Exploring the options

Large-scale developers often use property options to obtain the right to buy a property before a set future date for an agreed price, but smaller-scale investors can use property options slightly differently and enter into a rent-to-buy agreement.

With prices rising in various parts of the country, many families are years away from saving their first house deposit. Rent-to-buy schemes are an alternative to traditional lending, helping people get into the property market faster.

Andy Fermo is one investor who took advantage of this ‘outside the box’ approach to build a successful investment portfolio.

“A property option is essentially when you have an agreement with the vendor to purchase their property. I'll give them the price that they want and they’ll give me a timeframe,” Mr Fermo says.

Under an option arrangement, the buyer assumes control of the property but continues to act as a tenant. The buyer-tenant pays the vendor each month, partly for rent and partly for the option to buy the property in the future, he explains.

These option payments go towards building a deposit, which the buyer can use to apply for traditional finance when the option agreement expires. At this time, the vendor must honour the previously agreed sales price. However, if the buyer chooses to walk away from the deal, the sum of money that has already been saved is forfeited to the vendor.

The learning curve

When Mr Fermo first started out, property options were not on his radar. After leaving the army, he decided to follow his friends’ examples and buy negatively-geared properties via traditional financing.

“At the time, I wanted to invest in a house but I really didn't know how. I went with the flow with a couple of the other boys,” he says.

When the global financial crisis struck, Mr Fermo’s properties plummeted in value, to the point where he found himself in negative equity.

“The value of the houses I purchased was less than the loan was worth – like a lot of people at the time who were getting 95 per cent lends,” he says.

Selling the old-fashioned way meant losing money on the deal. Mr Fermo was faced with watching “all his hard work go down the drain”. Around this time, he discovered a property mentor who taught him to think differently about investing.

“You could transact property regardless of your skill level or financial situation. If you wanted to be able to invest in property, you didn't have to have a gazillion dollars to do it,” Mr Fermo says.

The “creative methods” advocated by his mentor piqued his interest and he decided to try them out for himself. He sold his properties in an option arrangement, allowing the buyer a long period of time to pay off a deposit.

Sometimes the traditional finance model doesn't quite fit someone's situation at the time

“Basically, my goal for that was to be able to on-sell them and be able to settle down the track and not owe the bank any money. The houses were so far underwater that I needed to just walk out and break even,” he says.

This method was so successful that Mr Fermo was inspired to pursue the strategy further. Three years and a dozen deals later, he has made property investment his full-time job.

Successful business foundations

Part of Mr Fermo’s strategy is buying from vendors looking to extricate themselves from their property.

“That's a quick way to build my portfolio – through people who no longer want their houses,” he says.

Generally, he is then able to on-sell the property, putting in place a new property option with the next buyer. In some cases, if the deal is not attractive to Mr Fermo, he may negotiate an arrangement between the vendor and a buyer better placed to benefit from it.

From Mr Fermo’s point of view, the major benefit of the strategy is leverage. If an investor has $50,000, they could use it to purchase one negatively geared property. However, through property option arrangements, they could put down $10,000 with five different vendors to get their foot in the door, he explains.

“For potential investors looking to use these strategies, you can leverage your money a lot better by being able to build your property portfolio quickly,” he says.

Mr Fermo sees himself as helping both the buyers and sellers achieve their aims.

“With vendors who don't want their houses any more, I get to relieve them of their debt burden or whatever it is they need to do. I help them move forwards,” he says.

On the other hand, buyers are able to gain a foothold in the market even without a large deposit. Instead of waiting several years to save a deposit, buyers can move in right away, even as house prices keep rising. Moreover, they can lock in a price years in advance.

“When it comes to home ownership, sometimes the traditional finance model doesn't quite fit someone's situation at the time,” Mr Fermo says.

“What we do is put a paperwork system in place that puts them in the best position down the track to be able to get traditional finance.”

In particular, young families, business owners and tradespeople favour this approach because they often lack the financial credentials to qualify for a bank loan.

“Sometimes they have the cash flow to prove it – a small business owner, for example – but the bank might say you don't have enough tax returns, or you need to prove your cash flow for a little bit longer,” he says.

While Mr Fermo also requests evidence that purchasers will be able to pay their obligations, he believes he is able to assess people’s financial capabilities on a more personal basis than a bank.

The last three years have not been all smooth sailing for Mr Fermo – one buyer was forced to pull out of an option deal after she lost her job.

“We mutually agreed the deal for the house would have been too much of a burden, so we both agreed to move on,” he says.

“If I have a buyer there and it looks all good on paper and they move in, I can't control whether that situation is going to change or whether they lose their job or the relationship breaks down. At the end of the day, you can only assess based on what you know at the time.”

In another case, he claims his buyer was still in the “renter mindset”. The buyer stopped paying, forcing Mr Fermo to take them to the Rental Bond Board to evict them. However, he says this is a risk that comes with any type of property investment.

“Unfortunately, that's one of the things you have to accept as an investor, whether it's using these strategies or not,” he says.

Ultimately, all investors must do their due diligence to ensure the deal stacks up and the area has strong growth potential.

“You might have an area that's stagnated, so it's going to be a low performing area no matter what property or strategy you have. If you try and on-sell the property it's not going to work as well,” Mr Fermo says.

Ultimately, Mr Fermo aims to build a business based on property options and vendor finance.

“For me, the reason I'm doing this is to make a dollar and have property investment as a tool that will ultimately create wealth for me,” he says.

His family, including his wife Claire and their infant son, are his major motivation.

“I have a young family,” he says. “I want to make sure there's food on the table.”