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Be Careful When Inheriting a Tenant

by Ken Corsini on May 9, 2012 · 8 comments

  

With the extraordinary number of short sales and foreclosures over the last few years, many distressed properties are actually being purchased with the previous tenant still residing in the property. For many investors, the thought of avoiding up front rehab costs as well as the time and expense associated with finding a tenant adds to the appeal of this scenario. Admittedly, I too have been drawn to certain properties because of the prospect of inheriting a tenant, but I’ve also learned that buying a house with a “leftover tenant” is far from a slam dunk.

Let me first differentiate between inheriting a tenant from a distress sale and buying a turn-key investment property with a tenant already in place. We are in the business of selling turn-key properties to investors and as such, are also in the business of placing tenants into our properties once our rehab has been completed. We do an extremely thorough job researching background, credit, income, etc. before placing somebody into one of our homes. The properties that are purchased through a turn-key company like ours come with highly qualified tenants already in place.

However, unlike purchasing from a turn-key company, a tenant that resides in a property during a distress sale may not be of the caliber an investor might expect. If the house was in a foreclosure, it may be that the tenant has been living in the house for months without paying rent. In the case of a short sale, you have to wonder why the previous investor couldn’t keep up with the mortgage payment if the tenant was paying on time.  In either case, trying to determine the tenant’s true payment history will probably be close to impossible.

Any potential investment should be measured on its own without the benefit of having a tenant already in place. While it is possible to buy a distressed property with an excellent tenant in place, this is typically the exception, not the rule. I strongly believe that an investor should always plan for the expenses associated with rehabbing and leasing the property – regardless of whether or not the existing tenant wants to stay in the property (and I’d even consider adding in the expense of an eviction should the tenant not work out).

For the investor that does purchase a distressed property with an existing tenant, I would recommend doing the following PRIOR to closing:

  • Ask the existing tenant to fill out an application that would allow you to obtain background, credit and proof of income.
  • Sign a new lease with your terms.
  • Determine where the previous security deposit is. If it is not obtainable, work with the tenant to acquire some sort of reasonable security deposit from them.

Buying a property with a tenant and cashflow already in place can be a great thing! However, an investor who is presented with this type of opportunity needs to be careful to still do their due diligence on the property itself as well as the tenant before getting enticed into a bad situation. A smart investor will hope for the best, but always calculate his/her numbers based on the worst (which is often the reality).

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{ 8 comments… read them below or add one }

Kevin Yeats May 9, 2012 at 1:00 pm

Ken, I like this overview but one part confused me … the security deposit.

Certainly, it is possible the the seller has “used” the security deposit for “other purposes” or that the funds are otherwise unavailable. If I were a tenant and the new property owner approached me to pay a “second” security deposit, I certainly would say “No” (politely) but I would also wonder if I had a chance of losing that deposit in the legal paper shuffle.

How would you handle both situations?

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Sharon Vornholt May 9, 2012 at 2:19 pm

That is great advice Ken. It’s always best if you can choose you own tenant. At any rate, I completely agree with requalifying them and having them sign another lease.

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Ziv Magen May 9, 2012 at 6:28 pm

Great and true advice. With the influx of in-place tenants and “rent guarantee” schemes rife at the moment, it’s very easy to be blidned by the promising numbers you’ll be getting for the next few months or even years, completely ignoring research, area trends, and the fact that a tenant in the house today means absolutely squat for tomorrow.
Know the area you purchase in well, be certain about the state of your property, and you can all but ignore the existence or non-existence of tenants at purchase time, in my opinion.

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Elma May 9, 2012 at 7:04 pm

This is a great article. Thank you very much for the idea very helpful. Thanks for sharing. I appreciate it.

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Chris Clothier May 13, 2012 at 6:40 pm

Ken –

Fantastic topic to cover and really, really good article. I cannot tell you the number of problems I ran into early on as an investor when I purchased properties from other landlords that were already “performing”. None of the experiences were pretty. I especially like the fact that you differentiated between a turn-key property and a distressed sale property.

I would also add though that not every turn-key opportunity is of the caliber that you offer so your advice of doing great due-diligence is much appreciated. Regardless, always know who and what you are purchasing before buying.

Chris

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Melissa Woycechowsky May 14, 2012 at 5:48 am

I prefer to put my own tenants into properties – like you said, if they have been paying their rent then why is the owner selling? Also, having a tenant in the unit makes it much easier to hide defects. You just can’t inspect an inhabited unit the same way you can a vacant one. With few exceptions I advise my clients to take their rental purchases vacant.

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Greg Brister May 18, 2012 at 10:01 pm

Also, be aware of any unwritten, understood, agreements the present landlord and tenant have. Some LL will make promises to the tenant on your behalf that you will do “this” once the sale is done. However, you know nothing about “this” and you cannot understand why the tenant is being hard to get along with.

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Scott Shapiro July 12, 2012 at 12:13 pm

Great article! Can someone dive into the issue of refinancing the investment property when occupied by a leftover tenant? For instance, I buy a single family home below market value, with a leftover tenant paying $1000 rent. I use private money to purchase and do some minor work to the home. Will I have trouble getting a good appraisal for refinancing if I can’t complete a full gut rehab because the tenant still lives there? Would you recommend trying to update the kitchen and bath while the tenant is there so the appraisal comes back high enough to refinance the private lender out?

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