When purchasing an investment property, more than likely, that property already has tenants under lease. When you close on the building, those standing leases will become your leases. Most commonly, as long as they abide by the agreement they signed, the tenant will have the right to stay in the property under the terms of their lease until that lease expires. A tenant’s lease is directly tied to the property, not the current or former owner. That means even though one of the parties (the landlord) has changed, the other terms of the lease agreement have not.
A quick word of caution: some rules governing inherited leases are different between states and municipalities. The content of this article applies to most situations, but be sure to double check your location to ensure you’re staying within your legal obligation when it comes to handling inherited leases.
What’s in a Lease?
Before we dive into how to handle different parts of an inherited lease, it’s important to define what those parts are. A lease agreement is broken down into separate clauses that establish various rules and obligations between a landlord and tenant. Those rules and the terms that govern them can vary widely in scope (believe me, we’ve seen one-page leases and leases with more than fifty pages). There is no end to the requirements a lease could include. But still, there tend to be a handful of common terms, clauses and sections that each lease agreement contains in one form or another. Some of these include:
- Parties involved – most often landlord and tenant(s)
- Descriptions and location of the property
- Occupancy limits
- Terms (start date and end date) and obligations
- Amount of rent
- Responsibility of utilities
- When and where to pay rent
- Late fees and penalties
- Security deposit amount (including pet and other deposits)
- Pet policy
- Unit alterations, maintenance, and repairs
- Property access
- Property amenities
- Any other important points
If you’re looking for more details on the basics of a lease, we’ve put together a list of ten of the most important terms you should include in your rental agreement.
Review the Lease Documents
It is absolutely paramount that you go through the lease documents that you’ve inherited with a fine-toothed comb. These contracts are now your obligations after all, and you need to know what you’re committing to. Make sure that all of the above sections are addressed (and maybe more).
In all likelihood, the leases will all be the same format with only a handful of variables changed, like the named renter, the rent amount, lease dates, and security deposit amounts. If that’s the case, your work will be a bit easier as you can skim through some of those common sections. But it doesn’t mean you can skip it.
Be on the lookout for strange clauses or commitments from the previous owner. In fact, depending on what they’ve committed to, you may find it necessary to adjust your purchase offer or to make sure arrangements are made to accommodate for whatever they’ve committed you to. For example, if you expected to have access to a basement to store equipment but you find it’s entirely reserved for a single tenant, you may want to negotiate a new arrangement with that tenant and it could cost you money.
Lease agreements govern the tenant-landlord relationship. If you know the ground rules of that relationship, you will be best equipped to manage your properties effectively.
More than likely, your prospective new tenant(s) should have made a security, pet, or other deposit to the previous landlord. That money will be transferred to you as part of the sale. In reality, this money doesn’t belong to you; it is to be held in safekeeping for if or when the tenant moves out. Some states require you to hold that money in a trust account separate from any other funds you receive, some require that you pay interest on the deposit when you return it. Again, be sure to consult a local apartment association or lawyer to confirm your obligation.
Before agreeing to the sale, be sure to have the seller give you the tenant’s payment history as well as any other documentation they have on file. Along with the financial paperwork, it is advisable to get any paperwork on the condition of the property when the tenant moved in. This will ensure you have the proof you need if there is damage later on. Meeting with the tenant ahead of the sale and inspecting the property is also a good idea. It can help get the landlord-tenant relationship off to a good start.
If you close on a property close to the rental due date for the tenants (e.g. the first of the month), there is a decent chance some of the tenants will have paid their rent already. A tenant paying early is definitely a good problem to have, but it does mean you’ll need to arrange a transfer of those funds from the previous owner as well.
In some cases, one or more of the tenants will have paid months or even years in advance. It’s a good idea to check with the existing tenants to match the rent balances provided by the seller with what they believe they’ve paid.
Professional Help for Inherited Leases
Consider having a few other professionals on your team if you are inheriting tenants. Their addition could save a lot of frustration, headache, and money down the road.
Hopefully, you’re already working with an excellent real estate agent or broker. They should be well-versed in the type of property you’re buying and the area you’re choosing. It is also the time to make sure you have a good accountant and lawyer lined up. Keep in mind that local is better when it comes to these professionals. They must know the laws and regulations that affect your area and state. What’s more, even a great lawyer or accountant is not great at everything. Hire those that specialize in real estate – even better, property acquisition.
Landlords are penny-pinchers, and for good reason. Real estate tends to operate on tight margins and cash flow is critical to paying bills and extracting the most value out of your investment property.
A local accountant can help you weigh the benefits vs. the disadvantages of being a landlord in your area. There are often favorable tax deductions associated with owning rental property. Some are federal while most are deductions that are specific to each state. Many repairs, upgrades, and other expenditures for your rental property will be deductible. There may be gray areas regarding what you can claim if you have hired a property management company. It may limit or change what you can write off on your taxes against the income you receive from the rental. This is when your accountant can become your best friend.
It is helpful to have a local lawyer look over any rental agreements that are already in place on the property. They can spot any potential problem areas in the lease and advise you if an issue does come up. Your lawyer can write up future agreements that protect both you and your tenants. It is a good idea to get your tenants switched over to your own lease as soon as possible. Ensuring that you have enough insurance is another plus to having a lawyer on your side. Standard homeowner’s insurance isn’t sufficient when dealing with rentals. Your lawyer can advise you on the coverage you need to buy.
How To Terminate Or Change A Lease
Hopefully, there is a clause in the current agreement about the change of ownership. Some leases will state that the lease is terminated upon sale or transfer of the property. If not, you’ll either have to wait until it expires, or the tenant breaks the lease.
All that being said, there are some exceptions that can help relieve you of an inherited lease agreement:
- You can specify in the property sale offer that it must be vacant upon closing (or other agreed upon date). This makes it the responsibility of the seller to find a way to break the tenant leases or lose the sale.
- Both you and the tenant decide to end the lease early or make changes to the terms. In other words, this is a mutually agreed upon termination or alteration of the lease. This may include some type of lease “buyout” or other incentive to the tenant.
- If your new tenant was on a month-to-month lease, you only need to provide a 30-day notice (in most states) to escape the lease. This will allow you to either end or renegotiate the terms of the current agreement. Check your local laws though, as it does vary.
- For a property that you are planning on making your home, there is a process called “owner move-in eviction”. It allows you to legally evict the tenant so you can move in. Each state varies on the terms of this type of eviction, so be sure to do your homework and consult a lawyer first.
- If you buy the property under a foreclosure sale, there is often a provision to remove any tenants in place. Again, consult your state’s laws though, as the required notices and times allowed will vary.
Alternatively, as long as the existing lease agreement doesn’t have any majorly problematic clauses (that’s what the lawyer is for), you could more simply modify it. You have a few options for altering a lease mid-term, but the two most common are using lease addendums and amendments. In either case, you may need to resort to some sort of incentive for the tenant (under most circumstances, they have no legal obligation to sign an addendum).
You should now have a better idea of what to expect when you decide to buy a property with inherited leases. Arm yourself with the right questions and have your team ready to make the transfer go smoothly. Time spent in preparation will benefit both you and your new tenants.
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