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Rent-to-buy is a lease agreement where tenants pay rent and option fees, then purchase the property at a predetermined price after the term ends.
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With property prices rising faster than incomes, rent-to-buy offers an alternative route onto the housing ladder that can lock in value early.
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If property values fall or financing fails at the end of the lease, buyers risk overpaying or losing the chance to complete the purchase.
Rent-to-buy or RTB is a lease agreement where the buyer agrees to rent the property for a specified term, then buying at a predetermined price once the term concludes.
It’s a way for buyers to get a sale contract in place quickly, before they might have saved a deposit or been approved for finance.
Data from Cotality indicates the median Australian property price had risen to 8.9x the average household income. Many banks don’t even lend for multiples above 7 or 7.5x.
RTB allows buyers to get their foot on the property ladder without spending years saving up for a deposit on the outside of the market, potentially watching the value of properties become increasingly unattainable.
Those not already on the property ladder can be forgiven for losing hope as the great Australian dream becomes less and less attainable. It’s easy then to understand why alternative paths to home ownership like rent to buy (RTB) are becoming more popular - but before diving in, here’s what you should know.
How does rent-to-buy work?
Rent-to-buy schemes (or rent-to-own) allow a buyer to agree a sale price with a seller for some point in the future (normally two to five years). The sale price remains in place, but might have a built-in appreciation rate as part of the contract.
In the meantime, the buyer moves into the property as a tenant, paying the seller rent as well as an ongoing ‘option to buy’ fee. When the lease term expires, the total of these extra payments is typically deducted from the final sale price.
A common way for a rent-to-buy scheme to develop is through a property developer. Developers might be offering rent-to-buy on newly constructed properties. Buyers could use a third party like PublicSquare, which buys the property on their behalf.
How to use an RTB scheme to your advantage
Exactly how RTB can be a benefit is based on how the property value has actually changed.
If it is worth far more than what you are paying, you are obviously paying below market value, and will also have a lower loan to value ratio (LVR) on the mortgage you take out, which might mean lower rates and not having to pay lenders mortgage insurance (LMI).
On the other hand, it’s also possible for the property to lose value, in which case you are overpaying and are taking out a mortgage with a high LVR.
As a hopeful owner looking to get your foot on the property ladder, you would hope for the former, where the real market value has outpaced the scheme’s appreciation rate.
Rent-to-buy scheme fees and charges
Regardless of who the contract is with, the buyer will generally have these fees and charges:
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Starter fee: an upfront payment that is credited toward the eventual purchase price.
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Rental rate: monthly rent is typically set above market value to contribute toward the purchase arrangement.
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Option-to-buy fee: a recurring payment that secures the buyer’s right to purchase the property at the end of the lease.
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Sale price: the purchase price is agreed upon at the start of the lease and applies when the buyer chooses to buy at the end.
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End-of-lease purchase: at lease conclusion, the buyer can purchase the property using a standard mortgage, with equity payments deducted from the final amount.
The lease agreement will generally specify a regular rental rate, which is usually above market value, an ongoing ‘option to buy’ fee, and a sale price at the terms conclusion. There is no requirement for a deposit, stamp duty or lenders mortgage insurance.
At the end of the lease agreement, the buyer can purchase the property for the agreed price, factoring in the appreciation rate, using a normal commercial mortgage. Any equity payments are subtracted from this amount.
If during the lease term, the buyer changes their mind about the deal, they can sometimes get the option to buy money reimbursed, but not always.
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Advantages of renting to buy
There’s a few reasons Aussies looking for a foothold on the property ladder might be tempted by rent-to-own arrangements.
Test the property before you buy
An important part of rent-to-buy is there is no obligation to buy until the actual purchase goes through. Buyers have the opportunity to live in the property for a couple of years before actually buying, so can get a good idea of whether it suits the needs of the household.
It’s often impossible to know all the ins-and-outs of the property and neighbourhood you’re buying in before you’ve lived in it for a while. For example, you might not know you’re under a flight path, or that turning right out of your street at peak hour is a real nightmare.
Buy without a deposit
If you’re buying property through the traditional method, you likely need to save up a far greater proportion to use as a down payment. A 20% deposit is a common threshold, since most lenders charge lenders mortgage insurance on loans with an LVR above 80%.
You can usually get underway with a far smaller initial payment for rent to buy. While there might be a starter or establishment fee to get the deal up and running, this will typically only be 1 or 2% of the property value.
Lock in a property value
Another one of the big appeals of rent-to-buy is the opportunity to lock in a purchase price years in advance. There is typically an annual appreciation rate that might be between 3 and 4%, but in a booming market, property prices can grow a lot quicker than this.
The property market ebbs and flows, and there is certainly a risk if it goes through a downturn, but you just need to look at historic data to see that the property market does usually trend upwards over the long term.
<Infogram of median property prices>
Disadvantages of renting to buy
Not everyone thinks rent-to-buy is a positive. The schemes have faced criticism from various organisations and regulatory bodies, and several aspects of these arrangements have been highlighted as potential issues for buyers.
Risky if things go wrong
When everything goes to plan, buy to rent can work out very nicely for both buyer and seller. However, there’s quite a few things that could derail the arrangement, and cause significant consequence for the buyer. For example, if the buyer runs into financial trouble during the lease and defaults on their rent payment, the contract might be terminated, leaving them at a loss.
The purchase is also dependent on approval for finance at the end of the lease. If you are unable to get the money you need to buy the property from a lender, this can also jeopardise things.
Potential loss if the market takes a downturn
While it's great for buyers if the property goes up in value and they are getting it at a heavy discount, the inverse also applies. The property market fluctuates in both directions, so you could get unlucky and see the property lose value while you are renting.
This means you’d end up paying more than the property is worth at the end of the lease, which could also affect your ability to get financing. There may also be a discrepancy with how the bank values your property, versus the market, versus the rent to buy scheme operator.
Smaller pool of available properties
It’s also worth pointing out these schemes are still relatively new, and make up a very small portion of the Australian housing market. Buyers who only consider properties available under rent to buy are restricting themselves from the majority of those on the market.
More expensive than just renting
The amount you pay in the rent period of a rent to buy is likely to be far greater than what you would have paid just renting conventionally. Rates are often marked up for these schemes, and you also need to pay the option to buy fees.
Some rent to buy providers like PublicSquare include utilities in the weekly or monthly payments, but you might not be getting as good a deal as you might have done choosing these things yourself.
Is rent-to-buy a good idea?
Rent-to-buy has been a controversial addition to the Australian property landscape.
The consumer advocates called RTB “extremely risky” and said there was not enough legal protection for buyers. The inflated rental payments were a concern, as well as the risk of the property losing value.
Some estimates suggest the rent in a RTB could be 50-100% higher than comparable rental properties.
If everything goes according to plan, though, and the property appreciates, it’s viable for someone to prosper greatly out of a rent-to-buy arrangement.
First published in August 2023
