Tenant Is Offering Full Year Rent In Advance

Rental Property Investor · Chicago, IL · Member since 2019 · 7 posts · 5 votes

My stellar tenant of two years plans on renewing his lease this month. He called me today to ask if he could pay a full year’s rent in advance for a ten percent discount. I told him I’d have to think about it and get back to him. As of right now, I’m leaning towards taking his offer. I plan on using the immediate profits towards a down payment on a new property.

Curious to hear what you guys would do in my situation?

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Nathan GesnerBusiness Member

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Real Estate Broker · Cody, WY · Member since 2010 · 28k+ posts · 41k+ votes

Originally posted by @Joshua Gordon:

Curious to hear what you guys would do in my situation?

Two thoughts:

1. Your lease should include an annual rent increase to keep up with cost of living and market rates. Your tenant should have a 3% increase this year so a 10% decrease will actually put you 13% behind market, possibly more. On a $1,000 rental that would equate to $1,560 lost in one year. I know some good charities that could use that money.

2. Just because you receive money today doesn't mean it's yours to spend today. The rent payment is earned the day it's applied to a charge. If you receive $12,000 today, you would apply $1,000 of it to November rent and keep the rest in your account. In December you would earn another $1,000 and so on. Why? Because there are many reasons why your tenant could legally break their lease and get that money back. If your tenant called on January 10th and said they broke the lease and moved out, that money is not yours to keep. You have to make a good faith effort to find a replacement tenant. Once the new tenant takes over, the old tenant is cut loose and his money has to be refunded.

I knew a lady that managed over 100 vacation rentals. Guests would put money down to reserve a rental and the manager would take her commissions and spend it. Then the guest would cancel and she would have take money from another reservation to pay back the guest. She was over $250,000 in the hole, robbing Peter to pay Paul.

Don't spend it until you earn it. The same applies to security deposits.

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Shain Ismailovski
Real Estate Agent · NJ · Member since 2019 · 237 posts · 169 votes
6y
If the tenant has had no issues before as you have mentioned I would consider the offer as well. Having that money up front would be useful especially for the purposes you explain. My only advice would be to negotiate the discount to something between 5-8%. That means more money to reinvest. Still, the offer as it stands seems like a decent one so long as even after the discount you are cash flowing positively and at a healthy amount.
12 Reply
Jason Turgeon
Realtor · Boston, MA · Member since 2019 · 244 posts · 275 votes
6y
I don't know. Normally after 2 years I'd be considering a rent increase, although for truly exceptional tenants I tend to keep their rents flat for many years since replacing them is so hard. But taking a 10% haircut is tough. Can you make the mortgage every month without that regular income? Will you make *considerably* more than 10% if you take that money and invest it in another property? Are there tax implications from taking all the rent at once? I would put some real thought into this before I jumped at it.
9 Reply
Joshua Gordon
OP
Rental Property Investor · Chicago, IL · Member since 2019 · 7 posts · 5 votes
6y
@Jason Turgeon Thanks for the reply, you bring up some good points. To answer your questions, yes I am netting sufficiently above ten percent so I don’t have an issue in that regard. As far as taxes goes, I don’t see why it would be any different. If anything, I’m netting less than I otherwise would so I’d expect to pay less. That said, I need to look more into that.
So...
1) Given that I am netting 30% before discount and
2) that I can acquire another property that nets similar gains only if I take the offer and
3) assuming that taxes are not an issue...
What would you do in my situation?
0 Reply
Jason Turgeon
Realtor · Boston, MA · Member since 2019 · 244 posts · 275 votes
6y
Sounds like you've already made up your mind.
1 I love it when I get 30% returns, but I never bank on it.
2 if you already have the property lined up, that changes things. If you're going shopping, that is less attractive
3 taxes are always an issue in real estate. You'll be banking an additional year of income now, but don't get the depreciation until next year.
Do what feels best. There's no right or wrong answer.
2 Reply
Mary M.
Rental Property Investor · Portland OR · Member since 2018 · 2k+ posts · 3k+ votes
6y
Be sure to check your local laws. In some places you cant take a years rent and spend it. You have to save it. So check

Also what contingency do you have if 2 months from now he gives you a 30 day notice ? You would need to give him his $$ back
12 Reply
Basit SiddiqiBusiness Member
Accountant · New York, NY · Member since 2015 · 8k+ posts · 3k+ votes
6y
@Joshua Gordon

pre-paid rent needs to be reported in the year received. Something to consider.
Maybe see if you can set up the lease for January 1st and collect then.
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Kevin Sobilo
Realtor · Hanover Twp, PA · Member since 2018 · 3k+ posts · 3k+ votes
6y
@Joshua Gordon, I echo @Shain Ismailovski when he recommended you negotiate.
Perhaps when you negotiate you could look at non-monetary items. Are there any upgrades to the property the tenant would like? If instead of giving the tenant a discount you improve the property, the tenant benefits from the use of the improvement and you benefit from an increase in the value of the property.
From a monetary standpoint its like taking that 10% discount and putting it back into the property!
5 Reply
James Mc Ree
Rental Property Investor · Malvern, PA · Member since 2016 · 1k+ posts · 934 votes
6y
I would try to negotiate a 5% discount. The tenant will receive a very nice 10% risk free return with the current deal. You may be able to do this by bundling it with a rent increase if tenant objects: 10% discount with a 5% rent increase. That won't quite net out to 5%, but gets you down from 10% and gives the tenant the 10% discount requested if that is the focus.
Try to negotiate it as non-refundable in case tenant terminates lease, especially since you plan to quickly spend it.
It's only worth it if you have an investment opportunity that exceeds the discount. If you give 10%, have an opportunity that pays better than 10%.
Keep in mind that steady cash flow you have been receiving disappears after the payment. Your mortgage, taxes, insurance and maintenance do not. Budget accordingly.
3 Reply
Theresa HarrisPro Member
Member since 2019 · 15k+ posts · 11k+ votes
6y
If you do it, go for 5%, but also have a clause that if he breaks the lease early, the rent is the full amount and the normal one month penalty (check your local laws) for breaking the lease. At 10%, he's getting one month's free rent every 10 months.
Make sure you have access to that amount of money. If you raise the rent every year, you also need to factor that in.
1 Reply
Brent Paul
Rental Property Investor · Shakopee, MN · Member since 2015 · 985 posts · 374 votes
6y
10% is too big of a discount for me even with the prepaid rent. That's a decent chunk of cash flow. Unless you have very high cash flow on the property.
0 Reply
Nathan GesnerBusiness Member
Moderator
Real Estate Broker · Cody, WY · Member since 2010 · 28k+ posts · 41k+ votes
6y
Originally posted by @Joshua Gordon:
My stellar tenant of two years plans on renewing his lease this month. He called me today to ask if he could pay a full year’s rent in advance for a ten percent discount. I told him I’d have to think about it and get back to him. As of right now, I’m leaning towards taking his offer. I plan on using the immediate profits towards a down payment on a new property.
Curious to hear what you guys would do in my situation?
Two thoughts:
1. Your lease should include an annual rent increase to keep up with cost of living and market rates. Your tenant should have a 3% increase this year so a 10% decrease will actually put you 13% behind market, possibly more. On a $1,000 rental that would equate to $1,560 lost in one year. I know some good charities that could use that money.
2. Just because you receive money today doesn't mean it's yours to spend today. The rent payment is earned the day it's applied to a charge. If you receive $12,000 today, you would apply $1,000 of it to November rent and keep the rest in your account. In December you would earn another $1,000 and so on. Why? Because there are many reasons why your tenant could legally break their lease and get that money back. If your tenant called on January 10th and said they broke the lease and moved out, that money is not yours to keep. You have to make a good faith effort to find a replacement tenant. Once the new tenant takes over, the old tenant is cut loose and his money has to be refunded.
I knew a lady that managed over 100 vacation rentals. Guests would put money down to reserve a rental and the manager would take her commissions and spend it. Then the guest would cancel and she would have take money from another reservation to pay back the guest. She was over $250,000 in the hole, robbing Peter to pay Paul.
Don't spend it until you earn it. The same applies to security deposits.

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15 Reply
Luke Saglimbeni
Rental Property Investor · East Longmeadow, MA · Member since 2019 · 154 posts · 64 votes
6y
@Joshua Gordon
I’d do it if you can legally. So if your rent is 12,000 a year you lose out on 1200$; which can easily be made up on if you buy another cash flowing property!!! Min rule of 100/mo
Make sure it’s legal to do so and ensure he won’t break the lease before the deadline.
Good luck
1 Reply
Luke Saglimbeni
Rental Property Investor · East Longmeadow, MA · Member since 2019 · 154 posts · 64 votes
6y
@Basit Siddiqi acquire a new property and use bonus depreciation to offset it
0 Reply
Paul M.
Medford, MA · Member since 2012 · 163 posts · 36 votes
6y
In my state it is illegal to take that much rent in advance, even if tenant offers. If it was a new tenant you should run as it will turn south once the 12 months is over. It sounds like for an existing tenant they just want to save money. Good for them, but I wouldn't do it.
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Joe SplitrockPro Member
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Rental Property Investor · Sioux Falls, SD · Member since 2015 · 9k+ posts · 18k+ votes
6y
@Joshua Gordon it depends where the property is located. In Chicago you would be unable to spend the money. You would need to hold it in an interest bearing account and pay them interest. Are you required to follow "City of Chicago Residential Landlord and Tenant Ordinance"? If you are, I suggest you read it ASAP before making any more business decisions.

Section 5-12-081
(c) A landlord who holds a security deposit or prepaid rent pursuant to this section for more than six months shall pay interest to the tenant accruing from the beginning date of the rental term specified in the rental agreement at the rate determined in accordance with Section 5-12-081 for the year in which the rental agreement was entered into. The landlord shall, within 30 days after the end of each 12-month rental period, pay to the tenant any interest, by cash or credit to be applied to the rent due.

Even in areas without laws governing this, it is not a wise idea to spend the money. If something bad happened, for example the property burned down, you would be required by law to return the rent immediately. If you were unable to return the prepaid rent in this case, it would be considered fraud.
Ultimately if the tenant is happy, you can get 10% more by just taking payment every month. It is hard to get a guaranteed 10% return anywhere these days, so it seems like easy money.
5 Reply
Ola Dantis
Multifamily Syndicator · Houston, TX · Member since 2016 · 1k+ posts · 2k+ votes
6y
@Joshua Gordon Since you are unable to take that money and deploy it based on what @Joe Splitrock mentioned above, as good as it sounds it is very interesting to get that kind of offer from this stellar tenant.
In addition, what I was thinking was you are still going to be paying the mortgage anyway, so even if you used the capital to buy a new property you still have to be servicing the current mortgage.
As with anything in Real Estate, it is always good to get a second (or third) opinion.
"You don't know what you don't know!"

0 Reply
Ned J.Pro Member
Investor · Manteca, CA · Member since 2017 · 1k+ posts · 2k+ votes
6y
As stated before, just because they give you the full years rent at one time, doesn't mean it really belongs to you yet... they basically made a lump deposit and you are going to withdrawal the $$ as each month comes up If the only reason you have the ability to buy another unit is due to the fact that they just gave you a lump sum of $$, then you are probably not in the best financial position to buy another unit. Is that new unit going to cover itself and enough $$ for YOU to pay the mortgage insurance, taxes etc on the first one? Because now YOU are paying that out of YOUR account each month. Do you have enough reserves to cover any unforeseen expenses on these units? What if the HVAC dies? Roof leaks? etc etc...... now you have 2 units to have reserves for...... That lump sum isn't really yours yet..... and if the only reason you are going to jump on that next unit is due to that lump sum of cash you just got I'd say no.... Plus, no way am I giving 10% discount...
1 Reply
Account Closed
Member since 2019 · 1k+ posts · 1k+ votes
6y
@Shain Ismailovski
My advice would be similar. I would NEVER start out like this but after a great relationship is built I would be fine with it. Negotiate ~3% using the rational that you will be able to deposit the money and earn exactly that in interest, so in spite of inflation being a continuous reality you can save them money and cause yourself no detriment. Therefore: win - win.
1 Reply
Natalie KolodijBusiness Member
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Tax Strategist| National Tax Educator| Accepting New Clients · Member since 2014 · 3k+ posts · 4k+ votes
6y
Originally posted by @Luke Saglimbeni:
@Basit Siddiqi Siddiqi acquire a new property and use bonus depreciation to offset it

I'm not sure why we're assuming having the funds up front means he can purchase an additional rental.

What if his cash flow after expenses monthly is only $100, or $200.

So now he has $12k lets say.

But he needs $10k of that to cover the expenses of this property through the year.

So if he uses that $12k to buy a second property

Assuming it's rented immediately- we're banking on property 2 being able to cover the expenses of both properties for the rest of the year.

Only if 1 year's worth of rent - 1 year's expenses on the rental = enough for a down payment on a 2nd rental does this really make sense.

And to Basit's original point- He was just stating that something to consider is that it could shift your income from one year into another fairly drastically which is something lots of people don't consider. Just something to be aware of and plan for.
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Luke Saglimbeni
Rental Property Investor · East Longmeadow, MA · Member since 2019 · 154 posts · 64 votes
6y
@Natalie Kolodij OP quoted,” I intend to use immediate profits to purchase a new property.”
He also has this whole year in write offs to offset rents as well. If he is not a real estate pro, I’m sure he has some Carry forward write offs too as well as the new property regardless if it’s rented or not.
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Angelica M Garzon
Rental Property Investor · Miami, FL · Member since 2018 · 110 posts · 113 votes
6y
I would definitely take his offer however, what happens if they leave before the year? I know they're long term tenants so changes are low. But, if it were to happen to do you have to refund their money? If so, maybe it won't be a good idea to tie it up in another deal unless you can come up with it quickly.
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Account Closed
Member since 2019 · 1k+ posts · 1k+ votes
6y
@Angelica M Garzon
Write it up as a one year lease with payment in full due on _____, 2019. This may negate having to refund if he bails. Similar to a monthly lease if they left on day 20.
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Natalie KolodijBusiness Member
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Tax Strategist| National Tax Educator| Accepting New Clients · Member since 2014 · 3k+ posts · 4k+ votes
6y
Originally posted by @Luke Saglimbeni:
@Natalie Kolodij OP quoted,” I intend to use immediate profits to purchase a new property.”
He also has this whole year in write offs to offset rents as well. If he is not a real estate pro, I’m sure he has some Carry forward write offs too as well as the new property regardless if it’s rented or not.
Just because he says his intent would be to immediately purchase a new rental it's possible he hasn't run through the actual math of it. It's not "Immediate profit". It's immediate cash being received prior to it's correlating expenses.
You're making a lot of assumptions.
Assuming he has carry over losses, we don't know if he was under the $150k mark and able to use prior losses, or if his rental generated losses at all.
And I'm not talking about his taxable income- I'm literally just talking about the operating funds to cover all actual expenses incurred by the property throughout the year.
If he takes alllll the income for the year and spends it on something else (a new rental). How will he pay the bills associated with the first property?
Now property 2 has to generate enough income during the year to cover 2 unit's worth of mortgage, taxes, insurance ect.

Or, OP is paying it out of pocket- which is the same difference as if he didn't take the year rent up front.

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Natalie KolodijBusiness Member
Moderator
Tax Strategist| National Tax Educator| Accepting New Clients · Member since 2014 · 3k+ posts · 4k+ votes
6y
Originally posted by @Joshua Gordon:
My stellar tenant of two years plans on renewing his lease this month. He called me today to ask if he could pay a full year’s rent in advance for a ten percent discount. I told him I’d have to think about it and get back to him. As of right now, I’m leaning towards taking his offer. I plan on using the immediate profits towards a down payment on a new property.
Curious to hear what you guys would do in my situation?
Joshua
What are your annual expenses on this property? What is the monthly cash after expense?
If you take the full year's rent up front, and set aside enough to cover the year's operating expenses on the property..... is there enough left for a down payment on a 2nd property?
Or
If they pay the year's rent up front- you immediately use it to buy a 2nd property...

How will the expenses on the 1st property be covered for the year?

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Angelica M Garzon
Rental Property Investor · Miami, FL · Member since 2018 · 110 posts · 113 votes
6y
Originally posted by @Account Closed:
@Angelica M Garzon
Write it up as a one year lease with payment in full due on _____, 2019. This may negate having to refund if he bails. Similar to a monthly lease if they left on day 20.

I don't think that would hold up in a court of law specially if the amount is substantial.

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