Rent-to-own: Best practices and the way forward

Rent-to-own: Best practices and the way forward

Julian Roche Chief Economist

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Origins and issues I once knew a very experienced oil executive in Australia, who was looking to relocate from the country to the beach for his retirement.

Keen to move quickly, he bought his new home on the basis of a firm rent-to-own (RTO)1 agreement of his place in the country with a tenant: a generous low rent for six months, followed by exchange and completion. Unfortunately, the tenant never completed, and he was left with both properties, mortgages on both, excuses from the tenant, and a ruined retirement.

My story is unusual only in that it was the owner, rather than the tenant, who lost out2. RTO as a real estate practice has undoubted pitfalls for all parties. In the Australian state of Victoria, after a slew of governance failures and lost deposits, traditional RTO schemes where vulnerable tenants have paid above-market rents as a contribution to their eventual deposit have been banned3.

Apart from that risk transfer, however, developers and buyers should realise that the ex post allocation of financial reward between them depends on four things. In order of importance: 1. Size of the RTO premium, which is currently higher in the Gulf than internationally4 2. Which party has superior price forecasting ability 3. Direction of yields during the lease period 4. How effectively developers use whatever deposit is provided

Potential advantages Problems in practice should not detract from the theoretical advantages that RTO can bring. Developers and buyers can use RTO as a way to circumvent the inefficiency of capital markets in relation to buyer deposits, in order to encourage sales in slow markets. Developers in the UAE certainly do believe that it is worth taking on buyer credit risk in exchange for diminished market risk.

With savings been widely drawn down during the global COVID-19 crisis of 2020, there are likely to be many more potential buyers without sufficient deposits in the years to come, and so a greater potential attractiveness of RTO schemes.

1

Variants are known as Try Before You Buy, Rent Save Buy, Rent to Own, lease-option, wrapping, and Intermediate Market Rent schemes. Schemes differ substantially, e.g. as to whether tenants are obliged to buy or just have an option.

2

See Katache, G. (2016) Rent-to-buy: Melbourne man in legal fight after losing thousands in ‘unfavourable’ housing scheme. ABC News [on line] 5 October 2016. Available at: https://www.abc.net.au/news/2016-10-05/

consumer-group-warns-against-rent-to-buy-schemes/7903172 Retrieved 7 August 2020.

3 See

the informative letter here from Consumer Action https://consumeraction.org.au/wp-content/uploads/2020/02/200128-Sale-of-Land-regulations-submission-to-CAV.pdf Retrieved 7 August 2020.

4 One

estimate placed it as high as 40%, compared to 5-10% internationally. See Mahmoud Alburai quoted in Gulf News, March 26, 2019. Available at: https://gulfnews.com/business/property/rent-to-own-scheme-is-this-

what-uae-tenants-need-1.62899692 Retrieved 7 August 2020.

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Rent-to-own: Best practices and the way forward

Learning from experience Both developers and indeed governments in the Gulf can learn from recent successful schemes in other jurisdictions.

In Europe and Australia, for example, RTO has been seen as a bridge to ownership technique, principally for affordable housing tenants. Newly built homes are initially rented out— usually at a subsidised rate, to allow tenants to save a deposit— for a fixed period of up to 10 years, during which the tenant can decide whether to buy the property or even part of it, under a shared ownership model. For example, the ‘Cheyne

model’ developed by the Cheyne Social Property Impact Fund, saw a housing association, a community investment company and a private investor come together in the city of Bristol to create an inclusive housing scheme in conjunction with local authorities5. In Melbourne, an RTO scheme by community developer Assemble for 6,000 apartments, which has built on the failure of traditional rentto-buy by introducing options and restricting rents, has achieved high rates of subscription. Assemble’s model includes a purchase price fixed in advance, market rents, and no compulsion to buy6.

Conclusion: A strict code of practice Worldwide, there is evidence that if properly managed, rent-to-own can be a successful way to improve market liquidity, encourage home ownership and contribute to affordable housing in particular, which is the main real estate challenge facing governments in the Gulf. There are real opportunities for developers to take advantage of information asymmetries and capital market inefficiencies. Rent-to-own is just one way of creating mutual benefit for developers, government and buyers alike. However, the success of such schemes depends crucially on the role of the government in encouraging community developers, as well as providing safe, secure and standardised legal provisions for facilitating them.

In Dubai, Article 513 of the UAE Civil Code has formed the basis for the work already undertaken by the Dubai Land Department to develop a legal framework for RTO. This is done through the creation of a conditional title deed—applicable as yet to freehold ownership only, although this might change in future—and also to apply ijarah to RTO schemes, both structurally and in terms of governance. The legal arrangements could, however, usefully be supplemented by a specific mandatory code of practice, especially when RTO is extended to forms of low-cost and affordable housing. Legislative supervision of this kind, as has been achieved in relation to escrow, is probably the best way forward both to increase competition and drive down the RTO premium, and to ensure that governments in the Gulf never need the kind of restrictive legislation that Victoria was forced to introduce.

5

United Communities (2019) 10 ways cities are tacking the global affordable housing crisis. 19 June 2019. Available at: https://www.unitedcommunities.org.uk/news/community-based-bristol-housing-association-on-world-

stage-for-affordable-housing-innovation/ Retrieved 7 August 2020.

6

Assemble (2020) How the Assemble Model differs from rent-to-buy. Available at: https://www.realestate.com.au/advice/how-the-assemble-model-differs-from-rent-to-buy/ Retrieved 7 August 2020.

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Rent-to-own: Best practices and the way forward

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