What is rent-to-own and how it helps renters buy a home

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Not every renter who wants to buy a house dreams of giving up their lease. Some wish to remain renters even when they become owners.

The idea behind “tenancy“is that a person rents out their primary residence in one city and then buys an investment property somewhere else that they let out as a short-term or long-term rental, according to Danielle Hale, chief economist at Realtor.com.

“It can be a good way to get into the real estate market,” he said, especially if you live in a city where housing prices are out of your budget.

That said, owning from a distance can be difficult, and rental investing can be more difficult for a first-time homeowner than buying a property they intend to live in.

“There are some costs that you’ll want to make sure you research and consider before you go in,” Hale said.

When “renting” can make sense

Rental investing may be an option for someone who has a relatively high income from a job in a big city where rents are high and home prices are even higher, Hale said. He said these people may have room in their budget to save, but find it too expensive to buy a home in their metro area.

“So they would look for a less expensive market where their savings could translate into a nice down payment,” Hale said.

Small investors, or those with up to 10 investment properties, made up 62.6% of investor purchases in the first quarter of 2024; according in a recent report from Realtor.com. This figure represents the highest share of retail investor activity in the data’s history, dating back to 2001.

Hale said the data doesn’t necessarily distinguish whether small investors are renters. It also does not specify whether they have their primary residence or a second rental home.

“There’s a lot of concern about big investors coming into the single-family home space and competing with landlords,” he said. “Although large investors have made progress and are increasing their stake, they still make up a relatively small share of the total owner population in the United States.”

Some changes in the market in favor of buyers may also benefit investors.

Mortgage rates have fallen to 6.85% for a 30-year mortgage, the lowest since March. according in a new analysis from real estate brokerage website Redfin.

“Someone on a budget of $3,000 a month can now spend $20,000 more on a home for the same budget,” said Daryl Fairweather, chief economist at Redfin.

He said the lower interest rates would be “welcome news” for renters looking for a mortgage. But it will be important to keep in mind that rental prices are falling as more supply comes on the market.

“They may struggle to fill it with a tenant if there are other properties down the street renting for less,” Fairweather said.

“Rents are going up a little bit, but not that fast, and they’re actually falling in parts of the country where a lot of new supply is coming online,” he said.

5 questions to ask yourself before renting

While renting can be an opportunity to become a homeowner, those who want to try this path should consider all the pros and cons. Here are five questions to ask:

1. Does this strategy work for the property I want to buy?

Take stock of the short-term rental regulations of the city, town and state you’re considering, as some areas may have rules that limit or even prohibit rental activity. As you narrow your search to specific properties, keep in mind that some homeowner associations and condo or co-op boards may also have bylaws that limit rentals.

2. Do I need to hire a property manager?

If you want to become a landlord, you could either manage the house or apartment yourself or hire a property manager to be the intermediary between you and the tenant.

About 55% of small portfolio rental owners hire a property manager because they don’t live near their rental property; according to the State of the Property Management Industry Report from Buildium, a property management software company. The site polled 1,885 property management professionals in May and June 2023.

However, hiring a property manager comes at a cost, which depends on factors such as the location of the property and the services provided. Property management fees can be up to 25% of the monthly rental price, depending on specifications, according in the partition list.

3. Can I afford all the costs associated with home ownership?

Buying a property goes beyond paying the down payment, closing costs and monthly mortgage. You also need to consider property taxes, insurance and maintenance, among other costs.

Having a clear understanding of what those dollar figures might look like now and how they might change over time is key, especially in an area you’re less familiar with.

After evaluating all the factors involved, then you can figure out if renting the house is enough to cover your expenses.

4. How much competition will you have?

You may have more competition with other owners or rentals if you enter the rental market now, Fairweather said, especially in places like the South, where more new construction is becoming available.

“Pay attention to rental trends,” Fairweather said.

Rents are rising in coastal areas. But in areas like the South, they are falling. That’s good news for renters, “but not good news if you’re a property owner,” Fairweather said.

5. Can you afford a vacancy?

Short-term rentals include perks like being able to use the property yourself and more flexible pricing based on seasonal demand. But high year-round vacancy can be a drawback, Hale said.

In slower periods, you could end up paying for two monthly housing payments: the rental price of your primary home and the mortgage payment on the investment property.

The monthly mortgage payment for the typical $400,000 home in the US is about $2,647 at the current mortgage rate of 6.85%, according to Redfin. Check to make sure you can possibly afford this on top of your own monthly rent.