In addition to all the other risks associated with rent-to-buy/vendor finance deals, the ‘buyer’ must gamble on a minimum increase in property value over a short-term. An examination of some historic property price fluctuations shows how high this risk this is.
Many lease option agreements are for terms of 2-3 years. Many vendor finance arrangements are set for a maximum of 3-5 years (or financial penalties are imposed if they extend beyond this time).
The potential buyer will usually lose all money paid if a mortgage application is unsuccessful at the end of the term, resulting in a wind-fall for the seller or investor. One factor that will influence a mortgage lending decision at the end of the rent-to-buy period is the lender’s valuation of the property. If the property is over-priced and/or the value doesn’t increase significantly, the mortgage application may be rejected. The “buyer” will lose everything and the seller will make a big wind-fall.
‘Rent-to-buy’ properties are often priced at a premium – often 10-15% above the seller’s (or intermediary’s) value estimate, but consumer representatives are aware of uplifts of up to 30%.
So, regardless of all the other factors that may influence a mortgage application (such as the consumer’s credit record, employment history, income and accumulated funds), an inadequate increase in property value is likely to kill the deal. Depending on the contract terms and price, an increase of between 5% and 15% per annum may be needed – or even more.
An increase in prices over these short terms can’t be guaranteed, let alone a large increase because property prices can be volatile within these short term frames. Add to this that some of the locations where these houses are located may experience lower than average growth.
In five Victorian locations where houses have been the subject of ‘rent-to-buy’ or vendor finance deals, the average annual increase in median prices over 2004-2014 ranged from 3.8% to 5%. However, prices decreased in each location over at least one year, and over at least a two-year period in 4 of the locations. In one location (Craigieburn) prices decreased over a 4-year period from 2010-2014.
Look back further and consider five locations where these deals were done in the early 2000s. Average increases in median prices in those locations over 1992 – 2002 ranged from 2.5% – 7.4%. However, excluding the two years of highest growth, average median price increases ranged from negative 0.8% to 4.4%. There were a number of years of negative growth in all five locations. In two of the locations (Morwell and Wendouree) median prices had actually fallen between 1992 and 1997.
Further details about these price fluctuations
Craigieburn – average increase in median prices from 2004-2014 was 4.2% per annum, but prices fell over 4 years between 2010 and 2014.
Truganina – average increase in median prices from 2004-2014 was 3.8 %. However, prices dropped from 2011-2012 and also between 2005 and 2007.
Doreen – the average increase in median prices from 2004-2014 was 6.2 %. However, prices dropped between 2007-2008 and 2011-2014, and remained constant from 2007-2009.
Wyndhamvale – the average increase in median prices from 2004-2014 was 5% per annum, but prices decreased over 2006-07 and 2011-2014
Tarneit – the average increase in media prices was 4%, with prices dropping during one year in the period.
(These calculations based on “Houses by suburb 2004-2014”, Dept of Land, Water, Environment and Planning (Vic))
In the early 2000s rent-to-buy industry figures provided some examples of “successful” vendor finance cases. These examples were provided at a time of rapid increases in property prices throughout Victoria. For example, two of the property locations (Ballarat and Wendouree) experienced price growth over a 2 year period of 2000 – 2002 of 48%.
However, median price growth in the five locations mentioned were much lower over 10 years (92-2002):
Ballarat 7%, Mildura 7.4%, Morwell 2.5%, Traralgon 4% and Wendouree 5.%.
If the 2 years of higher growth were excluded, the average annual increase over the 8 years from 1992 – 2000 were Ballarat 3.6%, Mildura 4.4%, Morwell -0.8%, Traralgon 1.9% and Wendouree 1.2%. There were a number of years of negative growth. Both Morwell and Wendouree median prices were less in 1997 than they were in 1992.
(Calculations based on A Guide to Property Values 2002 Education, Landata, Valuer General Victoria).)