Buying Rental Properties with Tenants

Writing offers on rental properties with tenants in place require a little more attention to ensure that you get what you think you are getting when the closing is over. If you miss something or simply assume everything will be fine, you may get a rude awakening after closing.

Here is one real life example I heard about from one of my property management clients:   buyer put in an offer on a single family house in February and the seller accepted the offer. During that process, the buyer received copies of the lease and confirmed the rent amount.  They showed up at the closing to find out that the landlord had signed a new lease with the tenant in March, dropped her rent by $300 and let her use the damage deposit to cover the March rent when she was out of work.  This resulted in a much smaller amount of cash at closing, no damage deposit, and the need to have a delicate conversation with the tenant that the new owner be raising the rent $300 (and she needs to pay a new damage deposit).

Here are some tips on how to write your purchase agreement when buying investment properties with tenants in them. Most of these will take the form of an additional addendum on the purchase agreement:

• Write into the purchase agreement that the seller is not allowed to sign any new tenant leases with the existing tenants without written approval from the buyer. This would have fixed the above problem or at least have given the buyer more notice than 1 hour before closing.  This also applies to not allowing the seller to sign any lease extension without your written permission and review.
• Write in the amount of the security deposit and language that effectively says: “Seller will provide the buyer the security deposit in the amount of $xxxx at the closing in certified funds, regardless of the disposition of those funds between the tenant and seller, as long as tenant remains in the property”.  This prohibits the seller from making a last minute issue out of not having the deposit or allowing the tenant to consume it on past due rent.
• Make sure the seller understands that you want to be notified instantly of any tenant issues at the property, such as rent collection, notice to move out, or other problems. This can be especially important when dealing with short sales that can take months to close after you offer on the property.  I typically have a clause that says “seller will notify buyer within 24 hours of any changes….”
• If you have concerns about the rent amount or there is no lease, demand the seller has the tenant sign a simple piece of paper that confirms the lease terms.  This is often called an estoppel certificate.
• Add a clause the agreement that rent will be prorated to the date of the closing regardless of disposition of rent paid by tenant to seller.  I have seen several situations where the seller says:  “well the tenant didn’t pay me for this month so you will have to collect it from them, I don’t have the money to prorate”.  Nope.  That is their problem they did not collect.
• Never close at start or absolute end of month.  It is inevitable that the tenants won’t know about the closing and they will send the rent to the seller (old landlord), creating some challenge to get that money.  Or, if you close on the last day of the month, did the tenant already put the rent in the mail to the old landlord?  Close 5-10 days before the end of the month so you have time to notify the tenant and it is less likely that the seller has not collected rent for that month.
• Similar to not allowing the seller to sign any new agreements with tenants, write into the purchase agreement that they can not enter any other agreement such as new trash service, new lawn service, etc.
• Get copies of any utility bills that you might be responsible for during your inspection period so you can confirm what the costs really are.
• If you see any pets during your tour of the property, make sure to check if there is pet agreements and/or pet deposits.

Buying a rental properties with tenants in place takes some additional due diligence and purchase agreement language to insure that you get what you think you are getting.  Make sure to use a competent Realtor that sells investment properties on a regular basis.