Lease-To-Own Purchase Or How To Profit From Spain's Market Downturn
Raymundo Larraín Nesbitt - Lawbird Legal Services
5th of November 2009
It has become Spain’s favourite sport to second guess on when the real estate market will finally pick up again. Reputed experts, both national and foreign, are jumping in giving all sort of contradicting timelines for the economical recovery i.e. 2011, 2014 and the most pessimistic ones on 2017. Although it may be fun to indulge in this sport on whether it will be an “L”,“U”,“W” or X-shaped recovery the gist is that it remains a fairly futile exercise as everyone, both experts and laymen alike, are basically clueless on where the market will be heading next.
As appealing an amusement as may be, nonetheless I believe it may be impractical and rather sterile for most buyers who are now sitting on the sidelines waiting for events to unfold, as in hindsight very few people do actually call the market bottom correctly and most miss out on the opportunity to pick a bargain in the dip.
These potential buyers who are now sitting on the fence musing over how much lower house prices can get may in fact already, unbeknownst to them, profit from today’s market turmoil. A rent-to-own contract does exactly that. It is an interesting alternative worth looking into in times of uncertainty, such as these, on where house prices will be heading next.
A lease purchase simply removes all the associated angst on whether one should still be holding out or else be moving in for the kill. The truth of the matter is that no one has a clue on when the market will finally hit rock bottom. And even then it may be lingering on a valley for a while until it picks up again. So it may be worthwhile reviewing this lease to buy option jumping in today at tomorrow’s prices TM.
What is a Lease–To-Own Contract?
This type of contract, “contrato de alquiler con opción a compra”, allows you to lease a property, whether off plan or resale, with an option to buy it within a deadline normally spanning 2-5 years. The main advantage being that the full let is actually discounted from the final purchase price. So if you finally do opt into buying the property within the deadline, the paid rent (rental premium) will be deducted in full from the pre-agreed sales figure.
This contract has multiple advantages for both grantor and grantee in the context of a deflationary environment such as the current one. The advantages under normal circumstances far outweigh the potential disadvantages. It is worth noting that the below listed advantages are almost certain to take place under normal circumstances; however, the disadvantages may or may not take place which is why I label them as potential.
For the option holder:
- Foremost is the flexibility it allows you. You can actually withdraw from the contract as if it were a normal Tenancy Agreement should you spot a better opportunity within the next years, forfeiting the lease of course. At no time are you forced to buy the property at the end of the deadline, it will be your choice. This lack of commitment actually enables you to be on the prowl looking out for other opportunities without being bogged down.
- You may freely agree on the time frame to exercise the purchase option tailoring to suit your needs. Normally they span 2-5 years but can agree to be made longer.
- The pre-agreed price of the property stipulated within the contract is normally well below the current market prices so as to provide a reasonable incentive to prospective buyers. This offsets normally the risk of property prices decreasing even further in the near future (next couple of years) as the pre-agreed sales price has already factored this in.
- As written above, the rent premium is deducted in full from the sales price, so it is not forfeited as it would normally be the case in a Tenancy Agreement.
- In some contracts you may assign the option to buy. This allows for even greater flexibility as the buyer can sell on the right.
- Unlike the UK, there is no option fee to be paid on exercising the option right.
- For off plan you can actually claim back the VAT you are overpaying for the lease which will be set at 16%. Buying off plan freehold property has currently set a VAT of 7% (which is due to be raised to 8% as from July 2010). You are entitled to claim back the difference only if you exercise the option to buy from the developer. It is advisable there is a clause worded on this point.
- You are actually living in the property that will be yours in a near future without being riddled now with the associated stress of applying for a mortgage loan. Although you may not qualify for a mortgage loan now you may in a few years’ time when the credit market ease’s up again.
- If the property is within a Community of Owners you may come to know of internal problems of which you may have been previously unaware that may ultimately affect your buying decision. You may possibly never come to knowledge of these quirks unless you’ve actually taken the trouble of letting the property. Not least is worthwhile mentioning that you will not be expected to pay the Community fees, these will be taken care of by the landlord.
- The applicable laws will normally be Spain’s Tenancy Act (Law 29/1994), the Spanish Civil Code and the Private Contract of course. Tenancy laws in Spain are historically biased towards tenants so it’s always good to be protected by them being a tenant. It may be advisable to lodge this contract before the Land Registry.
For the option grantor:
- The advantages are really self-evident. Foremost you actually have a tenant who is genuinely interested in buying the property not just in renting it avoiding time wasters altogether. An option to buy actually increases the pool of genuine potential buyers as it makes it easier for them to commit now.
- The let can help offset any mortgage repayments, community fees or expenses in general thus avoiding slipping into arrears.
- Having a tenant inside should normallyensure the property will be looked after properly avoiding it sitting empty which may lead to break-ins or in the worst cases even being vandalised.
- On very long-term options it is normal to implement additionally an option fee. If you’re tenant defaults you can always pocket it besides the let’s deposit and the rental premium.
For the option holder:
- You are actually letting a property. You must ensure you will be able to meet the let on time otherwise you will be jeopardising the contract. Bear in mind the currency exchange rate fluctuation if you’re source of income comes from abroad i.e. sterling pounds or dollars against the euro.
- As it’s a let, the rent premium may be revised annually by your landlord in line with inflation. Spanish Tenancy Agreements are normally referred to the Consumer Price Index (IPC in Spanish).
- For very long-term options, exceeding normally 3 years, an additional deposit (option fee) may be requested by the landlord besides the normal 1 or 2 months’ deposit for letting out the property. This may not appeal to everyone of course but it is done as prove of a serious commitment on behalf of the potential buyer.
- The main disadvantage is that these contracts last typically 2-5 years and in the interim the landlord’s financial circumstances may change. i.e. if the property has a mortgage loan taken against it and the landlord defaults, it may lead to a repossession procedure. You would still have a right to let the property if it’s repossessed, as the lender must respect a long term tenant, albeit you may no longer have the option to exercise the purchase of the property in the same conditions as you agreed to initially. You would actually have to raise the funds now and pay off the outstanding mortgage on the property if you wish to buy it off from the bank. Not to mention that if you additionally paid an option fee you would likely forfeit it in the event of a foreclosure.
- Buyers prefer long-term options to build up equity and in the interim keep an eye on where the property market is heading. Short-term options appeal to vendors but on doing they will be reducing the pool of potential buyers as few buyers will be interested. It’s a tug of war on which a consensus, balancing both opposed interests, must be sought.
- Another problem is that you are committing yourself on a pre-agreed price that in a few years time, despite the hefty worded in discount, may still be above the current market price. Obviously it makes no sense to execute the option if you are buying a property above the current market value. It would then be a case of a lost opportunity really as at no time are you forced to buy the property but you will of course forfeit in full the paid rental (opportunity cost) over the years negating the main advantage of following this option.
For the option grantor:
- From the grantor’s perspective it’s that you are actually letting your property with a potential view to selling it on at some point in the future. Letting entails the risk of the tenant defaulting becoming a non-paying tenant in which case a formal eviction procedure would have to be followed before the law courts. This can however be mitigated to a great extent requesting for long term options (those exceeding 2 or 3 years) a deposit (option fee) from the option holder as a token of good will or else you can always include an arbitration clause in lieu of having to resort to the civil courts which brings down significantly the timescale on having the tenant removed.
- The opportunity cost. On signing this agreement you will be held legally bound for whatever timeline you’ve agreed upon. This is particularly annoying in the event of a cash-buyer suddenly knocking at your door... Although it may sound unrealistic given today’s grim market, should the market pick up again sharply this is bound to happen and must be carefully considered. By accepting a rental-to-buy contract you are implicitly gambling the market will remain depressed for the next years.
- It goes without saying you will have to carry out a thorough screening procedure on potential candidates weeding out unsuitable profiles. Fortunately you can now rely on FIM’s database which can greatly assist you eliminating professional non-paying tenants that abuse Spain’s legal system.
Rent-to-buy schemes may not be everyone’s cup of tea albeit it is a very interesting option to pursue if you’re serious and committed on buying a property below the market value (BMV) taking advantage of today’s uncertainty. On following it, you will simultaneously retain a certain degree of freedom should either your personal circumstances or the market’s change. Buying property is always a serious decision for most people and this type of contract actually allows you the flexibility to live in it without forcing you into buying it.
When the market takes off again in .... (take your pick) years time, these contracts will no longer be as widely available as they are today both on off plan and resale property. It is precisely the current financial turmoil which drives landlords and developers onto offering this type of contract that may benefit both them and the option holder.
Those who are determined on buying cheap property which has already a pre-agreed significant discount in relation to today’s prices, may already profit from the current market uncertainty removing all the associated stress -and potential lost opportunity cost- of second guessing where today’s market will be heading next. Might as well leave all this guessing-work to the experts throwing darts, however fun it may be, and just play your cards safely. Mind you, these “confounded” experts do seem to always get it right...in hindsight.
And to close this article I cannot but recommend you hiring a registered Spanish lawyer to either draft this contract or else to review an existing one so as to avoid rash decisions that may lead you to future losses.
Please note the information provided in this article is of general interest only and is not to be construed or intended as substitute for professional legal advice.
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Discuss this Article
Sun, Jan 3rd 2010, 00:33
Great article! If one wanted to pursue this option, how would one do it? i.e. what exactly would I advertise and where would you recommend that I advertise to get the best exposure? Also, do you know people who have done it and what there experience were? Finally is there a spanish version to this article? Thank you in advance and apologies for all the questions.
Lawbird Lawyer Says:
Fri, Jan 8th 2010, 10:49
Thank you for your kind words and apologies for the belated reply.
There is no Spanish version of any of my articles, only in English.
Regarding advertising this option, you would really have to ask an estate agent on this point. As for how it works out, it´s just a normal rent contract with this special clause. So it pretty much works like any other tenancy agreement.
The experience we´ve had is that it´s becoming increasingly popular as today´s market provides the right breeding ground for it to work well. I´ve only given a general overview of such contracts, there are many specialities. There´s freedom to draft such agreements.
I.e. you can include clauses whereby for example the first two years of rental 100% of the rental premium is deducted from the sales´ price but starting from the third year onwards you reduce it following a sliding scale. So on the third year year you may deduct only 80%, on the fourth year 70% and so forth. This can be agreed so as to incentivate the purchase of the property as soon as possible.
The main caveat of this contract is that the discount must be real and significant. It´s fairly pointless to offer a rent-with-an-option-to-buy contract at a 2007 price. The whole point of signing such a contract is to be offered a significant discount in relation to today´s market so as to attract potential buyers. I write this because I´ve observed quite a few vendors offering rent-to-buy contracts with ridiculously overpriced properties. As they are unable to sell their properties they offer this type of contract at exactly the same sale´s price of three years ago (the peak of the property boom in Spain), this will not do.
Buyers will simply not sign such contracts at such high sales´prices and will just wait until there´s a steep price drop. If the landlord can afford to wait, fine; if not then he ought to price the property realistically and tag on the aforesaid discount if he´s to offer a rent-to-buy successfully. Nowadays selling a property successfully and pricing it correctly go hand in hand
Raymundo Larraín Nesbitt
Suzie C Says:
Tue, Jan 19th 2010, 14:43
I was forwarded this article by a friend, and it certainly sounds very interesting, with advantages to both parties.
I would be interested to know who would bear the cost for the upkeep and maintenance of the building, because under normal lease agreements it is the responsibility of the owners (landlords) to maintain the building.
To me, agreeing to sell at a low price, (particulrly if waiting would achieve a higher sale price) whilst also bearing the burden of building maintenance and upkeep seems to be quite a disincentive for the owners, although hugely beneficial to the would be purchsers / tenants.
Lawbird Lawyer Says:
Tue, Jan 19th 2010, 16:07
There's freedom in Spain to decide and agree whom pays what in private contracts as long you do not breach our laws, moral or the Public Order (art 1255 of the Spanish Civil Code)
Normally, as you suspect, it would be the landlord who pays for the building's upkeep, yes. Just like in any other Tenancy agreement.
As I write in my article:
It’s a tug of war on which a consensus, balancing both opposed interests, must be sought.
You must both find a middle point yielding in your positions so an agreement can be made possible. It is up to the parties to find and strike this balance. You have freedom.
Basically a rent-to-buy contract works just like any other Tenancy agreement only that the tenant has an option-to-buy the property at a competitive price should they choose to. In the case of developers being the option grantors it may be slightly more tricky (from a fiscal point of view).
The idea of rent-to-buy is catching on and is becoming increasingly more popular nowadays given the fact that lenders are not... lending. Last year for example, as I've written in other posts, all our conveyance procedures involved exclusively cash-buyers. We have many people interested and lined-up to buy bargains but if banks are not lending then sales just fall through despite the continued advertisements that lending is back to normal.
A rent-to-buy contract allows genuine would-be-buyers to get a foot on the property ladder at a price well below today's market (BMV) in the hope that credit will flow once more in 1 or 2 year's time. Borrowers whose loan applications are rejected now will be accepted in a couple of year's time when the credit market easen's up giving way to a new property cycle (boom-bust).
Credit is the lifeblood of our property industry, if lenders sap it away everything grinds to a standstill unless you are a cash-buyer, of course; and there are few of those. That's why cash is king nowadays.
Rather than sitting on empty property for the next 5 years (with the risks of break-ins, dampness, mould, general decay etc) some landlords would be better off offering this option to potential buyers who are now unable to secure a mortgage loan out of no fawlt of their own. Under normal market circumstances they would be given credit.
Many landlords are still in a denial stage on the price of their property and I understand them, no-one wants to take a loss. But sooner or later it has to give and someone will have to cave in. We will probably reach within the next two years a capitulation stage when thier savings are depleted and weathering off the storm no longer seems like a plausible option for many struggling to keep their heads above water. Better to be smart and take the plunge now than waiting until it's too late in my humble opinion. At least you have a choice now.
In any case, as I've written, these contracts will no longer be available once the market gathers pace with the slightest expectation of a market recovery; so it's pretty much a case of do it now or never.
Raymundo Larraín Nesbitt
Tue, Feb 23rd 2010, 14:39
This is a fantastic site, full of very useful information and I will recommend it to anybody looking to buy a property in Spain.
We're currently looking at an older property that is available as either a sale or as a rent to buy, for financial reasons we prefer the rent to buy option. The problem is that since the property was not maintained for the last few years, it now needs a lot of renovation work to make it livable. The owner proposed that if we choose the rent to buy option, we should cover the cost of renovation because it will increase the property value. Is there a standard way to deal with this situation? My concern is what will happen if either party brake the lease?
Thanks in advance of your advice.
Lawbird Lawyer Says:
Tue, Feb 23rd 2010, 15:00
Thank you for your kind words.
It makes sense that if you are looking into renting with an option to buy it is actually you who pays for these renovations.
If it were the landlord who paid for them it would make sense he charged you a higher monthly let to offset the expenses incurred. The landlord has no guarantee that you will eventually buy the property from him so it could be labelled as an unnecessary expense for him.
Another matter is if the property is not fit to dwell in i.e. the water is undrinkable, the house is infested with mould and decay, the electrical system is in disrepair etc. the landlord must let a property that is fit to dwell in (Art 21 of the Tenancy Act) and is obliged to mantain the property fit for purpose without raising the let because of it.
So basically there is freedom to decide on who pays for renovations unless they are regarded as essential to make the property habitable.
Raymundo Larraín Nesbitt
Tue, Feb 1st 2011, 10:45
Dear Raymundo, Thank you for posting such an informative and well written article. It has already helped us in our current situation. My wife and I are interested in purchasing a house on a buy-to-rent scheme. We've been made an offer by the owner which we're not happy with at the moment and will be making a counter offer. The owner has suggested a 3 year option where he would retain 10% of the rent in the second year, and 50% in the third. He also requested a 10% deposit. This all seems very steep. We have managed to decide on a deposit closer to 3%, and will be aiming to get 100% of the rent back the first 2 years, and maybe 80-90% in the third.
What I'm wondering about is the next step when, and if we decide to go ahead with the purchase. Would we then have to find another deposit for the bank in order to retain a mortgage?
Sun, Feb 20th 2011, 18:12
Hi Biskit, Ive just read your post... we are also interested in purchasing a property rent to buy scheme...we re at the 'just thinking' stage. Would like to ask you a few questions ...not sure if we can private message on here??
Ken Millingham Says:
Thu, Dec 1st 2011, 23:18
great article. Can you tell me what costs are associated the rent to own as fr as taxes etc are concerned?
Thu, Aug 9th 2012, 02:51
I am rather late to this thread and hope it is still monitored.
After entering into discussions with a Spanish resident living in the UK who is selling a house in Spain I wonder if this type of tenancy agreement would suit the situation.
What we are planning so far is that I pay an agreed asking price for the property over 5 years possibly 8 and that my monthly payments should add up to the selling price. Effectively the vendor is giving me a mortgage. I have spoken to a few solicitors and they do not seem to be able to help with the contract writing.
The vendor has a mortgage of 20,000 Euros and what we seem to be agreeing is that I pay the purchase price over say 60 equal monthly payments and I also pay the interest on his mortgage. If I am able to pay the total amount sooner then I have less interest to pay. I would plan to make extra payment to end the mortgage as soon as possible which is in both of our interests.
This rent to buy scheme seems to fit our scenario and would mean that the agreement will be noted by the land registry, I assume?
Does anyone know if an agreement can be written legally to include clauses such as me the tenant being responsible for the building, maintenance, repairs etc and the interest payment element that I will be paying off the vendors mortgage?
Mon, Oct 8th 2012, 10:38
I hope this reply is not late now.
I understand that you want to pay the 20000 Euros mortgage as purchase price and as there is a minimum fiscal value that will be applied, you will pay high taxes when registering the ownership. Formalizing such contract entails taking the risk the owner does not deposit that amount against the mortgage payment after 5 years ( he could choose to use it to cover other expenses ). We recommend that if you decide to go ahead, a rent to buy agreement should be exceuted within 5-8 years that indicated the vendor/owner/landlord has the obligation to deposit those amounts for the mortgage repayment, that is, in the mortgage bank account, but a fixed purchase price must be set; if it is only 20.000 Euros and the Tax office sets a higher value for the property, you will have to pay taxes for the difference and then register the ownership.
That is, once the contract expires or at any time during that period ( after, 3, 4, 5 etc years ) you would have to go to the Notary and formalize the purchase, indicating a pruchase price of 20.000 €. The Tax office will ask you to pay for the corresponding tax deriving from the difference between that amount ands the taxable value they have given to the property. After that, the inscription can take place at the Land Registry.
We recommend to have a solicitor check this type of agreements in the interest of both parties. I take the opportunity to offer our legal services for that end, so please feel free to contact me directly by e-mail if you wish to discuss in detail ( click on my profile).
Sat, Jan 19th 2013, 16:56
Just wondered if thread still going
I rent a house at the moment and its from a very close friend
She would like to sell and I would like a rent to buy contract
What I am proposing is a substantial rent over 8 years and she takes this off the agreed price
Is this legal in Spain, or even doable ?
We would have agreement drawn up by a legal representitive and her current " right of attorney"
Any comments please
Tue, Jan 22nd 2013, 15:58
There would be no problem with what you are planning to do. It is completely legal.
The procedure is as follows: a normal rental contract is drafted, with the only difference being that you would add a clause stating that after a period of time, the tenant would be able to make use of the purchase option which the parties fix at a value of xxx amount (property value). All money paid during the life of the rental contract, as rent, will be deducted from this sale price. You would also need to state the conditions under which this sale would take place (who pays the expenses, etc.), as in any purchase. The owner will most probably add that, in the event of not proceeding with the purchase during the agreed time, all funds received as rental income will be kept by the landlord.
If you need any help drafting this document please don't hesitate to contact us.