Issues To Consider When Buying/Selling Multi-Unit Residential Income Property

When purchasing a multi-unit [tag]residential property[/tag], there are additional items that must be addressed at settlement that are not routine in typical residential transactions. For this very reason, it is essential to ask your [tag]real estate agent[/tag] if he/she has significant experience in handling multi-unit properties (I would also strongly suggest that you involve a [tag]real estate attorney[/tag] in these transactions). It is imperative that you create a pre-draft checklist that you bring to settlement in order to be certain that all issues have been resolved at the closing table. Here is a list of just some of the matters that you will have to concern yourself with, whether you are a buyer or seller of multi-unit residential properties:

1. Assignment of Lease – Typically, an assignment of lease is utilized for a commercial property when a tenant wants to vacate his/her respective lease by assigning the terms to a new tenant. In the residential context, an assignment of lease is needed in order to extinguish the seller/landlord’s interest in the security deposit, pre-paid rent and future rent payments under the lease. Both the buyer and seller benefit from having this document executed–the buyer is assured that he/she will be solely entitled to the future rent payments of the tenants and the seller is freeing himself/herself up of all future responsibilities for maintaining the property under the [tag]tenant[/tag] leases.
2. Pro-Rated [tag]Rent[/tag]/Transfer of [tag]Security Deposit[/tag] – The buyer is entitled to pro-rated rent from the date of settlement through the end of that particular month as the new owner/landlord of the property. If the settlement takes place on January 14th, then the buyer is entitled to a pro-rated share of the rent through January 31st (assuming the January rent payment was due on January 1st). It is also necessary that the tenants’ security deposits being held in escrow by the seller along with last month’s rent, if any, are transferred to the buyer at closing. The buyer will now be responsible for opening up a new bank account to hold the security deposit and other monies. If the lender gives prior approval, it is possible that the pro-rated rent and security deposits may be reflected on the settlement statement and transferred to buyer from the seller’s proceeds on the sale. If the lender will not allow for the monies to be handled in this manner, then the seller can issue separate checks “outside of closing” to buyer for the amount required.
3. Notice To [tag]Tenants[/tag] – Prior to settlement, a buyer should review all tenant leases that are going to be assigned to him/her upon settlement; check to see if there are any required notices to the tenants or other actions that must be taken by either seller or buyer with respect to the tenants upon sale of the property. For example, most leases require the seller to provide notice to all tenants that their security deposits have been transferred to the buyer and must provide an address of where future rent payments are to be sent. Buyers should also determine when the tenants’ leases expire and if there are automatic renewal terms built into the lease.
4. Real Estate Transfer Tax– Multi-unit properties are generally purchased for [tag]investment[/tag] purposes. However, I have often seen instances where a buyer will rush into an Agreement of Sale before setting up a business entity (such as an LLC or corporation) and obtain title of a new property as an individual. After the fact, the buyer decides that he/she wants to transfer the property to an LLC or S-corp. Most states will require an individual to pay real estate transfer tax upon transferring a property to an entity owned by that individual. Therefore, the person ends up paying the transfer tax once at settlement and AGAIN when the property is transferred to the LLC or S-Corp!! Before you make that extremely costly mistake, make sure you decide prior to closing whether or not you intend to hold title in your name or in the name of an entity that is legally formed before settlement.

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.