Real Estate Investing

Legal Checklist When Buying a Rental Property

April 9, 2020

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What Legal Items Should You Tick Off When Buying A Rental Property?

There are countless articles, books, and conferences instructing budding landlords on how they can get started in real estate and grow a substantial and formidable portfolio of income earning properties. For the most part, this is a good thing – property investors have a great deal more information available to them than ever before. Prior to signing a purchase agreement for their first real estate property, a soon-to-be landlord will likely have read and learned techniques for financing through a mortgage lender, marketing their rentals, managing their tenants, using cash-flow and cap rate analysis on an investment opportunity. They may even have substantial projections laying out their best laid plan for growth.

While this information is tremendously valuable, sometimes the nuts and bolts of real estate transactions are lost in the mountain of information and excitement. When you’ve finally found the perfect first purchase, what should you do next? Most importantly, which legal steps should you take to ensure your investment is smart and protected? The following article serves as a legal checklist that you should run through before purchasing a rental property. Some of this may seem mundane and even tedious, but like the property you’re purchasing, the foundation of your investment is critical. After all, a “good investment” is only good if it’s protected.

Check the Property Title Documents

You may have heard the words “deed” and “title” used interchangeably. They are relatively synonymous but still distinct, so let’s quickly clear the confusion. In the context of real estate, “title” is a concept that conveys ownership of a property. A deed is the physical representation of that ownership. In other words, a deed is a document that proves the property owner has title to a property.

The deed to a property will include signatures from both the buyer (you, the new owner) and the seller (the previous owner). Every deed ever associated with a given property is held by your county assessor. When viewed in aggregate, this “chain of title” provides proof that ownership transfer (represented by your new deed) is legal and binding.  

The very first thing you should do when purchasing a property is to review the latest deed on file and verify the seller is the current owner. You can certainly pull this information yourself, but it’s typically best to have a title company, attorney, or your lender research the full chain of title. They’ll ensure all documents are unearthed and that you have a full picture of the property you’re considering purchasing.

This is important because, through the history of a rental property, additional documents can be added to the deed. Here are just a few examples:

  • An easement – an easement is an agreement that permits someone that does not own a property to use some or all of the property for a specific purpose. Common examples include running utilities across someone’s property or a shared driveway.
  • A covenant – a covenant is an agreement that restricts or defines the ways in which a property can be used
  • A lien – a lien is a legal claim placed on a property by someone for money owed. For example, there may be a mortgage lien if the owner has defaulted on their mortgage loan, a property tax lien if they haven’t paid their taxes, or a federal tax lien if they haven’t paid income taxes. Liens can be both voluntary (as is the case with a mortgage lien) or involuntary (such as tax liens, judgment liens, or other legal claims). As long as a lien is on a property, its title cannot be transferred because someone else has a claim on it.

In the case of a property lien, these can stop a deal in its tracks. Easements and covenants can also be painful if they’re unexpected.

As an additional layer of protection, you should also get title insurance. Title insurance protects you in the case that a lien or some other encumbrance goes undetected. To protect their financial investment, your lender will likely require this, but regardless, it’s a relatively inexpensive assurance at a typical rate of around $1,000. You may think you can get away without it, but skipping title insurance is a risky move that could return to haunt you if there’s a lien left undiscovered.

Receipts of Property Taxes

You’ll learn that most of the checklist is just verifying the information you have regarding the property. Now that you have the title sorted, it’s time to confirm all necessary taxes have been paid. Request receipts confirming payment of taxes on the property from the seller. If they cannot provide them, you’ll want to reach out to the local government tax office to confirm. An unpaid tax bill can be a very unwelcome surprise. Usually this means there are property tax liens on the property that represent the government’s legal claim on the property and will prevent it from being bought or sold.

Crafting a Property Purchase Agreement

Now that you’ve confirmed the seller owns the property title and your purchase will be unencumbered by any unexpected obligations, it’s time to create your property purchase agreement, also known as a purchase and sale agreement or real estate purchase contract. This is your primary contract, and it outlines the conditions of the purchase, the closing date, down payment, closing costs, any earnest money deposit, and the agreed upon purchase price. Fortunately, not much work is required on your end for real estate purchase agreements. Real estate agents usually handle this aspect for the buyer and seller.

The buyer’s agent (i.e., your real estate agent in the transaction) will provide the real estate purchase agreement. Be sure to let them know any specific requirements you have of the seller (for example, if you’d like them to replace a broken window) or contingencies you’d like in place that allow you to exit the real estate transaction.

Beyond these two very important documents, there are several additional certificates your lender will require. These may include an Encumbrance Certificate, No Objection Certificates, Commencement Certificate, and / or a Conversion Certificate. These all amount to legal approvals of the ownership and representations of the seller and the intended use of the property. Your agent should briefly explain each of these to you, but they are fairly standard and (assuming you have an agent you trust) are not worth investing too much of your time in.

Overall, buyers and sellers who have a good, licensed real estate agent representing them should not have to worry too much about crafting the house purchase agreement or ensuring that purchase and sale agreements include all the necessary components.

Physical Inspection of the Property

Your property purchase agreement should afford you the right to inspect the rental property. Unless you are a licensed property inspector, do not do this yourself. It’s your last chance to avoid a major mistake so leave it to a professional. They will check just about everything, but there are a few specialty inspectors you can bring in if needed. Ask your inspector what they’ll cover so you can determine whether or not you want to bring any additional resources in.

Completing the Purchase

If the inspection checks out, and there are no existing property liens on the home, you are all set. You are now prepared to sign the real estate sales contract with the sound knowledge that you’ve ticked all the legal boxes. Both the buyer and seller agent want a good deal to go through, so they’ll happily walk you through any additional questions you have. Overall, it should be a painless process, but being well-informed will ensure no mistakes are made.

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