Tenant prepay lease 10 years!!!!

19 Replies

I have a small multi I am looking at purchasing where an older woman with M.S. wants to prepay 10 years of rent for $40,000 upfront. She wants the simplicity and stability over the long-term. She likes the place and wants to stay. Market rate for the unit she is in $500/mo. The $40k would finance a portion of down payment instead of taking it out of a HELOC. All things equal it looks like I would be losing $20,400 of potential rents as well as rent increases however I would have 0% vacancy in one of the units. Further, I would theoretically pay $26,000 of interest over the ten years if a) interest rates stayed the same on my adjustable rate HELOC b) I never choosing to pay down the principal on that portion of debt. Finally - this would be state allowable and a lawyer drawn contract. Feedback appreciated!

You don’t know that you would have 0% vacancy. All you know is that you’d be locking yourself into no rent increases for the next 10 years. 

In almost every state (including yours I believe), if she moved out or died a month after signing that lease, you'd be obligated to make a reasonable effort to find a new tenant and then refund the balance of the unused pre-paid amount that she gave you.

Plus, what if you decided you wanted to sell the place in the next 10 years for some reason? You wouldn’t be able to because no one else would want to inherit this 10-year lease.

Honestly, the only benefit I see in this arrangement is to the tenant. I see zero benefit to you. 

The tenant then owns you . Its their money at all times , if she breaks the lease you still have to rerent as per law and refund her the balance . If you spent it you are screwed 

Also you'd be reporting $40k of extra income all in 1 year on your taxes with no correlating expenses. 

So your taxes would suck that year.

I can see her wanting a stable housing environment, especially if she has MS. Tell her you can write up a lease, but every year you will revisit the amount of the rent to allow it to keep up with inflation. I'd have her put the money in some sort of account where she has control of it, but every month payments are automatically made to you. I would NEVER take the $40K up front.

You will loose, for all the reasons above, but also for now being obligated to meet her needs.  Say in a year her ms is bad enough she now needs a handicapped bathroom, so you must install the bars.  Now 2 years after that she needs an handicapped kitchen, wider door openings, and a ramp for her new wheelchair.  IT goes on and on.  Since you took the rent up front, you really can not say that the accommodation is not reasonable for your house and you do not want to do it.  You knew her illness going in.

Also, as the disease progresses, the damage to you house can be bad.  Ever see a house with narrow hallways and doors that had a wheelchair in them, its bad even with good drivers?  Walls and doors and trim need to be fixed/replaced.   Also the floor is forever impacted.

Also, in time she may want a live in aid.  You will need to allow that, and you maybe not in control of who is chosen.  e.g.  her drug addicted grand daughter.  

I would think that it would be better for her to put the money into something safely invested and then have a yearly lease that you increase the rent on to keep up with inflation.  If she can not handle money, then she should look for an immediate pay annuity or a series of step CDs.

BTW, when renting to someone with health issues, its important to have information about her 'to contact in case of emergency' and 'who can access the unit to remove things in case of emergency' Or her death.

Think can of worms.  Large can of worms.  The law of cans of worms is that it takes a larger can to put them back than the one they escaped from.  Just the mere fact that your rent is fixed and you could never change it if she lived that full ten years is reason enough to say no thanks.  From her perspective, what if you were a crappy landlord by her standards and she wanted out, then what.  Also, I know there's some weird stuff going on with landlord tenant rights and rent fixing etc in your neck of the woods, but I'd be having a conversation with a local attorney about this as well.  See, there's this thing in contract law that goes something like this:  You can't make a contract to make a contract.   And a ten year lease could fit the definition since performance is outlined for an extended period into the future without any guarantees that performance can be achieved.  What if there's a fire?  What if she deteriorates and needs a ramp installed.  In other words, there are a pile of what if's in your proposal and no answers.

Hi Spenser,

I feel that the time value of that money alone wouldn't be worth the deal. Just by inflation at say 3% a year, the future value of $40,000 today in 10 years will only be $13,333.32. And your expenses and taxes will increase with inflation at about 2% a year making your cash flow each year less and less. The savings in interest today and more principal paydown initially might be negated by higher taxes and expenses in the future and no way to bring your cashflow up to market value. Just imagine your cash flow decreasing 2% a year and property taxes and expenses increasing 2% a year. 

Look at book by Frank Gallinelli what every real estate investor needs to know about cash flow. The examples and math are great.

Interesting idea of your tenant. Great deal for her. Not great for you. 

@Spenser Harding

I can see how it would be tempting to get prepaid rent but as many pointed out the tenant would be in better position to control things than you. What if she wants to move a year later now u have to come up with the money. Amend your taxes. Etc.

I’d suggest she open a bank account exclusively for paying rent. She can have it automatically direct deposited into your account each month. She gets the ease of not worrying about paying and you are not locked in to a 10 yr lease. You can still enjoy getting one unit guaranteed rent until she moves but not obligated to any specific long term. Can’t predict the future.

Best of luck

@Spenser Harding Is there a way you can put the money in escrow or a bank account and auto withdraw the rent every month? This will allow her to achieve her goals of simplicity and stability. Also instead of doing a 10-year lease which others have said is not a good idea and I agree, maybe see if she will go for 2-year leases with built in increases for each renewal?

Thanks for everyone’s input! Definitely interesting information and insight.  Going to move forward a normal rent scenario. I have no problem signing a 2 year lease with her at a discount for the stability. Also, going to advise she look into some savings options so her money keeps up with inflation and make it a win-win for her and I. 

Before answering the question, let me point out that, in some jurisdictions, pre-paid rent must be handled the same way as a security deposit (for example: in Chicago, it must be held in a separate, interest-bearing account). Now, to the question of whether I would allow a tenant to pre-pay that many years of rent. For me, it all comes down to whether the tenant is willing to agree to annual rent increases as part of the agreement. In this case, you've already noted that no, the rent will stay flat. If the tenant is basically exchanging 10 years of pre-payment for flat rent, I would have to think for a while about whether this is a tradeoff that is truly in my favor (to answer that, it isn't). I likely would not allow 10-years of pre-payment in exchange for flat rent. The reason for this is that my units are in an area where 5% annual rent increases are normal and there's a lot of demand for units. With the 5% compounding, if I'm collecting $500/mo today on this property, 10 years from now what I'd expect to receive is grossly higher than today's current $500 price. Personally, I'd be fine w/ dealing with a bit of turnover in the 10 year period. And as others have noted, if something happens where the tenant is moving out a month or two month's later, that rent more than likely has to be returned. @Spenser Harding

Where is this or what is this that monthly rent is 333 a month?

And your willing to give her a 33% discount off of current market rate????

I have accepted 1.5 years of rent in advance and it was a nightmare. The tenant ending up doing damage to the property of $8k +++. I will never accept more than a few months in advance. When they want to pay so far ahead in advance, it's a red flag for me. It signals instability to me and I don't want to deal with it.

@Spenser Harding . You could take that 40k and buy a c class SFH and rent it out to someone else. Make up for her rent and you also have another property producing income. Seems like a win for me. I would also make her sign a contract that you won't be making any accommodations to her living sickness or adding anything special to her unit the way it is is the way it shall remain and in the event of her death that money is mine and nobody else's. I don't want to be mean but people go downhill pretty quick with that disease so I wouldn't count on her being there for that long. If she will sign a contract it would probably be good for you.

@Rob B.

Great points, I was informed about a legal contract the tenant has already drawn up. 

@Jermell Shavers I see your point about the contracts however I feel having a contract that states you won't accommodate someone's disability/illness indicates large litigation risk. We are OK having a tenant with challenges. We also look at this as a people business rather than savagery and maximizing profit at the expense of others. We all need a place to sleep at night. 

That being said - Haven't yet closed on the property but we have chosen to go the regular lease route to give the most flexibility for us as well as the tenant. Should they need different care in the future I don't want her locked in a place that may not suite her needs as well as should she pass I would rather not deal with probate and funds that's tide up in a property.


Originally posted by @Spenser Harding :

@Rob B.

Great points, I was informed about a legal contract the tenant has already drawn up. 

@Jermell Shavers I see your point about the contracts however I feel having a contract that states you won't accommodate someone's disability/illness indicates large litigation risk. We are OK having a tenant with challenges. We also look at this as a people business rather than savagery and maximizing profit at the expense of others. We all need a place to sleep at night. 

That being said - Haven't yet closed on the property but we have chosen to go the regular lease route to give the most flexibility for us as well as the tenant. Should they need different care in the future I don't want her locked in a place that may not suite her needs as well as should she pass I would rather not deal with probate and funds that's tide up in a property.

It looks like you've already made your decision regarding a regular one year fixed lease. An out of the box idea for your consideration- A few years ago one of our business partners found a free & clear property & worked out a deal with the owner where he would spend the $ required to renovate the property but not purchase it, then he shared the profit from the resale with the owner. (He was flipping properties) While your scenario is different, you do have a tenant w/ some cash- If you're a trustworthy guy and can proof it, maybe make your tenant a business partner in one of your future deals. 

 

I would never allow someone to prepay 10 years in rent.  The tenant will get a locked in rate with no increases for 10 years.  Sounds good to her, but not good for you.  That's potentially losing thousands of dollars in rent increases throughout the 10 years.  That won't even cover the damages that could occur or the cleanup you might have to do after 10 years of 1 tenant.

Instead offer up a 1 year or 2 year lease and bring it to her to sign. If something were to happen to her in say year 5 of 10 you would have to refund her the money in unused rent. That could potentially be troublesome especially if you took that 40k and bought another property with it or fixed up another one. I understand from her perspective how this will make it easier for her. I can't even imagine trying to get 20k if I had to get it by the end of the month because my tenant moved or passed.