Buying Investment Properties with Existing Tenants
As a buy and hold investor, tenants are the lifeblood of my business. They pay our bills plus give us a little extra to put food on our table and gas in the car. There are many tenant horror stories out there, but most of these can be avoided with proper tenant screening techniques and a strong lease.
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We generally like to buy vacant distressed properties. But sometimes we also buy properties that are not distressed and have existing tenants in them. These are tenants that have not been though our screening process and are not under our lease and thus can pose a risk. What should you know about buying a property with existing tenants?
The first thing you should know is that the existing tenants have rights. You as the new owner cannot modify their lease without the tenant’s consent. That means you cannot kick them out six months into a year lease. Nor, can you raise their rent. Plus you have to honor what ever other clauses or agreements are in the lease. Basically, the lease stays in place and a change in ownership (except foreclosure) does not void it.
Inheriting Tenants: Both Good and Bad
Existing tenant’s can be both good and bad. On the good side, you can purchase a property with paying tenants. This should mean instant cash flow to you, without the hassle of finding and screening new tenants.
On the negative side you could be stuck with some rotten eggs. The seller could have loaded up the property with anyone who could fog a mirror to claim “100%” occupancy. Or, several of the tenants may not have paid the rent in a while and the seller just wants out.
You as the buyer can protect yourself several ways. Get copies of all leases and agreements as part of your purchase contract. Review and approve them before you close. Search for the tenant’s names on various databases to see what appears. Do not pull their credit reports, you do not have that permission unless it is specifically granted by the tenant to you in writing!
Next, review the property’s income and expense statement for the past two years. This review should give you a pretty good idea of what is going on and if you have any deadbeats.
What If There Are No Leases?
Finally, if there are no written leases (or even if there are), use a one page estoppel agreement. An estoppel agreement is a short legal form that outlines contractual terms. Get every tenant to fill one out, detailing the amount of rent paid, the amount of the security deposit, term of tenancy, which appliances are theirs and if there are any other special agreements. Get each tenant and the seller to sign and date each one. This agreement will protect you and clarify the property’s financial condition. But it can also serve another role as we shall see.
From the tenant’s perspective you need to understand that the sale of a property equals change. People generally do not like change, especially existing tenants. All kinds of things will be going through their heads. “Am I going to get kicked out?” “Is my rent going to go up?” “Will the new landlord be a jerk?”
You can make the sales and ownership transition process a lot easier on yourself if you do some legwork upfront and immediately upon the sale. Talk with the tenants if you can (get permission from the owner first). Use the estoppel agreement as an excuse. Sit down with the tenant and help them fill it out. Explain who you are, what you do and what your plans are. Explain that all existing leases will be upheld.
Upon closing, have an info packet ready for the tenants. In this packet provide your contact information, what to do if there is an emergency or a repair and explain when, where and how they should pay the rent. See that each tenant gets a packet as soon as possible after the sale closes.
So there you have it, what you should know about buying a property with existing tenants. It is not as easy as buying distressed properties without tenants, but with a little effort the sailing can be made as smooth as possible.
Photo: Éole Wind