M5 Step Up Conference starts 19 April 2021 - Click here for more details!
Home Blog Success Team M5 Team Join Now Login

Rent-to-rent strategy (step-by-step)

investment strategies Aug 11, 2020

When I started my property investment journey the only thing I knew how to do was to buy a property and rent it out.  So you can imagine how my mind was absolutely blown the first time I listened to a very inspiration property investor explaining how he lived in his house for free (he was renting) by subletting this house to other people on airBnB….

I literally hung on his every word and have been following him around ever since.

Even though I had all the evidence of this strategy working for him, it never occurred that I could do it as well.  Surely he had some magical negotiation skills that I could never copy and definitely he must have a secret network of people that would connect him with owners that would allow you to do this….

And that was my belief until recently. 

Whilst looking urgently for accommodation for some of my overflow students (I was never going to be able to buy and furnish a property in the timeline required) I started discussions with some student accommodation landlords to place my students with them. As the discussion progressed I learned that they were really tired of managing students as they had a much bigger portfolio and couldn’t be bothered with the small student houses (40 students!!) anymore.  I didn’t miss a beat and offered to rent the property from them whilst renting it out to my (and their) students.  They accepted and just like that my first rent-to-rent agreement was born.

I stumbled into my first rent-to-rent deal but it can be done much more scientifically… so here is a breakdown of the process and how to do this strategy.

WHAT IS RENT-TO-RENT?

It seems fairly obvious...but let's start by getting totally clear on what rent-to-rent actually involves. So where do both of those “rents” come from?

  • You rent a property from someone…
  • You rent it out yourself, to a tenant

Effectively, you’re taking control of the property and acting as if you’re the owner – just like you would if you owned the property yourself.

Now, of course, this is all pretty pointless unless you make a profit from the arrangement – otherwise you’ve got all the hassle of property ownership with none of the benefits!

That’s why in rent-to-rent you normally give the owner a guaranteed rent which is lower than you’ll be able to charge to your tenants. The owner is happy because they have a guaranteed income, without any of the effort that renting out a property normally involves. You’re happy because you’re making a profit – which is effectively your reward for taking on the effort and risk of managing the property.

Win-win?

THE BENEFITS OF RENT-TO-RENT

Rent-to-rent is still a niche property strategy, and is far from being suitable for everyone – but it does have some unique plus points that make it a good choice in some situations...

NO NEED FOR A BANK BOND

You’re not buying the property – you’re just renting it. That means, obviously, that you don’t need to worry about getting a bond. We are not at all against getting a bond in fact we believe that this provides great leverage and is one of the great things about investing in property.  But this is awesome if you do not qualify for a bond due to some credit history issues, or a low credit score or maybe even just earning commission and not a steady salary. Rent-to-rent gives you a way of generating an income from property while bypassing the need to go anywhere near a bank.

NO NEED FOR HUGE DEPOSITS

When you buy a property with a bond chances are that the bank could require you to provide 10% or 20% of the purchase price as a cash deposit. With rent-to-rent you will require a rental deposit but that will not nearly be as much as a deposit to purchase a property.  That’s what makes rent-to-rent a popular strategy for people with limited funds. For example, if you’ve got R10,000 in savings that’s not going to be anywhere near enough for a deposit on a property – but it could be enough to set up a couple of rent-to-rents.

NO TRANSFER FEES

Again, you’re not buying the property – so there’s no transfer fees or taxes to pay to SARS. And while you might pay need an attorney to put an agreement together for you, it’s not going to be anywhere near the cost of regular property conveyancing. Also due to the property not needing to be transferred to you, you can start earning an income much quicker than a traditional purchase agreement.

SUMMARY

This strategy is far from perfect, but if you’re keen to get involved in property but don’t have much in the way of cash or maybe just wanting to give property rentals a try without jumping straight into it with all your life savings, this might be a very good place to start.

WHY WOULD THE OWNER DO THIS?

It is important to understand the benefits to the owner as you might need to explain it to them to get them to agree that you sublet the property.

The two main advantages for the landlord are a guaranteed income and no effort. They get to hand over their property to you, and (all being well) they’ll get paid every month for the next few years without having to do anything at all. So you are offering them passive income.

 They won’t have to worry about:

  • Gaps between tenants, because you’ve promised to pay them whether you have a tenant or not
  • General Maintenance – NOT upkeep of the property condition
  • Tenants not paying (other than you not paying!)

From the owner’s perspective, this is different from just giving their property to a rental agent – because while an agent could remove a lot of the hassle, the owner would retain responsibility for costs and only get paid as long as there are tenants in place and paying.

Of course, there has to be some degree of compromise – and in this case, it’s that the owner will probably (but not necessarily) need to accept a lower monthly rent than they’d be able to charge if they were doing everything themselves. Otherwise, there’d be no room for you to earn a profit in exchange for the risk and effort you’re taking on.

THE DISADVANTAGES OF RENT-TO-RENT

NO CAPITAL GROWTH

This is one of the main benefits of investing in property and growing your wealth so this is a huge disadvantage. You don’t own the property, so you won’t benefit from any increase in its value over time.

Imagine you have a rent-to-rent agreement in place, where you’re making R5000 profit per month. Over five years, you’ll make R300,000 in exchange for looking after the property. Great!

But if the property is worth R2,000,000 and it grows in value by 5% per year, over the same time period the landlord will make R500 000 (not compounded) – without doing any work at all!

Capital growth is a huge, benefit of owning property: for some investors it’s all they care about, and historically the gains from growth have far outstripped the returns from rent. And with rent-to-rent…you don’t get any of it.

By default though you also benefit from the opposite if the property falls in value, you still get your rental

This is why rent-to-rent should never be your first choice if you can afford to buy property yourself, it’s far better to do so: you have control, and you benefit from the rental income and the capital growth. 

But if you don’t have the capital and don’t qualify for a bond with rent-to-rent you can at least generate an income – which you might be able to save up to build your own portfolio.

YOU HAVE THE RISKS OF PROPERTY OWNERSHIP

All the risks of property ownership now become yours:

  • Vacancies (gaps between tenants)
  • Maintenance
  • Bills

Even if you have a month where there’s maintenance to do and no rental income comes in, you still need to pay the landlord.

YOU DON’T HAVE CONTROL

You cannot change anything major on the property even if it has a negative impact on your tenants. What if the owner stopped paying his bond and the property goes up for auction or if your rental agreement is cancelled with the owner you have a very tricky discussion with your tenants.  It doesn’t mean something will go wrong if you stick to your side of the agreement and you make sure that your rental agreement is set up correctly, but control is a risk you need to be aware of. Luckily in South Africa we have “huur gaat voor koop” law which means that even if the owners sells the property the new owner much honour the rental agreement.

HOW DO YOU MAKE MONEY FROM RENT-TO-RENT?

You obviously need to rent the property out for more than you are getting it for, but how do you do that?

1: SINGLE LET, WITH THE OWNER ACCEPTING A DISCOUNT

The owner in a rent-to-rent scenario is getting a guaranteed income stream without the usual risks and hassles associated with renting a property, so it’s not unreasonable that they should accept less than the market rent from you.

Remember though all the costs of maintenance and voids are your responsibility now. If you get unlucky, this profit could easily disappear completely – but with the work remaining very much intact. This model is by far the simplest and easiest of the three. To make it work, you just need to negotiate hard to make sure you leave enough room to make a good profit even after your likely costs.  Check out this video from Zak (Investor if the year - Beginner category) on how he started in property investment through rent-to-rent.

2: TURN THE PROPERTY INTO STUDENT ACCOMMODATION OR ROOM RENTALS

If you have a 3-bedroom property that’s always been rented to a single family, you’ll make more money by renting it out as three separate rooms to sharers, or even renting out beds to students.

The advantage of this method is that you might be able to pay the landlord the full “single family” rent and still make a profit – or at least not have to negotiate so aggressively.  

The obvious disadvantage is that managing it for students or rooms is that it is much more work. You’ll also need to bear in mind that:

  • Student accommodation is erratic if you house bursary students and you will still need to pay the rent while waiting for NSFAS to pay the students.
  • Room rentals come at a higher default and eviction risk
  • There may be set-up costs to convert the property into student accommodation such as a better fiber connection and furniture. So that could mean that you actually make no profit during the first year of operation.
  • You’ll need to be aware of any zoning requirements, which are beyond the scope of this blog.
  • If the landlord has a bond, it might be a breach of the bank terms for the property to be let to students

Still though, even after taking the negatives into account, turning the property into muli-person rental is probably the most popular rent-to-rent strategy.

3: TURN THE PROPERTY INTO AIRBNB ACCOMMODATION

Airbnb accommodation just means that you are renting to short term tenants on a daily/weekly or short term monthly period. It is usually fully furnished and comes with services like daily cleaning, bedding etc. This also works well near hospitals for intern doctors, large business employing intern staff such as call centres and technology companies. The location of these types of properties is critical to get right to make it work.

This also takes up more of your time, you’ve got bills to worry about, there are higher set-up costs (like furniture and accessories) and higher running costs, but profit is higher than the other models if you can keep the place occupied for a good period of the month. To see a case study of this from someone that is doing this as a business, check out this video on YouTube.  Rent-to-rent on Airbnb

FINDING RENT-TO-RENT OPPORTUNITIES

Rent-to-rent is not going to be suitable for the majority of landlords. Most of them are happy either self-managing or using a letting agent – and finding the landlords for whom rent-to-rent is the right solution is a point where many people fail and give up.

 The methods you can use to find rent-to-rent opportunities are endless. Once you understand who you’re trying to reach, you’ll be able to come up with methods of your own – but to get you started, here are three…

RENTAL AGENTS?

Rental agents have no direct role in this arrangement and therefore it will be extremely difficult to convince a rental agent that this is the way to go.  Rental agents make their money through finding tenants (once off fee) or/and through monthly fees for managing tenants. As they will not be managing anything you will probably need to offer them compensation from your side as well to open up the discussion with the owner.

DIRECTLY CONTACT THE OWNER 

If you are looking to do student accommodation take a drive through a student accommodation neighborhood and see if there are properties to rent in the area. Student accommodation are normally rented and managed by owners themselves so schedule a viewing and meet up with the owner as a prospective tenant.  Based on what you can see on vacancy rates and the persons energy levels (for managing his/her students), gently open the discussion of letting out the whole property to you.

You can also view normal single rental properties in these areas where you can see that the ads for rentals were place directly by the owners. Those are normally on private ads in Gumtree or Facebook marketplace.

 VIEW PROPERTIES FOR SALE

Look for properties that have been on the market for a long time and are empty.  You can offer to rent these properties (with an option to buy after 2 years – this doesn’t mean you HAVE to buy but prevents the property from being sold without your knowledge). Sometimes some money is better than no income for the owner.

Some properties are also being sold due to the owner being tired of managing the property (unwilling landlord) or inherited the property so will be open to rent it out if they don’t have the hassles of being a landlord

ANALYSING A RENT-TO-RENT DEAL

There's a lot more detail to consider when you really get into it, but broadly speaking there are four main steps you need to run through when assessing a rent-to-rent deal:

 1: IS THERE TENANT DEMAND?

It’s possible that the owner is so keen because they can’t find anyone else who’ll rent the property from them – so a first step is to assure yourself that there’ll be demand when you turn the property around and market it to potential tenants.

 2: FIND OUT HOW MUCH YOU COULD CHARGE IN RENT

You need to know what the normal market rent is – or what you could charge after improvements, if there’s work you can do to the property. We love to use the investor report from TPN to analyse rental rates. Bear in mind how many rooms you can fit in, whether they’re singles or doubles, whether they have en suites, and generally what the quality level of the property is – and make sure you’re comparing like with like.

3: CALCULATE YOUR NET INCOME

Next, deduct all the costs you’ll have in the running of the property as well as voids.

Say you can charge R10,000 in total rent, which nets down to R7000 after factoring in all your costs. This determines how much you can offer the landlord: clearly R7000 or more wouldn’t work because you’d make a loss, so you need to decide how much profit you’re happy with making for all your hard work. Would offering R5000 be reasonable – giving you a R2000 per month profit? That’s for you to decide. Here is a video where I break down in more detail how to calculate your net income from a rental property

4: WORK OUT YOUR PAYBACK PERIOD

You’ll have some kind of expenses when it comes to setting up the property – which might be just a quick clean and a few items of furniture, but could involve full redecoration or even some internal work. Once you know how much this will cost you and what profit you’ll make per month, you can calculate your “payback period”: in other words, how long does it take for you to recover your costs and start making a profit from the deal?

If you’re making R2000 per month and it costs you £35,000 to prepare the property, that means you won’t break even until you’ve been running the property for nearly 18 months.

Is that acceptable? That’s for you to decide. Clearly, if you are OK with this, you’ll need to agree a long rent-to-rent period – perhaps five years – because if you agreed a two year period you’d only have six month where you’d actually be making money.

SECURING THE RENT-TO-RENT DEAL

There’s lots of think about when it comes to the deal, and you should definitely involve an attorney or someone who’s done this type of deal before. While this doesn’t cover everything that should be in your agreement, these are probably the three biggest deal points you’ll need to consider:

WHO PAYS FOR WHAT?

You’ said you will cover routine maintenance – but there’s a point at which you’ll probably want to draw a line. For example, say the roof caves in, or a new regulation comes in that requires expensive energy efficiency measures. You’re unlikely to want to pay for these, because it’s ultimately not your house – so one big expense could wipe out years of profit, and you’ll never benefit from your capital input.

The tricky part is being clear about where the line is drawn, so there’s no arguing when the time comes about who should pay for what. Then there are other considerations to think about: for example, the owner will probably need to continue insuring the property, but who should pay for it?

HOW LONG IS THE AGREEMENT?

As long as the arrangement is profitable, it’s in your interest to agree as long a term as possible – because as we’ve seen, it takes time to recoup the upfront cost (and effort) involved in setting the property up.

The landlord may feel similarly, or might want to keep the term short in case they want to sell the property or maximise their income by doing something else with it. One solution to keep both sides happy might be to have a longer term with a shorter cancellation clause – but you should make sure it will still be worth your while even if the landlord cancels the arrangement at the earliest opportunity.

For students you need to align your period to the semesters that the students will stay at your house.

CONCLUSION

Well what have you decided about rent-to-rent?

1: It’s an exciting way to get into property quickly and start generating some cash

2: Is all the work worth it even if you don’t get the biggest benefit of property investment – capital growth?

But if you’re willing to put in the work and it’s your only option…rent-to-rent might just be the what you’ve been looking for.

HOW DO YOU GET STARTED WITH RENT-TO-RENT?

The biggest stumbling block is finding deals. So although there are lots of other things to think about (negotiation, marketing, agreements…), you’re best off working on developing a system to find properties before getting stuck in other details.

To get help you can also join our group-coaching sessions that are available for M5 Property Varsity members or you can create a shortcut to your success and book some 1on1 coaching to get you going!

Want to chat?

Want to learn more about M5 Property Varsity? Schedule a call to explore how M5 Property Varsity can assist you on your road to financial freedom.

Don't worry, your information will not be shared.

Schedule a call
Close

50% Complete

Two Step

Lorem ipsum dolor sit amet, consectetur adipiscing elit, sed do eiusmod tempor incididunt ut labore et dolore magna aliqua.