When Landlords Buy Tenant Occupied Properties
When Landlords Buy Tenant Occupied Properties.
Existing tenants in rental property that is being considered for purchase can be either assets or liabilities.
The most obvious benefit is having no rent-up time for any units that are currently leased. A related secondary benefit is that obtaining financing may be easier because the lender knows what the true rental income is for the property rather than having to depend on the borrower’s projections, possibly overly optimistic, or do extensive market research of its own.
However, inheriting existing tenants can also mean more risks unless the buyer takes adequate steps to know exactly what he/she is getting. In this short article we’ll briefly discuss a few of the issues.
Some potential risks are minimized by (1) actions prior to making an offer, (2) writing a good purchase offer contract, (3) adequately analyzing accounting records and lease documentation during the due diligence period, (4) verifying the condition of the unit interiors as early as possible, and (5) corresponding with the tenants immediately following close of escrow. We will discuss these items only as they relate to the existing tenants.
Pre-Offer Tasks
If possible, require certain written information prior to even writing a purchase contract. In addition to knowing the current rents and the lengths of existing leases, this should increased, tenancies terminate, and introduction of the buyer’s own lease agreement can be important to current value and future operations. It is particularly important to know such information for commercial properties before deciding on the price to offer, because multi-year options are almost always part of commercial lease agreements, while only occasionally seen in residential agreements.
Writing a Good Purchase Contract
In general, the most important issues related to a good purchase contract is that it contain requests for copies of all relevant documentation and adequate contingency clauses related to all issues that are material factors in a buyer’s decision of whether to own the property for the price that will be offered.
Regarding existing tenants, the most important documentation includes lease agreements: Rules & 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. It 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.
It is recommended that there be contingency related to inspection of units early in the due diligence period, not only to determine general interior physical conditions, but to also ascertain that there are not damages that could not be reimbursed from existing security deposits – hence the need for move-in checklists.
The 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 about any tenant.
Avoid potential after-closing problems by utilizing Estoppel Certificates and making execution by all tenants a contingency. Although often not utilized unless required by the lender, as they usually are for lager properties, Estoppel Certificates should be used for every purchase of a tenant occupied property. An Estoppel certificate is a document signed by a tenant that, among other things (1) affirms the lease documents (attached to Certificate) and the deposit/rent amounts: (2) confirms that there are no agreements outside of the attached documents; and (3) confirms the amount of security deposit, the current rent, and the date to which rent has been paid. The document is sometimes called a Certificate of No Defense. In addition to verifying information provided by the seller, the Estoppel Certificate “stops” the tenant from making claims regarding the included issues after close of escrow.
If closing is delayed, it might be necessary to get updated amendments to the certificates to cover rents collected since the previous versions were executed or because of certain other special changes in circumstances, including amended or new leases.
Although the buyer would theoretically have legal recourse against the seller if he/she had been provided false information or not been provided “material” information, doing anything about it might take years. It might even be impossible, for example if the seller moved to Switzerland immediately after closing escrow.
Escrow Issues
Since the buyer will be responsible for returning all or part of security deposits when the existing tenants leave, the purchase offer contract (and any subsequent escrow instructions) should explicitly state that the buyer is to be credited with security deposits at closing. The seller should also be required to provide a signed letter at close of escrow informing the tenants that the property has been sold to the named buyer.
After Closing
A buyer should correspond with the tenants immediately following close of escrow. A copy of the letter from seller mentioned above should be attached to a letter from the buyer. The buyer’s letter should confirm being the buyer, instruct the tenants where to pay their next rent and how to contact the new landlord, inform them that he/she and /or his/her vendor will be making a detailed inspection in the near future (with reasonable notice) to check for maintenance problems, and request them to report any problems of which they are aware. If the previous owner utilized Rules & Regulations and the buyer wishes to change them as would be allowed under the lease agreements and general lease agreement legal principles, the new Rules & Regulations could also be included. the new landlord can also affirm that he/she is a “Fair Housing” landlord.