#164 Winter 2010-11 — TOD

Can Lease-Purchase Save Us?

As developers struggle to find buyers for rehabbed affordable homes, many are looking to a lease-purchase model to expand the pool of potential owners. But lease-purchase is far more complicated than just an end-run around the credit crunch.

Albany CLT

Three historic row houses rehabbed by the Albany Community Land Trust. The middle one is a lease-purchase property.

“We can’t afford to keep a rehabbed home vacant.”

Susan Cotner, director of the Albany Community Land Trust, sums up a problem increasingly facing affordable housing developers and local governments who have stepped up to try to respond to the epidemic of foreclosed vacant buildings over the past couple years.

Holding costs for an unsold house have been difficult to absorb even in better times. Enter a flood of Neighborhood Stabilization Program (NSP) money focused on acquiring and rehabbing properties; a still-worsening economy that is leaving households less able to buy and less interested in buying, especially in marginal neighborhoods; and a severely tightened credit market and more people with damaged credit limiting the pool of qualified buyers.

The result? Houses that aren’t selling and organizations that are slowing down their acquisition and rehab out of fear that they’ll be burdened with unsold properties. And yet neighborhood stabilization depends on getting these homes occupied.

Many see lease-purchase, where not-quite-mortgage-ready buyers occupy the house they intend to buy as a tenant until they are fully mortgage-ready, as a way out of this bind. “Lease-purchase provides an alternative or ‘plan B’ rather than let completed homes sit vacant or going to rental,” explains David Cramer, a consultant who conducts NeighborWorks America’s lease-purchase training module and wrote a lease-purchase toolkit for HUD’s NSP Web site.

Indeed, early on it seemed like nearly every local plan to address vacant foreclosures started with a description of a for-sale approach and ended with “and we’ll probably include some lease-purchase in there.”

Not So Simple

Lease-purchase is not a new concept, but it has been fairly rare for a long time, in large part because it is not easy. Unfortunately, when it’s approached as plan B by an organization under duress, the level of planning and capacity needed to make a successful program is often not in place.

“Many nonprofits and local government sponsors are ‘backing into’ lease-purchase as they fail to sell completed properties,” says Cramer. “Too often lease-purchase is attempted without a program design or much planning — just occupy with a renter with the hope that they will eventually buy.”

Leaders of some of the few long-term lease-purchase programs in the country all say treating lease-purchase as merely a delayed version of a traditional for-sale homeownership program is a very bad idea.

Bill Goldsmith, now president of Mercy Housing Inc. in Chicago, and Cindy Holler recently wrote a white paper about the lessons they learned on the way to developing what became a successful lease-purchase program at a faith-based CDC called New Cities in Chicago’s southern suburbs. New Cities was formed by its member churches in 1989 expressly to deal with a single-family home foreclosure crisis. “New Cities did a lot of great things, but our initial trial at lease to purchase was not one of them,” wrote Goldsmith and Holler. “Although it took almost 10 years, over half of these 60 homes [from the original trial] eventually failed as lease to purchase properties and were sold at a significant loss [to the organization] to local speculators.”

Goldsmith and Holler say that several things sunk their first trial: They didn’t screen or coach their buyers sufficiently, leading to participants with not enough capacity for or commitment to homeownership. The homes were bare-bones rehabs in struggling neighborhoods, meaning that families were less committed to or excited about buying them. And they were trying to take on what was essentially scattered-site single-family property management (“the hardest kind of rental”) with no particular capacity or infrastructure for it.

Cleveland Housing Network, now known for its long-standing lease-purchase model using Low-Income Housing Tax Credits, also abandoned short-term lease-purchase early on. “Our short-term lease-purchase program was all of one year long,” says CHN executive director Rob Curry. “We just didn’t have enough people taking title. Someone who is making a decision to purchase a home [is] most motivated to get all their ducks in alignment before they move in. After they move in, the motivation is not as clear.”

CHN’s current lease-purchase model is a significantly different animal than typical short-term lease-purchase arrangements. It gives tenants in CHN LITHC properties the option to buy their unit at a very low price after the 15-year LITHC eligibility period expires. The timeframe is associated with the property, not the tenancy — two-thirds of buyers are not the original tenants. The program has been highly successful, with 95 percent of tenants making the transition, but because of its long-term tax-credit-based financing, it’s not an option that can be adopted by those looking for an alternative exit strategy for already-developed homes they can’t sell.

What’s the Goal?

There are two major goals of a short-term lease-purchase program. One is to allow promising homebuyers who aren’t quite mortgage ready, usually because of credit problems, a chance at homeownership anyway, while getting to live in the house they will buy. “Every one else has told them: ‘Your credit sucks [and] you have to wait two to four years,’” says Staci Horwitz of City of Lakes Community Land Trust in Minneapolis. “They want the home; they want homeownership. I have yet to encounter a buyer who wants to be contract for deed long term.”

The other goal is to stabilize neighborhoods by quickly occupying homes for which it is difficult to find a traditional buyer. “Our primary goal is ‘lights on, grass mowed’ for these neighborhoods,” says Catherine Godschalk of Self-Help Federal Credit Union, which has developed a credit-enhanced lease-purchase mortgage product that is offered to organizations and then assumed by the families when they are ready (see sidebar, “The Self-Help Model,” below).

Most lease-purchase programs are trying to achieve both goals, but the extent to which they prioritize one or the other affects how their programs are designed — and how they define success.

A Homeownership Assist

A focus on the transition to homeownership tends to result in a program with a focus on homes in stronger markets, strict screening guidelines, aggressive financial counseling requirements, and an emphasis on buyers taking on all homeowner responsibilities from the start. In these programs, if you don’t make it to purchase within a certain time frame, another household is given a chance instead.

In its second lease-purchase iteration, for example, New Cities required a six-session homeownership training course for all potential participants, followed by an ongoing intensive financial counseling program with three tiers, or “buckets,” for participants with different distances to go to become mortgage-ready. Failure to attend one of the sessions was a breach of the lease.

Project Reclaim, the lease-purchase program created by City of Lakes CLT, developer Urban Homeworks, and social service agency Lutheran Social Services (LSS), is taking a similarly active approach. LSS’s role is to focus on the credit enhancement work, with quarterly reports to the other partners. If other warning signs crop up, such as lease payments not being made to CLCLT, they’ll consult with each other to intervene.

One of the most important pieces is the counseling and follow up, says Horwitz. “It’s not going to be knocking on the door in two years and saying ‘Are you ready to refinance?’ It’s partners holding each other accountable so we don’t get to time to refinance and find ourselves in a world of hurt because we didn’t know what was going on our homeowners’ lives.”

New Cities and Project Reclaim also both made homeowners responsible for all aspects of maintenance, including major systems. “It was their home; New Cities was merely carrying the paper for them,” write Goldsmith and Holler. “We want them to have the experience of full homeownership,” says Horwitz. “We’re not going to do maintenance for you.”

Stabilization First

But what if simply an occupied home is more important in a struggling neighborhood than an owner-occupied home? For Self-Help, “success is occupied, responsibly owned, and maintained units,” says Godschalk. “The secondary goal is homeownership.”

Albany Community Land Trust in Albany, N.Y., has been offering a lease-purchase option for 20 years. They’ve sold 28 buildings through lease-purchase, nearly 90 percent of their total sales. But many other tenant-purchasers have lingered on in the program for years without buying. And no one’s quite sure that’s a bad thing.

“These are neighborhoods where people wouldn’t buy if they were mortgage ready,” says ACLT volunteer Louise McNeilly, who has worked with community development groups in Albany’s low-income neighborhoods for many years. “It was our option to entice people in. Our goal of selling these houses isn’t at 100 percent, but our other goal — stabilizing them? We’re there.”

“It’s a fantastic model for long-term property management,” adds Susan Cotner, ACLT’s director. “You get fantastic tenants who think they own the house. They tell their friends they’ve bought a house. They step up to the maintenance, even if they don’t necessarily step up to the financial steps.”

Though ACLT has been constantly adapting its screening procedures and budget counseling offerings, it still does not employ rigid credit score and debt-to-income ratio requirements, focusing instead on a broad guideline of “could be credit ready within a year,” and more subjective things like prospective tenants’ reactions to a tour of the house. “Are they willing to get up on the roof and clear the leaves out of the gutter?” says McNeilly.

ACLT has one lease-purchase tenant who has been in the program for 15 years. When she moved in, her husband was just coming out of jail. Now they are stable, active participants in the community, with a beautifully maintained property. At this point, the only reason she isn’t buying is that her income is too high to qualify for a subsidy; since ACLT needs to overinvest in houses in the weak-market neighborhoods they work in, the cost would be more than the house’s market value: not worth it for the tenant if there’s no subsidy to cover the gap.

“A funding agency would say in this case, ‘You failed,’” notes Roger Markovics, an ACLT board member who helped found the organization. Instead, chimes in Cotner, “I think we should feel good about that kind of tenure.”

John O’Callaghan, the executive director of the Atlanta Neighborhood Development Partnership, Inc., one of the first organizations to use Self-Help’s lease-purchase product, says their first goal is to sell homes, but they have to be realistic. “In metro Atlanta, many neighborhoods that had an appropriate balance of homeownership and single-family rental have now tipped to more rental and would be best served by a new homeowner,” he says. “That said, there’s not much credit and there’s job loss. And getting a good renter in there is, in my opinion, a major asset to the neighborhood. If during this transitional process, we’ve got good renters and there’s not a backlog of people who could meet that need for homeownership, we’re renewing those lease terms [for lease-purchase tenants]. It’s something we have to constantly reevaluate.”

The Property Management Question

As soon as you get into the prospect of long-term ownership, you need to address the question of property management.

ACLT, for example, retains responsibility for “major repairs,” even though lease-purchase tenants take on much more than ordinary tenants. In addition, ACLT has resorted to a “plan C” of conventional low-income rental for some properties where the lease-purchases repeatedly did not work. Between these two sets of responsibilities, long-term property management, which was never its mission, has become a large portion of what it does, and it has put a strain on the group’s time and resources — enough that it has slowed the process of taking on new properties so as not to get further overloaded.

O’Callaghan knows ANDP will have to face the same question as it moves beyond their small pilot project to more NSP-funded lease-purchase work. “We as an organization are grappling with the question of whether we can manage long-term rental at scale,” he says. “We’ve decided that we need to learn to do that, because others aren’t.”

Given the continuing turbulence in the economy, Godschalk thinks that even programs with a primary focus on the homeownership transition need to be thinking about property management capacity. “To the extent that [participants] aren’t qualifying because of damaged credit, but they have an income, great,” she says. “But we can’t ignore that there are other drivers in these neighborhoods,” like job loss.

Though Self-Help’s lease-purchase mortgage requires participating organizations to use certain eligibility criteria to ensure that lease-purchase tenants are good candidates to eventually buy, Godschalk still underwrites Self-Help’s lease-purchase product as if the borrowing organization were doing rental development, and she requires them to show a property management plan. “I’ve talked with a lot of groups who are seeing lease-purchase as a product to facilitate the sale of a home,” she says. “I’m not comfortable with that. They need to be prepared to be the long-term owner of these properties. If they can get buyers to a sale in 18 months, that’s great, but I’m not counting on that. I’m assuming it’s going to be harder and harder for these tenant-purchasers.”

The city of Chicago is taking this kind of dynamic to heart: instead of trying to create a lease-purchase program that is a subset of for-sale approaches, they are coming at it from the other direction: They are first exploring ways to create a to-scale scattered-site rental program, clustering nearby groups of one- to four-unit buildings for coordinated management. Then, they figure, lease-purchase will actually be a subset of that rental program. “If some of them do become long-term rentals, we want to make sure that they are well managed,” explains Katie Ludwig, assistant commissioner of Chicago’s Department of Community Development.

Given the economic climate and state of the housing market, it seems likely that the coming few years will see an expansion of, and experimentation with, lease-purchase programs. If they are afterthoughts, they are likely to merely put off problems, or create new ones. But if their sponsors understand what it takes to balance homeownership and stabilization goals — and are ready to do both — they could be a powerful tool.

“There’s such a need,” says Atlanta’s O’Callaghan. “I think lease-purchase is a going to be a big solution to the foreclosure crisis. We just have to figure out how to make it work.”


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