RENT-BACKS: A POWERFUL TOOL IN A BUYER’S TOOLBOX

by Mike Maher, Contributor
FORBES – Real Estate

One of the complications of a hot housing market is that the intense competition for homes is making it harder for home sellers to plan their next move. Those who are selling a primary residence have additional factors to consider – like how long it will take to find their next home and where they will go in the interim if their current home sells quickly. As a result, one increasingly popular tactic to make a  buyer’s offer stand out more is the use of seller rent-back agreements.

Seller Rent-Backs have Increased in Proportion to the Competitive Housing Market

Many homeowners would love to take advantage of this extremely competitive housing market and reap the benefits of bidding wars and inflated prices. But those same market conditions have made sellers wary of leaving their home without the next place lined up. This attitude is justified considering that it’s fairly normal now for homes to go for 15% or even 20% over asking price depending on the region – and for buyers to experience multiple rejections before an offer is accepted.

Seller rent-back agreements (also known as seller lease-backs), in which the seller rents back the home from the buyer for an agreed-to term, have become increasingly common in this market. In the past, agents have typically steered their clients away from rent-backs to avoid potential complications, but many agents are now embracing them as a temporary solution in a tough housing climate.

The advantage for sellers is clear: it saves them the hassle of having to move twice and renting in between homes, while also helping them avoid placing home sale contingencies on their offers. And with the market this competitive, it’s something sellers can ask for – and receive.

The risk for buyers, though relatively low, is something they should consider – they’ll be navigating a temporary tenant-landlord relationship where the sellers could potentially leave the home in poor condition. But in a multi-bid situation, offering a rent-back is one way for buyers to present a more appealing offer to sellers without having to increase their offer price.

Although seller rent-back agreements have risen in popularity across the country, this has become especially prevalent in extremely competitive and transient markets like the greater DC metro area (Virginia and Maryland). It’s mainly a result of the housing market in the region starting to cool and sellers not wanting to miss out on the excitement of the past few months (according to data from Bright MLS, homes in the DC metro were on the market for 7 days in July, compared to 6 in June – and the median sales price fell by 3% in July when compared to June).

Sellers are realizing that a tight market and profit go hand-in-hand. Once it becomes easier for sellers to buy their next home, they’re not as likely to get 10 bids and top dollar for their current home. By selling now and entering a post-occupancy agreement, they can maximize their profit while ensuring they have time to find their next home.

How the Rent-Back Agreement Works

In most purchase agreements today, the seller rent-back is typically included for free as part of the offer for the home (or, the buyer can request a monthly fee from the seller). This is because buyers are using the free months of occupancy as a negotiation tool in a highly crowded market – usually in addition to going over the asking price. Rent-back agreements are typically 30 day and 60 day agreements, though they can be shorter or longer than this. The seller typically pays a security deposit of several thousand dollars.

The terms of the contract, especially the post-occupancy agreement, are essential for having a smooth seller rent-back experience. If there are any issues, it will almost always come back to the language of post-occupancy agreement.

Whether a seller rent-back makes sense for a buyer depends on several factors, including location. For instance, in DC, seller rent-back agreements are typically frowned upon because of tenancy laws – if something were to happen, the departing seller could occupy the home for up to six months (which is how long it takes to evict in DC).

A licensed real estate agent is ultimately the best resource here for structuring the contract to protect the buyer, and also to guide them toward the best option for their needs.

Potential Complications of the Rent-Back

In the past, agents have often cautioned clients against making or taking rent-back agreements because of the potential for complications. The question of whose responsibility it is to fix a laundry machine that breaks before the new owners can move in, for example, can feel a bit murky.

There are also a lot of details to figure out regarding who pays for what. Renters’ insurance is highly advisable, as is going to a lender or insurance company to make sure the seller is covered specifically for this situation. Typically the seller will pay for utilities until they move out.

Not surprisingly, buyers are often wary of the condition that the home will be left in. The final walk-through typically occurs once the seller has removed all of their belongings from the home, but in this situation, the final walk-through comes after the home has completely exchanged hands. Even in a best-case scenario, it’s likely that there might be clogged drains or blown-out lightbulbs that were missed. Once closing occurs, though, there’s less of an incentive for the former owners to attend to these details.

Although the main concern is typically that sellers will leave homes a mess or refuse to vacate, many of the potential complications are from the buyer’s side instead.

Although the market is still white hot, things have cooled down a little in some regions. Buyers who opted to go tens of thousands of dollars over asking, or who opted for a free two-month rent-back agreement, are now experiencing a bit of buyer’s remorse and looking to recoup some of their money.

This can create a powerful incentive for buyers to look for any sort of reason to keep the security deposit. And the last thing sellers want – as they’re likely trying to move into a new home – is to deal with a small claims court battle.

Because of all the potential complications that can occur, it’s important to work with an experienced agent. This is especially important in a situation where a seller will continue to have a relationship with the home buyer after the home is closed on.

How to Structure A Rent-Back Agreement

A well-structured post occupancy agreement is essential for limiting liabilities. This is not a part of the contract that can be copy/pasted over from a prior settlement – it really needs to address the needs of the individual buyer and seller.

if the buyer is working with a lender, it may be necessary to keep the rent-back agreement to 60 days or less. Under some loan policies, 60 days is the limit for a residential move-in – at that point the home switches over from being a primary home to an investment property, and investment properties come with higher interest rates. This is true for the Fannie Mae, Freddie Mac, FHA, VA and USDA loans: the buyer must establish occupancy within 60 days of signing the agreement. The buyer may also run into tax implications if they rent their home out for greater than 60 days. Sellers who are looking for longer post-occupancy periods may be incentivized to accept all-cash offers in order to avoid potential loan qualification setbacks.

The home buyer should also take it upon themselves to double check their insurance plans and make sure that both the rental insurance and the home insurance can cover a rent-back situation.