Rental Agreement vs. Lease

18 Replies

Hi BP! I'm purchasing my first multifamily property located in Redlands, CA. The property is nicely located near a university and the area generates a pretty decent selection of tenants. I've been reading about the pros and cons of having a rental agreement vs. a lease and I'm having difficulty determining which I prefer to use for tenants. I like the flexibility of having a rental agreement so that I can increase rents or modify the language of the agreement as needed. I also like the security provided by the lease option in reducing vacancy rates. However I believe that a tenant will leave when they want regardless of the consequence of breaking a contract.  With such a large pool of renter in the area, filling vacancies shouldn't be a problem, so I' m  leaning more towards rental agreements...what do you guys think? Which one works best in your business?

Also if anyone has suggestions for a solid rental agreement or lease form that adheres to CA law, please share. 

@Danielle J.  We use a "hybrid" and tenants tell me they really like it.  It is technically a month-to-month rental agreement but it encourages longevity by prorating the return of the security deposit.  A lease protects the tenant as much or more than you.  If I have a problem with a tenant (or their children) that does not violate the lease I can still give a 20 day no-cause notice of termination (Wa State).  

Practically, people have treated it as a lease and don't generally leave until after at least a year, when their deposit become fully refundable.

Curtis Bidwell MBA, Philia Holding Co LLC | http://www.PhiliaHC.com | Podcast Guest on Show #95

@Curtis Bidwell sounds like a great idea! Can you elaborate on how you promote longevity using a month to month agreement?

@Danielle J.  it sounds like the tenant "builds up" back to the full security deposit. If the tenant only stays for 6 months, he's only entitled to receive back half of the deposit. If he stays for the full 12 months, he's entitled to receive the full deposit.

(At least I think that's what @Curtis Bidwell  means)

@Danielle J.  No problem.  My proration is very simple.  If you stay less than 6 months there is no refund -I am compensated for short-term residency, but the tenant has freedom to go without buying out a lease.  Between 7-12 months they get 50% back! after 1 year it is fully refundable based on condition at move out. 

Life moves and my tenants are free to move with it.  It's not worth chasing after them for rent they won't ever pay anyway.  But it costs me to turn over a unit after just a few months.  So, they are free to go and I get some compensation for the early turnover.

Curtis Bidwell MBA, Philia Holding Co LLC | http://www.PhiliaHC.com | Podcast Guest on Show #95

Thanks @Will Porter   for your input :)

@Curtis Bidwell  I really appreciate your explanation of how you work the security deposit. It makes a lot of sense and I can totally see tenants wanting to stay longer to ensure that they get there security deposit back, especially if they are planning to move and pay yet another security deposit somewhere else.  I also agree with you on allowing tenants to utilize "free will" when deciding whether to stay or go. Freedom to choose is so important for both landlords and tenants. I have to check in with CA law to make securty deposits can be handled like this.

I love using month-to-month rather than a lease.  Near a university, though, not sure I'd give full month-to-month flexibility, since mid year vacancies could be harder to fill.

The hybrid with the security deposit is a great idea, make sure it is legal in California.  Our agreement wording is:

After additional deductions for cleaning and repairs necessary to restore the premises to its original condition (less allowance for reasonable wear and tear), along with deductions for any rent due (including rent loss during periods of restoration), late fee, caused inspection/eviction, utility, notice, legal and any breach of contract costs, the balance of the security fee shall be refunded pro rata as follows: 10% of the remaining balance for up to one month of occupancy; 20% for two months, 30% for 3 months, 40% for 4 months, 50% for 5 months, …and so forth until 100% for 10 months or more of occupancy.

We also look for applicants who have demonstrated by past behavior that they are capable at staying at an address for some length of time; one year minimum, more is better.  If they are consistently moving every few months, they likely will for you too. 

@Michele Fischer  thank you for sharing this! I think it is fair, giving them 10% per month if everything goes well.  A combination of your approach and @Curtis Bidwell  approach would be great. Combining the two approaches for refunding security deposit may say: 0% for 1 month, 10% for 2 months, 20% for 3 months, 30% for 4 months, 40% for 5 months, and 50% for 6 months. Between 7-12 months they still only get 50% back, and after a year, they get the 100% back if all other factors are met. What do you guys think about this one? There seems to be so many ways to write up an agreement, however for me, it's important that it's fair on both sides.

@Danielle J. , I like your hybrid method. This is very interesting. I wouldn't have thought of this. I need to check KY laws. The only thing I remember reading about LY, was that there is no pre-determined amount of time to return a security deposit, unless there's a dispute of some kind and then it's between 30-60 days. Don't remember exactly where I read that, but I definitely need to brush up and double check.

Hey thanks @Mark S.   at this point I am not sure if this is right or wrong, but it sounds fair. Yes I recall reading in my CA landlord rights book that once the tenants moves out, there is a specific time frame for returning the security deposit, however I have to review as well. 

I would strongly recommend that you accomplish the same thing via an Early Termination Fee (ETF). A deposit is intended and interpreted by many courts to be refundable unless there is damage or other more firmly calculable damages, what I'm seeing above is arbitrary. A fee is agreed on and regardless of it's arbitrariness (within reason) is more enforceable. You also run the risk, granted decreasing as time goes on, that there could be damage in excess of the remaining deposit and they could walk and you are in no better position.

Just explicitly state in the lease that the ETF is one month of rent or if you prefer, have it declining over time that the lease has been in place.

For an overview from the state of the relevant laws:

http://www.dca.ca.gov/publications/landlordbook/ca...

Two books I found helpful is Leigh Robinson's book http://www.landlording.com and Nolo's Tax Deduction guide for Landlords. Make sure to look at the new IRS regs and get the update from online.

I could be totally off base here or California is completely different than what I am accustomed to but to the best of my knowledge a Rental Agreement is the same thing as a Lease Agreement. The fact that your adjusting the terms to longer or shorter does not change what it is. How you handle the Security Deposit is usually dictated by state specific law not the wording in your agreement. It sounds as if your trying to treat a Security Deposit as an Option Fee and I don't know if a court would support that?

A rental agreement can state that the rental is periodic, i.e. month to month or week to week from the beginning or a fixed time period (a lease).

The fixed time period is the lease (i.e. 6 mos, 1 yr, 18 mos.-whatever you and the tenant agree) even if it is paid monthly. No notice is needed at the end, the tenant needs to be out unless there is a provision on how to extend the lease, for example that it converts it to a periodic rental i.e. month to month.

The a benefit of the lease to the renter is the rent can't change during the term (unless there are automatic risers) and for the landlord is that there is more stability in markets where the tenants are collectable. Also, if they depart at some miserable time like November 15 you can collect until you find a new tenant as long as you make a concerted effort to find a new tenant.

@Mark B.  Thank you for providing insight on the ETF! I have not heard of this before.  My goal is provide a solid contract that is fair, while adhering to CA law. I am definitely leaning towards month to month agreements and will do more research to see how to incorporate ETFs. I am such a newbie and definitely humbled by all the great information/food for thought you all provide.

Danielle

@Dick Rosen  

In California, a "month-to month" is called a rental agreement and a "fixed term" is called a lease. I am not sure if this is the case for other states.

Originally posted by @Danielle J.:

@Dick Rosen 

In California, a "month-to month" is called a rental agreement and a "fixed term" is called a lease. I am not sure if this is the case for other states.

I guess I'm only familiar with AZ and MN, where they are both one in the same just different terminology used by different people.

Great post Danielle. I am accustomed to using a lease agreement and I find that our GA lease agreements are more protective of the owner. I manage a 234 unit luxury community in GA and the lease covers everything it seems. 

I have rarely ever faced a resident issue that the lease does not cover or protect us from. Most issues ,I believe derive from negligence on either the resident or the owner's part.  

Thanks for posting a great topic! I've enjoyed reading. :)

Regards,

Tiffany 

I've several Ca rentals, all have SD.  Ca law is very specific about SDs.  Neither you nor tenant can agree to violate Ca SD laws.  This means you cannot agree to any proportionate SD proration.  The security deposit must be accounted for within 21 calendar days of your getting possession and all deduction items on it backed up with repair receipt copies or rental agreement/lease violation fee deductions.  If you prorate the SD you'll lose in court, the potential bad faith penalty is 3X the total SD.  You can get plenty creative with SD accounting so it's not worth it to mess with the SD when a structured ELT can achieve the same result.

@Cam Coplin  is right. You can't pro-rate the security deposit in California. 

I personally prefer a 1 year lease. Even though if they want to leave, they will. But by having a 1 year lease, most people will stay the 1 year.