What are some of the risks in buying occupied rental property?
When purchasing an occupied property, the buyer has a risk of potential material lease defaults from the existing tenants. The inherited tenants were qualified and selected under the seller’s rental standards. Those rental standards may or may not be adequate for the buyer’s business model.
Although the buyer will conduct due diligence to determine his purchase offer, there is still the potential of unknown risks. A buyer should request the seller to provide information regarding occupancy, vacancy rates, current rents and termination dates of existing leases, and options for lease extensions and renewals of existing tenants. To protect his business interests, a buyer should require the seller to provide copies of all relevant documentation related to all issues that are material factors in the buyer’s decision to own the property for the price that will be offered. The buyer theoretically would have legal recourse against the seller if the seller provides false or misleading information or does not provide information material to the sale.
A buyer must take into consideration the issue of the existing tenants’ rights. The sale of a rental property does not terminate a tenant’s lease. The lease agreement between landlord and tenant is a legal contract that is attached to the property. A change in ownership of the property does not negate the tenant’s lease agreement and its terms and conditions. The new buyer 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.
There should be a buyer contingency clause for inspections, including a physical inspection of the exterior building and related structural and mechanical systems. Inspection of the interior of the rental unit should be done to determine the general physical condition of the units. 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. A buyer 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.
The buyer’s offer should require that the seller 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 and require a warranty that the seller has complied with federal and state lead laws and other potential contaminants. It should require that the seller 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; security deposits, 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. The buyer should also require copies of leases and related documents and verify that leases agree with information previously provided and contain adequate legal clauses and no illegal ones.