Contract Void? Undermarket buddy hook-up prior to closing on storage

10 Replies

Must annual contracts be upheld after transfer of ownership?

Scenario:  Closing on a storage facility.  A few annual leases in there at under market rents.  I was going to leave them in place; however, this weekend the sellers had an existing tenant sign an annual lease at 50% the market rate.  Definitely smells like a buddy hook-up to try to protect him and hose me.

I'm intending to raise rents by 1 October.  I'm now of the opinion to cancel all contracts and start over.  The month-to-month are easy...new rates are X...take it or leave.

May hit up an attorney, but not big enough money to warrant paying for a sit-down with an attorney.  Just annoying.

Seems it's not someone's home, so I can do what I want with the commercial property...tear everything down, if I wanted.

Thoughts??

I'm not an attorney - you should seek the assistance of a local one. 

As the new owner, you will have to honor the existing leases. However, your contract should have stated that the current owner can not enter into any new agreements prior to close without your approval. If that clause is in there, you can void that "buddy lease". 

It doesn't matter whether it is commercial or not, legal agreements have to be honored upon transfer.

@Nate B.

If I make the assumption the storage facility is operated as a business (StoreUSelf.com) under an LLC/corporation, the the contracts would be between the tenants and the company.

Are you buying the asset or the business (as a going concern)?  If you are buying the business, then the change in control has no effect on existing contracts (with tenants or suppliers) and they will run their course.

Where you are dealing with commercial and not residential leases, if you are simply purchasing the asset and plan to launch your own - differently branded - storage company,  you may be able to make the case that the existing leases cease to exist - though it would be considered bad form not to honour them.   You would stand a better chance of requiring that tenants need to execute a new contract with the new operating company within, say, 90-days of when you assume operations.   Even then, just because you can legally require tenants to enter into new contracts - and potentially change the terms and up their rent - does not mean it would be a wise business decision.   You also need to review the wording of the present contracts/leases as they may have a clause designed to thwart just such a move.

Since I am in no way qualified to offer you legal advise, particularly in your jurisdiction on the left coast of another country, I would advise you check with your attorney on this matter before you complete your diligence and go firm on the deal.

We have a condition in our agreements of purchase and sale whereby any contract/lease entered into by the Vendor once we have entered diligence (i.e. have an accepted offer), must be vetted and accepted by us before it can be signed.

Typically speaking, from a legal perspective, it depends on the terms of the lease and the local landlord/tenant laws as to the status of the tenancies upon transfer of ownership. Most of the time, when an owner of a property is transferred, it is done so subject to the already existing tenants. This general rule could be modified by local law, and you should listen to a local lawyer.

There are some options available to you that are non-legal; settlement to buy out the existing tenants, etc. 

@Brad M. and @Roy N.  Thanks for the feedback.  Roy, I think we're on the same page on this.  We're purchasing the asset, not the business.  New name, contract, etc.  Redoing all paperwork.  

My intent was to honor the few annual contracts; however, the sellers executed an annual contract a couple days before closing, which is the main contract in question.  The others are primarily monthly or about to expire, so easy fix on those.

No, it wasn't in the offer to purchase contract to clear through me...lesson learned...which is much what this project is about.  

Regarding the potential backlash for poor business decision...we're looking to clean house.  Five years of mismanagement has allowed folks to become accustom to extremely reduced rates and in many cases just don't bother paying since previous owners wouldn't go after them for payment....or other random barter agreements for other services provided to sellers.  Although it might be painful up front, we welcome some of the tenants departing to make way for fresh faces and higher standards of management.

Again, appreciate the feedback and we'll see how it plays out!

Several years back, I read an article about how people are so attached to their things, that even if they don't have enough room in their house, they will continue to pay to store them off-site. 

I don't know about your specific area, but anytime I have called about renting a storage locker, I have had to call multiple properties before finding one that was vacant. 

You should have no problem filling the units at the new rate, as long as the rate is in line with the rest of the area.

I am also not an attorney, and will recommend you talk to one about the possibility of getting that 50% discounted lease tossed out or voided. 

@Matthew Kreitzer and @Mindy Jensen  Thanks for the feedback!  Yes, our area is about the same...typically 98% occupancy...this sits at 75% right now...goes back to mismanagement.  Concur that in the long-run it will be good to clean house a bit. 

Nate, 

Hold the phone here!  ABSOLUTELY Get your attorney involved before taking the advice of people on this thread, including the attorney that weighed in on this.   Landlord tenant law doesn't apply to self-Storage. 

I'm assuming you have an attorney involved in this purchase that understands storage and/or industrial? If not, Get one. 

I would have them modify the assignment and assumption agreement of all leases/rental agreements to state that "any/all contracts entered into by seller AFTER the signed purchase agreement are subject to review, and may NOT be counted toward NOI, and will be subject to exclusion from the transfer....." (obviously, this is a sticky mess to clean up post-closing, so I would have them do it prior to closing, again, with the help of your attorney)

Make sense? 

Also, if this clown is running rough shod on stuff like this, I would definitely review EVERY rental agreement prior to closing, and match them up with physical locks in the facility to flesh out any "Phantom" rental agreements that can falsely boost the NOI.

For the record, avoid signing any 6 or 12 month agreements once you own it - that's the beauty of self-storage - we can raise rents, and NOT renew an agreement if the need arises. 

Keep us posted! 

This post has been removed.

@Scott Meyers  Thanks so much for the feedback.  Understand seeking out professional advice...just wanted to ping here to get ideas and potentially meet someone like yourself.

We close today, so modification of the contract isn't an option.  Lesson learned.  This is a very "backwoods" amateur transaction...to include myself to some degree.  If it uploaded, their "financials" are attached.  Literally a piece of scratch paper.  Hence, I feel I'm buying at a discount to cleaning house of a ill-managed property.

Your comments on NOI makes complete sense, and I've been trying to eductate them along the way...and myself. The sellers, nor the realtor, understood NOI, cap rates, etc. It's been interesting. I have an acquaintance with over 4000 units that has taken a look and offered a bit of advice on the big picture...just not specifics like contracts, voiding them, etc.

We've walked the property and inspected locks, etc.  I feel pretty comfortable in that arena...only catch is these guys have never sent invoices, don't offer autopay, and generally let 6 of the tenants to consistently be delinquent for 30+ days with no ramifications.  Hence the clean-up.

Your take on annual versus monthly contract is interesting.  I'm increasing rents almost immediately, so don't anticipate an increase for a while.  The administrative burden of monthly payments, non-pays, etc. may not be worth the lost rent of "1 month free"...and could always increase rent after contract expiration.  Again, I'm an absentee owner doing more of the administrative management with local management for lock-outs, etc.  Thoughts?

I'm also looking for a good automated solution for invoicing and payments.  There are a number of online options...and of course having an account just to receive direct deposit funds.  Any recommendations on what works for you?

Thanks so much!

Nate,

First of all, Kudos for having the cahones to buy this before analysis by paralysis stepped in.  Next time, however, I'd seek just a little more advice....  But no Worries - I'm proud of you!

Some Quick Resources: 

1.  Sitelink or Centershift Property management software (or is the mgmt company using something different?) will assist in automating the day to day. 

2.  Join the State Self Storage Association and immerse yourself in it. 

3.  If I may, we hold a 3 Day Self-Storage Academy that teaches investors about the business.  We've been doing it for 8 years, and helped countless investors launch, and grow their SS Business:  www.SelfStorageInvesting.com/academy. 

4. HEAVILY interview the management company you choose - only one that understands the Self-Storage Industry - tenant and toilet companies won't help you grow your NOI.

Lastly, Welcome to the wonderful world of Self-Storage. 

Cheers, 

Create Lasting Wealth Through Real Estate

Join the millions of people achieving financial freedom through the power of real estate investing

Start here