s even an internal pool-service technician.

Both Palmetto and T.W. Lewis list homes for rent on their website, as well as other sites focused on single-family rentals in that region. Palmetto also uses military databases and the MLS, and T.W. Lewis uses Postlets.com, a site that links to Facebook and Craigslist. But Dwyer says the biggest draw for renters is the builder’s reputation: “We’ve had a lot of Realtors bring clients to us.”

T&M’s Ugalde thinks rent-to-own programs will continue to be viable in the near term. “We will, on an ongoing basis, finish out a subdivision with rentals if it makes sense to do that,” he says. “We’ve seen a shift in the marketplace to larger numbers of young professionals and first-time buyers that are happy to stick their toe in the water with a rental.”

Renting single-family homes is as much about customer satisfaction as cash flow. Kym Farrell of Palmetto Residential Rentals says her customers “become emotionally invested in what they hope will be their house someday, and we want them to feel that way.” And T&M always errs on the side of goodwill, says Ugalde: “It’s worth it to us in this day and age to keep as many buyers happy as we can.”

The Future of Single-Family Rentals

 Marketing consultant Debra Bernard says that for home builders, rent-to-own is merely an offshoot of their primary business. “It’s a cash-flow strategy,” says Bernard, president of the Bernard Partnership in Simsbury, Conn., and Walnut Creek, Calif.

But perhaps it could be something more. Gadi Kaufmann, managing director and CEO of RCLCO Real Estate Advisors in Bethesda, Md., points out that while most people think of rental properties as multi-family, approximately one-third of all rental units are detached single-family homes. According to John Burns Real Estate Consulting, Irvine, Calif., homeowners who have gone through foreclosure would rather rent a single-family home than an apartment.

“Even without the downturn, there is a huge market for single-family rentals,” Kaufmann says. “Given that the share of households who rent is expected to increase to 36 percent by 2015 (up from the historical low of 31 percent in 2005), building single-family homes for rent is not a bad strategy, even if it is just as an interim activity while waiting for the for-sale market to more fully rebound.”

If the homes are properly designed, built, and marketed, investors may want to acquire the rental portfolio and operate it as a long-term program, he says: “The single-family  sector could be a significant segment of the rental housing industry as it represents a variety of opportunities, including building for other bulk owner/operators, providing value add/rehab services to companies that buy existing distressed homes, and an exit/recapitalization strategy for builders with significant unsold standing inventory.”

Kaufmann adds that the possibility for converting rentals to sales in the future is attractive to institutional investors, REITs, and other long-term owners of income-producing real estate. “We expect to hear a lot more about the single-family segment in the years to come,” he says.