Are rent to rent and lease agreements legitimate investment strategies?

3 March 2021 | Investment

Anna Clare Harper, chief executive of asset manager SPI Capital, as well as being a podcast host, property entrepreneur, author and TedX speaker, argues property is an attractive option to the investors her company works with. “[That’s] because it is considered a safe place to store and grow wealth, because it creates ‘passive’ income, and because of the tangibility and ability to control the asset.”

By contrast, she says, rent to rent only delivers income – ‘no store of value, capital growth, or full control over the asset’.

“Lease options do give you the opportunity to access capital growth and income. For both of these, the barriers to entry are very low and as a result, people see them as a way to ‘get rich quick’,” she adds.

“While it is possible to make money from these strategies, they are a far cry from the ‘low risk, strong reward’ more usually associated with investing in property. In some cases, for example in flats, they may even be illegal.”

Steve Jacob, chief executive of Fabrik Invest, believes rent to rent and lease option agreements are definitely a legitimate strategy but strongly questions the idea that they are tickets to near-instant financial freedom.

“Fabrik Property Group regularly uses options as a way to secure property so that we can add value via planning permission,” Jacob explains. “We’ve also leased property and rented it out for a higher value than we’ve leased it for.”

Lease options explained – what do investors need to know?

“If you take an option over a property, you have control over that property. The owner can’t sell it without your permission, and you have the benefits of being able to lease it out for more money and obtaining planning permission,” Jacob states.

“However, you do want to find yourself a really good, specialist options solicitor; someone who writes options on a regular basis. That’s because you need to ensure that the terms of the option are written out correctly, so that both parties have a fair contract.”

He adds: “I’ve found options to be the most profitable strategy in Fabrik Property Group to date. We use them all the time. With options, you need a willing seller and a willing buyer (option taker). Both parties sit down with an estate agent and agree a list of terms, which can include obtaining planning permission, key undertakings to get the builders in, the length of the option and the price.”

He goes on: “If you agree a ten-year option, for example, and agree a price of £100,000 that’s fixed for ten years, and the property is worth £200,000 in five years’ time, you can refinance that property into your name, only paying £100,000 for it and taking the benefit of the capital appreciation.”

Another example, he says, is taking an option on a property and renting it for £300 per month, then renting it out for £500 per month, where you keep the difference.

“You can also take the property on an option, add value and then flip it, all within the option. This can be much more efficient than buying a house outright and incurring stamp duty liabilities, as with the option you just have the refurb costs and the sales agent costs to cover. You could do a deal with the owner to split the profit,” Jacob says.

“In a nutshell, taking an option on a property gives you the benefit of control but without the obligation of any financing that the current owner might have in place. An option gives you flexibility without the usual obligations that come with property ownership. If you don’t pay the mortgage, for example, that problem sits with the owner, not the option holder.”

What are the pros and cons to lease options?

“Options are a legitimate strategy. If I was going to advise my children on a strategy, it would be either sourcing property or lease options (some people call it rent to rent),” Jacob says.

“The biggest advantage, in my view, is that an option is a low-risk strategy. Another key advantage is that you can do deals quickly, without a long conveyancing process; you can secure the property fast and get cashflow fast.”

He adds: “An example is turning a four-bedroom house into an HMO on an option. You can do this and get to £10,000 per month of passive income relatively quickly. I’ve seen people do this within a couple of years – it can be a very profitable strategy.”

The downside, however, is that you don’t own the property – although Jacob argues if you’ve got a good enough option in place there’s no need to own it.

“Another downside is that there aren’t that many property owners out there who are willing to do an option, simply due to a lack of understanding of what it is and how it works – there’s a lack of clarity.”

“Also, if an option agreement is prepared by the wrong solicitor, it can be written incorrectly, with holes that can end up being picked apart in court. You need an experienced professional for this.”

He also cautions against the idea of people being able to become ‘financially free’ very quickly, without any money or experience behind them, as promised by some property trainers.

“I was educated by a variety of companies and the more seasoned I became, the more I saw through the strategies they were using,” he says. “They were essentially building the excitement in the room in order to then sell a course. Property is in many ways quite an unethical industry, sadly.

Nevertheless, he says he does owe the industry for ‘giving me that push to stand up and put the work in’.

“Some people do need a push, but there’s also an element of needing to be real with your audience. So, is it possible to become financially free from rent to rent or lease options? Yes, it is. And if you’re trained correctly, by the correct trainer/mentor, you can get there quite quickly.”

He adds: “If you had no money to start out with, you would need to find someone who was short on time but had a pot of cash. You could then invest your time in finding a mentor to guide the two of you through the strategy and warn you of the many pitfalls. You would need a solid shareholders’ agreement between the two parties, to outline each party’s responsibilities.”

He also says would-be investors need a good dose of realism and to go into the industry with their eyes wide open. “To be clear that you’re going to make mistakes, but that you’re prepared to see your way through them together.”

Jacob believes that saying that someone can invest in property with no money down isn’t quite the right terminology. “Somebody needs to put some money on the table to get things started. Personally, I treat somebody else’s money with far more delicacy than I treat my own! This kind of investment can certainly work as a partnership,” he says.

“Can you be financially free in a week? No, I don’t think you can. That would be near on impossible. Could you find a deal that replaces your income in a week? You could…it’s not an impossibility. But you would still need to go through the process of the deal and get it operating. So, you couldn’t be financially free in a single week but it’s possible to do so through a single deal. That kind of deal is rare, though.”

Ultimately, he says, educators who promise financial freedom in seven days are putting up a façade.

“This highlights the need for a level of regulation within the industry,” he says. “Within a year, two years, five years…yes, property can be a seriously profitable business. However, with so many pitfalls along the way, you need the right team in place to execute your strategy successfully.”

He says there should be a level of regulation whereby people are told ‘at the start and end of these kinds of presentations’ that property investment can be risky, along the lines of the FCA warnings that investments can be risky.

“Rent to rent and many other property strategies can definitely lead to being financially free, but you need the right education, mentor, team, knowledge and people. Then you need to pick a market and make sure your chosen strategy works within that market,” Jacob concludes.

To this end, Fabrik Property Group is focusing on publishing much more educational content over the coming two years. The firm’s goal is to help provide the right education and resources for investors so that they can have an in-depth understanding of sourcing, construction, investment and more.

This post has originally been featured in Property Investor Today.