Buying an investment property always means calculating the expected return and evaluating the potential risk. Running the numbers is one way we investors calculate our expected return and attempt to evaluate risk. When buying an investment property with existing tenants, the tenants are one of those risk factors. Most tenants will be prompt paying, honest and respectful of other’s property. But we all know there are some bad eggs out there. So how can you reduce your exposure to this tenant risk? You can use an estoppel agreement.
According to The Free Dictionary, Estoppel means “A legal principle that bars a party from denying or alleging a certain fact owing to that party’s previous conduct, allegation, or denial.”
What that means to us landlords is that we get our potential future tenants to spell things out on the front end before we purchase by filling out an estoppel agreement, thus preventing them from claiming different circumstances down the road.
What Should An Estoppel Agreement Include?
An estoppel agreement should reiterate the terms of the lease currently in effect, but at the very minimum should describe:
- Names of all tenants and occupants in the unit
- Lease term with both start and end dates
- Rental payment amount and when it is due
- Security deposit amount
- Who pays utilities
- Who owns the appliances
- If there are any pets
- If there are any problems or repairs needed
- If there are any other agreements with the landlord
The tenant should fill out the Estoppel Certificate, and both the seller and tenant(s) should sign the agreement before you buy the property. This important step should be close to the top of the list on your Due Diligence Checklist. You want to know what you are getting in to, before you travel down that road for too long. Once you review and sign it yourself, you should provide the tenant with a copy for their records.
Why Should I Have Tenants Fill Out An Estoppel Agreement?
You now have a legal document that will prevent the tenant from claiming something against you after the deal has closed. For example, tenant claims such as “I paid 6 months rent in advance,” or “My security deposit was $1,000 not $500,” or “I own those window AC units and I am taking them with me,” can now be refuted with the estoppel agreement. Knowing the current property owner will see the Tenant Estoppel Agreement should prevent the tenant from providing false information.
Simply reviewing the existing leases (if there are any) may or may not give you the full picture. Believe it or not, there are unscrupulous tenants and landlords out there. They will try to take advantage of the ownership changeover. The estoppel agreement can stop these folks cold and can even be used in court if the need arises. It is a spectacular example of “an ounce of prevention being worth a pound of cure.”
Protect your investment and reduce your risk when buying properties with existing tenants by using a simple estoppel agreement. Know what you are getting yourself into and save yourself future drama. To get you started, I have posted a copy of the one I use here.
Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.