Rent and Buy

When purchasing a dwelling buyers typically obtain a bank loan then purchase the dwelling with the loan funds.  The borrower repays the loan in instalments while having full possession of the dwelling. When a bank creates a loan the money created has interest attached to it. As repayments are made the interest is paid first then anything remaining is paid off the capital.  This approach causes the cost to buyers to be higher than necessary and to be loosely related to the rental value of the dwelling.

An alternative approach to loans is Rent and Buy. With rent and buy the buyer pays off the capital in instalments, much like the repayments of a loan, and at the same time, accumulates a rent debt. After the capital is repaid the rental debt is paid and only then is the asset transferred to the buyer.

With bank loans the amount the buyer will pay is related more to the interest rate and the difference between interest payments and repayments – both of which are difficult to estimate. When the rent and buy approach is adopted, the financial cost of buying a dwelling is directly related to its rental value which is a stable, known value. The buyer will always pay less with rent and buy compared to a traditional loan regardless of whether the loan is supplied by a bank or directly via the seller. Most purchases of dwellings are financed through loans because there are few alternatives for most people.

However, there are investors and potential investors who have cash – such as superannuation funds or landlords who own properties – who will be attracted to this system because they are in the business of investing funds to get a secure inflation resistant future return.  By using the rent and buy approach such investors will get a higher return than through simple purchase and rent.  This is because many of the costs of rental are shifted to the buyer.  With a normal rental approach the owner of the property is responsible for the maintenance and running costs of the asset. With a normal rental the owner of the property is responsible for the maintenance and running costs of the asset. Under rent and buy the buyer becomes responsible for these costs. This means that the saver gets a higher return on their investment because they do not have to cover many of the costs that landlords normally incur.

Outline of Rent and Buy

Let us assume a person has a dwelling they wish to sell and the person has no mortgages or encumbrances on the dwelling. They find a buyer who is willing to pay their price and to pay a rent on the equity still outstanding. The title to the property is transferred to a trusted custodian who will ensure that both parties will honour the agreement. Title is only transferred to the buyer when all rent and capital is repaid. During the sale the buyer and the seller have shared equity in the dwelling. The buyer lives in the property and is responsible for all running costs, insurances and maintenance. If either buyer or seller spends money on the property they can ask a third party to rule on the impact on rental value of the dwelling. If it has increased the value, the increase is added to the equity of the party that spent the money. In addition, if the rental value of the property does increase, the rent paid on the remaining unpaid equity also increases.

At anytime either buyer or seller can sell their part of the agreement.  The rules are that if a buyer is living in the dwelling then they can only sell to another buyer who will live in the dwelling.

Buyers can choose to vacate the dwelling and cease to make repayments. In this case all the rent owed to the seller is added to the seller’s equity. The equity of the exiting buyer remains with the dwelling and the buyer now becomes a seller. If a buyer cannot meet the repayments then the seller has the right to find another buyer and to force the previous buyer to vacate the dwelling. However, while-ever the buyer can meet their repayments, they cannot be forced to sell.

Loans versus Rent and Buy for the buyer

The problem for buyers is illustrated in this graph and in the spreadsheet “Loans versus rent and buy” which is available on request.

Rent and Buy compared to a Bank Loan

Here the effect of small variations in the repayment rate shows a dramatic difference in the cost of buying a dwelling of value $100K.

Rent and buy costs change linearly if the rental prices are increased linearly whereas loan costs do not vary linearly with repayment rates and interest costs.  This means buyers purchasing with rent and buy can make better choices when purchasing a dwelling because they will know the final cost of the dwelling.

Rent and Buy for Investors

The Spreadsheet, available on request, titled “Renting with rent and buy” has the following assumptions.

• The rental rate is related to the actual rental value of a property.
• The tax rate is 30% and is only paid on rent.
• All the funds received by the seller are either deposited or are reinvested in similar projects.
• The rental rate is 5% of the capital value.
• The landlord costs are 2% of the capital value and are paid by the buyer when using rent and buy.
• The time period is 65 years.

Under these circumstances rent and buy is always better for the investor than renting if the repayment rate is greater then the real rental cost.

With rent and buy running costs are covered by the buyer not the investor and tax is deferred until the capital is repaid.

Rent and buy means investors prefer a rapid repayment of capital because they can re-invest their rental payments and start to compound their investments.

Rent and Buy for Investors

Rent and Buy Advantages

Both buyers and investors are financially better off with rent and buy than with the alternatives of loans for buyers and owning a whole property and renting for investors.

Both buyers and investors can sell their agreements to others without having to sell the dwelling.  This makes the agreements a liquid investment for both buyers and sellers. This in turn makes the market in dwellings accessible to more people. The dwelling market is currently funded almost exclusively through loans and dwellings are relatively illiquid.

Agreements can be amalgamated or split.  This means that the approach can be used by large investors or by small investors.

The cost to purchase a dwelling is related directly to its rental value and is predictable.

Both buyers and investors are protected from inflation.

Rent and Buy Innovation

Rent and buy combines several components each of which already exist independently. The innovation is to bring all these together into a single system. One component is that loans are not used to facilitate transfer of ownership. Rather ownership is transferred incrementally through a shared equity arrangement. The shared equity arrangement means that the value to both buyers and sellers is related directly to the earning potential of the asset or its rental value. Another component is that the shared equity is structured so that the shared equity parts can each be purchased and sold independently of the dwelling and of the other parties to the transaction.

Implementation details cover:

• The ability of the buyer to make repayments will be monitored closely and continuously.
• There will be systems to keep track of the running costs of the dwelling so that buyers are fully informed of the total costs.
• All calculations of rental liabilities and returns on investments are performed by the system.
• All payments and transfers of money are recorded and stored by the system.
• Both buyers and sellers will have a record of their reliability and actions with previous sales.
• There are procedures and rules to handle property improvements and inflation of assets

In effect, the Rent and Buy agreement is a combination of a rental agreement and a mortgage agreement. The Rent and Buy system will charge an administration fee of 0.2% of the capital value paid each year.

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