Inherited tenants can be a blessing or a curse. And sometimes they can fall somewhere in between. Some real estate investors argue that they would never purchase a rental property if it would mean inheriting tenants, as they want to have full control over tenancy decisions. Others feel that, if properly vetted before the sale, inherited tenants can be an advantage. If a real estate investor can confirm the following, then an inherited tenant might be perfectly acceptable:
- The inherited tenant meets the same criteria the incoming landlord would use in making his own tenancy decisions (g., credit score, employment circumstances, background check, prior landlord references, etc.)—this obviously means that such information collected by the seller when he evaluated the tenant initially must be available to the purchaser
- The tenants have been paying in full and on time–and proof of those payments has been provided to the seller
- There have been no reports of damage or disturbance caused by the tenant
- The current owner received a security deposit from the tenant
- There is a written lease in place and such lease has been provided to the seller
- The current rent is at or near market rent
- The purchaser has been able to inspect the occupied unit and is comfortable with its condition
Even if not all of the above criteria can be met, there are some workarounds. For example,
- If the lease agreements do not exist, the purchaser can request that the tenants sign Estoppel Agreements. Note that “best practices” relating to Estoppel Agreements would have to be the subject of a separate discussion. (For example, one online commentator mentioned that the Estopped Agreement must be specific as to ownership of appliances; otherwise, the appliances the purchaser thought came with the property might grow legs and walk away.)
- If the current rent is not reflective of market rent, the purchaser has a few options available to him post-purchase:
- The purchaser can advise the tenant that the rent is going to be raised once the current lease expires. Since that will not be welcome news for the tenant, it can be softened by providing information about what the market rent is (using comps) and offering to phase-in the rent increase over a period of time. In addition, the purchaser can offer to make small updates to make the rent increase more palatable. It is important to note that in Maryland, even though there are no rent control provisions, “If your lease has an automatic renewal clause, the landlord must notify you of a rent increase or any other change with enough notice for you to decide whether you want to renew.” (https://www.marylandattorneygeneral.gov/Pages/CPD/landlords.aspx)
- The purchaser can communicate with the tenant that the current rent is below market but agree to maintain the current rent for some period of time in an effort to maintain goodwill and encourage continued tenancy.
- If the current rent is not reflective of market rent, the purchaser will have to consider whether the condition of the unit does not dictate market rent. In that case, the cost of a vacancy plus repairs may make more sense in the long run. This would mean not renewing the current lease when it expires.
If the purchaser decides he simply will not go through with the purchase with inherited tenants, he has a few options, as we discussed in a previous blog post:
- Make the purchase contingent on the successful eviction of the nonpaying tenant before the closing, or
- Factor into the offer the legal costs of having to evict the tenant, the estimated number of months it will take to evict the tenant, and the estimated number of months before the property can be re-rented (if the tenant has caused any habitability issues or if the unit is in need of an upgrade).
Assuming a purchaser decides he is comfortable with inheriting a tenant, there are a number of best practices that have been discussed online:
- Some of the best practices that were recommended relate specifically to the negotiations between the seller and purchaser:
- The Purchase agreement should state that the seller will give prorated rents and security deposits to the purchaser at closing. If there are no security deposits, those should be negotiated.
- The Purchase Agreement should state that no new leases can be agreed upon after such agreement is signed.
- If any unit is going to be delivered vacant, the Purchase Agreement should state that the unit will be delivered empty and will be “broom clean” at closing.
- The Purchase Agreement should require the seller to provide all relevant tenant records to the purchaser.
- Security deposits and prorated collected rents should be credited to the purchaser at closing.
- Have the title company hold the rent amount in escrow until the purchaser receives payment in full.
- The purchaser must be allowed to do a walk-through of the units prior to closing so that he can accurately assess their condition.
- Many online commentators suggested that it is best to get the existing tenant on the current owner’s rental agreement as soon as possible, and further that starting with a month-to-month agreement is the safest approach. However, it is important to note that (at least according to our understanding of Maryland law) the tenant is under no obligation to sign a new lease if there is an existing one in force.
- Ask the seller to send a written notice to the tenant to advise him of the sale.
- Follow up with a letter of introduction from the purchaser. This should lay the groundwork in terms of expectations: when rent is due, how rent is paid, how/when the landlord can be contacted, how maintenance requests are made, etc. This can be combined with a more personal approach of connecting with the tenant in person and inquiring as to whether there is anything regarding the condition of the unit of which the purchaser should be aware. Some online commentators even suggested the idea of a welcome basket to engender goodwill.
The gray area relates to having to do a cost-benefit analysis of having an existing tenant vacate as a condition of sale (if on a month-to-month lease) and therefore risking vacancy while looking for a replacement tenant versus “making do” with a less-than-perfect tenant. For example, what happens if the existing tenant is an excellent tenant (long-time tenant, maintains the unit very well, is quiet, always pays in full and on time, etc.), but is an indoor smoker and the smoke is permeating the second unit of a duplex? Does it make sense to move forward and inherit that tenant, or would it be better to make vacancy a condition of purchase? What happens if the existing tenant is “perfect” in every way, except that he has an aggressive dog?
There is no one-size-fits-all answer for these types of scenarios. Ultimately, the purchaser will have to determine if he thinks it makes more sense to keep the existing tenant versus risking a period of vacancy and/or finding a replacement tenant that also seems “perfect” on paper but turns out not to be.
Please note that the information provided in this blog post does not, and is not intended to, constitute legal advice. Instead, all information in this post is for general informational purposes only. Those individuals contemplating purchases of rental properties should seek guidance from appropriate professionals.