Rent-to-Own: An Emerging Asset Class That Can Work in MexicoBy Wol Birch Reynardson | Mon, 02/08/2021 - 09:08
Rent-to-own as an asset class is in its infancy, even in the US. But times are changing.
The post-financial crisis tightening of bank mortgage requirements has triggered the emergence of several technology companies with a new breed of rent-to-own program. They are designed as a first step onto the property ladder for those without the credit quality or sufficient savings for a down payment to qualify for a traditional mortgage. Tenants build toward their future down payment while they rent, and purchase their home when they are ready. It is the cost and time efficiencies afforded by technology that enable the scalability of the model.
In the US, companies offering these programs have attracted high quality capital from both property and technology investors. Real estate investment legend Sam Zell, alongside Blackrock, backed Home Partners of America in 2016. They have completed over 55,000 transactions, demonstrating the rapid scalability of the model with the required capital. Two years later, Divvy Homes raised money from Andreesen Horowitz, among other leading venture capital investors. They recently announced a $110 million Series C round with a view to expanding to 20 markets in the US by the end of the year.
In Mexico, rent-to-own remains virgin territory and an immense opportunity. In a less mature mortgage market, there is an even more acute need for a more accessible home financing model, together with a large and growing addressable market. In this article, we consider how rent-to-own as an asset class compares to typical investment opportunities in residential real estate, particularly in the context of Mexico.
Rent-to-own investment returns are enhanced by lower entry prices and higher rental yields. Because of the all-cash nature of rent-to-own acquisitions, with short timelines, properties can be acquired with a liquidity discount. This is particularly attractive in Mexico, where the sales inventory turns slower than in other markets. The model can generate a small premium to the market rental yield owing to the customer’s optionality to purchase the property, generally at a fixed price.
The costs associated with rent-to-own are favorable in comparison to a traditional rental portfolio. Customer acquisition is partner-driven and therefore cheap. Since customers join rent-to-own programs with a view to buying the home in the future, the program has significantly lower turnover and therefore lower vacancy costs. A typical rental portfolio has turnover of 50 percent annually, and, therefore, vacancy and its associated costs are a significant drag on returns. Moreover, rent-to-own tenants look after the property because they share in its ownership. This drives down maintenance costs and the repairs in the case of the tenant leaving. In the famous words of Larry Summers, “Nobody has ever washed a rental car.”
Rent-to-own also has attractive risk characteristics owing to the alignment of interest between landlord and tenant. This results in a lower rate of default and lower cost in the case of default. Investors retain legal title of the underlying property until the customer completes the program. A typical rent-to-own tenant will put forward between 3 percent and 5 percent of the value of the property as a deposit to initiate the program. This is more than a normal rental deposit and grows as the customer builds ownership in the property through the program. The unique risk profile of the model accommodates a capital structure of both debt and equity in order to enhance returns.
Demographics in Mexico dictate that housing demand will grow meaningfully over the next decade. However, a restrictive and expensive mortgage market and a widening affordability gap are excluding this emerging generation from realizing their aspirations. Rent-to-own can enhance access to home ownership, while generating attractive returns for investors