What about buying tenant occupied properties? If I’m interested in “buy and hold” wouldn’t that make more sense?
For an investor, buying rental properties with existing tenants can have many advantages. Due diligence by the prospective buyer is required to accurately assess the property’s performance, property condition, tenant lease agreements, tenant security deposits, and other existing terms and conditions that could have a material effect on the sale. You want to be able to write a purchase offer that protects you through escrow closing and beyond.
A benefit of purchasing an occupied property is that the sale is a package deal. The property comes with installed tenants; there is no rent-up time for units that are currently leased; and there could be instant cash flow. You may be able to more easily obtain lender financing since the true income for the property is known.
While existing tenants can be of considerable value to an incoming buyer/landlord, inheriting existing tenants can mean more liability for you unless adequate steps are taken to reduce risks. You must assess the risk from the perspective that existing tenants were qualified and selected under the seller/landlord’s rental standards. Those standards may be less stringent than what you will utilize for tenant screening after close of escrow. The potential exists for possible material lease defaults by a tenant that have not yet been disclosed or that could occur before close of escrow.
A change in ownership of the property does not negate the tenant’s lease agreement and its terms and conditions. You must honor the tenant’s existing lease agreement. Until the lease term ends or there is a negotiated modification of a lease term or condition with consent of all parties, the tenant’s existing lease remains in effect.
You should require certain written information from the seller before a purchase contract is drafted. In writing a good purchase contract that protects your interest, you should include adequate contingency clauses for disclosures and inspections. The seller should provide information regarding occupancy, vacancy rates, current rents, the terms of all of leases, termination dates of existing leases, and options for lease extensions and renewals of existing tenants. The documentation could be material factors in your decision to own the property for the price you will offer. You would in theory have legal recourse against the seller if the seller provides false or misleading information or does not provide you required information material to a sale.
Contingency clauses for inspections should include a physical inspection of the exterior building and related structural and mechanical systems. Inspection of the interior of rental unit(s) should be scheduled early in the due diligence period to determine the general physical condition of the unit(s). Existing conditions should be noted for damage, repair, or replacement. A copy of the tenant’s move-in checklist can confirm the condition of the unit at time of move-in. You will want to determine that the condition of the rental unit, if damaged, will be covered by the tenant’s security deposit upon the tenant’s move-out.
Your offer should require the seller to confirm that there are no lawsuits, regulatory agency actions, or other claims pending against the property related to previous or current tenants not previously disclosed in writing. You should require a warranty that the seller has complied with federal and state lead laws and other potential contaminants. The seller should be required to provide copies of required disclosure documents for existing tenants under federal, state, and local laws and any inspection reports related to possible contaminants. The contract should require that the seller provide copies of documentation related to complaints by other tenants, neighbors, and government agencies regarding any tenant.
The most important documentation regarding existing tenants includes the lease agreements; rental rules and regulations or other policy statements issued by the seller to tenants; rent payment histories; and application forms, screening reports, and move-in checklists. If the property currently has a resident manager, the employment contract and associated lease agreement as well as instructions and policy statements related to management should be requested. You should also require copies of leases and related documents and verify that the leases agree with information previously provided and contain adequate legal clauses and no illegal ones.
To help avoid potential after-closing problems, you should require Estoppel Certificates and make execution by all tenants a contingency in the purchase offer. The Estoppel Certificates should include information regarding current rents and the amount of the security deposit currently held by the seller.
Since you will be responsible for the accounting and return of tenant security deposits upon existing tenant move-out, the purchase offer contract and any subsequent escrow instructions should explicitly state that you as the buyer are to be credited with security deposits at closing. The seller should also be required to provide a signed letter at close of escrow notifying the tenants that the property has been sold to the named buyer.