This is what gives Rent-to-Own (a.k.a. Lease-Options) a bad name.
The British Columbia real estate regulator issued a rare ‘Emergency Suspension’ to a BC realtor and his company. Briefly, the realtor allegedly looked for homeowners in foreclosure. Then he would buy the properties from them at less than market value and rent them back under a Rent-to-Own scheme. The homeowners were always unrepresented by realtors or lawyers.
Here’s the kicker; their rent payments were double their mortgage payments. Of course, if the homeowners could not make the mortgage payment, they could never consistently make a rent payment that was double the mortgage payment! Once they couldn’t make a payment, the realtor would evict them.
Here’s what the regulator said:
The terms were highly disadvantageous, to the point of the ‘rent-to-buy program’ being ‘predatory’ in nature. Mr. Brach offered sellers a lifeline, bailing them out of their immediate financial predicament with foreclosure proceedings, but in return, engineering the purchase of their property—whether in his name or in the name of a numbered company… at less than market value, using the vain hope that they could regain ownership of their property at substantially higher prices.
The BC regulator will undoubtedly confirm the realtor’s suspension and issue a large fine. A similar situation was found in an Alberta court decision. For the full case, see Lydian Properties v. Chambers , 2009 ABCA 21. The circumstances were an exact duplicate of those found in the BC matter. The Alberta Court of Appeal upheld the justice in the lower court who had concluded that the arrangement breached the Unconscionable Transactions Act, the Fair Trading Act, and the criminal interest rate provisions in the Criminal Code. Alternatively, the court rescinded the transaction on the basis of unconscionably. Here is a summary of the Court of Appeal findings:
A presumption of fraud is created when there is:
- proof of inequality in the position of the parties arising out of the ignorance, need, or distress of the weaker, and;
- substantial unfairness of the bargain obtained by the stronger party.
The necessary criteria to establish that a transaction is unconscionable are as follows:
- a grossly unfair and improvident transaction;
- a victim’s lack of independent legal advice or other suitable advice;
- overwhelming imbalance in bargaining power caused by a victim’s ignorance of business, illiteracy, ignorance of the language of the bargain…or similar disability;
- the other party knowingly taking advantage of this vulnerability.
Note that both the BC regulator and the courts in Alberta made specific reference to the homeowner not having independent legal advice.
I teach investors how to use Rent-to-Own with the intention of it being a win-win situation for buyer and seller. ‘Creative’ real estate strategies are, by their nature, not well known. As much as you might be assisting a homeowner in exactly the way they want, the independent observer might see you taking advantage. Always consider the benefits of having the other side of your creative transaction get independent legal advice. Watch for a future post on use of what we call our CILA letter (Certificate of Independent Legal Advice letter), not quite independent legal advice, but way better than doing nothing at all.
Long-term real estate success as an ethical real estate investor, no matter what strategy you employ, depends on making sure your transactions are win-win. Yes, you might achieve some short-term success by beating up or taking advantage of the other side. But, that is a fool’s game sure to collapse on you. Stick to what we know works. Understand your strategy, market hard to find opportunities, do your homework, and put together a win-win deal.