A rent-to-buy contract let’s you enjoy a Spanish property now, whilst leaving the door open for purchasing later, if house prices continue to fall in Spain (as most people expect them to!).
By Raymundo Larraín Nesbitt
Lawyer – Abogado
8th of April 2012
Original article from 5th November 2.009
It has become Spain’s favourite sport to second-guess on when the real estate market will pick up again. Reputed experts, both national and foreign, are jumping in giving all sort of contradicting timelines for its recovery i.e. 2014, 2017 and the most pessimistic ones on 2020. Although it may be fun to indulge on 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. Property prices are now cheap but who is to say they won’t be cheaper next year or even the year after?
As appealing an amusement as may be, I believe it is impractical and rather sterile for most would-be buyers who are now sitting on the sidelines waiting for events to unfold, as in hindsight very few people call the market bottom correctly and most miss out on a lifetime opportunity to snatch a bargain in the dip.
These potential buyers who are now sitting on the fence musing over how much lower house prices can fall may in fact already – unbeknownst to them – profit from today’s market turmoil. A rent-to-buy 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. In this article I will show you how to take advantage of today’s market uncertainty turning it around in your favour.
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 quite a while until it picks up again. So it may be worthwhile playing it smart following this rent-to-own option, jumping in today at tomorrow’s prices.
What is a Let-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 given deadline normally spanning 2 to 5 years. The main advantage is that the full let is discounted from the final purchase price. So if you finally opt to buy the property within the deadline, the paid rent (rental premium) will be deducted in full from the pre-agreed sales figure. Alternatively, should you choose not to, you can simply walk away and move on.
This contract has multiple advantages for both grantor and grantee in the context of a deflationary environment – such as the current one –. If you are of the opinion that property prices in Spain will be falling steadily over the next years, rent to buy will appeal to you.
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 is your choice. This lack of commitment actually enables you to be on the prowl looking out for other opportunities without being tied down.
As written in the definition, 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.
The pre-agreed price of the property stipulated within the contract is normally well below the current market price so as to provide a reasonable incentive to prospective buyers. A markdown varies from contract to contract, but in my opinion should span 20 to 30 per cent discount on current sales prices to warrant signing it. This helps to offset 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. By the same token, should property prices rise again, the pre-agreed price is respected. Win-win.
It allows you the opportunity to scout the area and know your neighbours well before you move in for the kill (commit to purchase). Did you know your next door neighbour may be a local DJ playing music late into the night? Well you could have easily avoided all those sleepless nights if you had first rented the property rather than buying it outright. When you are a foreigner it is important you carefully choose an area where you can blend in nicely. For example, not all areas are family friendly, so it may take a while until you find one that ticks all the right boxes.
If you are still based abroad, and find yourself constantly commuting to Spain, this contract is a great option as it gives you freedom and you only commit if you decide so. No strings attached.
You may freely agree on the time frame to exercise the purchase option tailoring it to suit your needs. Normally they span 2 to 5 years but can agree elsewise.
In some contracts you may assign the option to buy. This allows for even greater flexibility as the would-be buyer can sell on the right to a third party allowing for a speculative angle.
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 18%. Buying off-plan freehold property has currently set a VAT of 8%. You are entitled to claim back the difference only if you exercise the option to buy from a developer. It is advisable there is a clause specifically 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 at the present time you may qualify in a few years’ time when the credit market ease’s up again. Currently lenders in Spain are focusing on lending only against properties they own (because they are desperate to get rid of them).
If the property is within a Community of Owners you may come to know of internal problems which are non–apparent. You may possibly never have come to knowledge of these quirks unless you had gone through the hassle of leasing the property first. 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. I advise lodging this contract before the Land Registry.
For the option grantor
The advantages are self-evident. Foremost you actually have a tenant who is foremost interested in buying the property not just in renting it out, avoiding pesky 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 normally ensure 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. It’s a win-win.
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 currency exchange rate fluctuations 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 bringing it 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 a sign of a serious commitment on behalf of the potential buyer.
The main disadvantage is that these contracts last typically 2 to 5 years and in the interim the landlord’s financial circumstances may change – for the worse – i.e. if the property has a mortgage loan taken against it and the landlord defaults, it may lead to a full-blown repossession procedure. You would still have a right to let the property if it’s repossessed, as the lender must respect long-term tenants, 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. But truth be said, lenders are showing themselves very flexible with properties they own allowing for plenty of room to negotiate. It is a buyer’s market after all and they are unlikely to let go easily of a potential buyer caving in where necessary to secure the sale.
Buyers prefer long-term options to build up equity and in the interim keep an eye on where the property market will be heading next. Short-term options appeal to vendors but on doing so 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. At the end of the day concessions will have to be made by both parties.
An important problem to consider is committing yourself on a pre-agreed price that on the long run, despite the hefty built-in discount acting as an incentive, 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; what could you have done with the rental money if you hadn’t signed this contract? At no time are you forced to buy the property but you will of course forfeit – in full – the paid rental (opportunity cost) negating the main advantage of pursuing a let-to-buy. If you are of the – gloomy – opinion that property prices will be cheaper in five years’ time, you may want to hold out a little longer until you sign a rent to buy contract.
For the option grantor
From the grantor’s perspective it’s that you are letting your Spanish 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 – and costs! – on having the non-paying tenant removed from your property.
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 springing out of the woodwork knocking at your door… Although it may sound unrealistic given today’s bleak outlook, should the market pick up again this is bound to happen and must be carefully weighed in. By accepting a rent-to-buy contract you are implicitly gambling the market will remain depressed for the next years. It makes no sense whatsoever to grant this option if you expect the market to rebound in a couple of years.
It goes without saying you will have to carry out a thorough screening procedure on potential candidates weeding out unsuitable profiles (bad debtor´s list). Fortunately you can now rely on external databases, such as FIM’s, which can greatly assist you eliminating professional non-paying tenants that abuse Spain’s legal system.
Rent-to-own 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 market turmoil. On following it, you will simultaneously retain a certain degree of freedom should either your personal circumstances – or the markets’ – 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 picks up again in “X” years’ time (take your pick), 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 uncertainty which drives landlords and developers to offer this type of contract that may benefit both them and the would-be buyer (option holder).
Those who are resolute on buying a cheap property, which has already a pre-agreed significant built-in 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 property market will be heading next. Might as well leave all the guessing-work to experts throwing darts, however fun it may be, and just play your cards right. Mind you, these “confounded” experts do seem to always get it right… in hindsight.
And to close this article, I recommend you hire a registered Spanish lawyer to either draft this contract or else to review an existing one (if it’s the case) so as to avoid rash decisions that may lead you to future losses.
Remember: only because a contract is labelled as a “let to buy” it doesn’t automatically qualify it as a good deal (it could very well be a raw deal); especially if the built-in discount is not high enough to offset the risk of prices decreasing over the next years – very likely.
“All that glitters is not gold” – Aesop.
Ancient Greek fabulist or story teller.
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