Each investment property comes with its own risks and rewards, and this is even truer when your property comes with rent-paying tenants, so you can start collecting rental income right away.
However, there are ins-and-outs to buying a tenant-occupied rental, and every investor should know the potential roadblocks and benefits to inheriting tenants with your new investment property.
Leases Are Still Legal
While a lease is a legal agreement between tenants and a landlord, the lease does not dissipate with the sale of the property. Just like easements and other covenants that are considered to “run with the land” the leases are tied to the property itself and not simply the owner. This means that the lease stays “attached” to the house if you purchase the property and you will not be legally able to raise the rent, modify clauses or kick the tenant out simply because you are the new owner. The only exceptions to this are instances where the termed lease specifies that the owner (the property’s seller) has the right to termination upon transferring the property, or if you are purchasing the property as a foreclosure, in which case you can refer to your state’s regulations regarding notice to vacate.
If you truly do not want the tenants in the home–because you would like to occupy the property yourself or because you would like to start fresh, you can submit an offer that is contingent on the property being vacant upon closing. In this instance, the burden is placed upon the seller to legally break the lease.
[Note: Since the tenants have a legal right to live in the property until their lease term ends, this can often mean the best option for the seller is to offer the tenant cash for keys.] The other option is to buy the property and then break the lease(s), renegotiate the terms or “buy out” the tenant(s) yourself. This can be a risk however because the tenants are not obligated to accept, and you could put yourself in the position for a lawsuit if you attempt to break the lease or force an eviction.]
When to Make a New Agreement:
If the current tenants are not in a termed-lease, but simply a month-to-month agreement you are afforded a few more options to change the rental situation. You can ask your new tenants to sign a new lease agreement or can raise the rent as needed–provided you give them the notice as dictated by your state and local laws. This can be useful to protect yourself, your investment, and guarantee that both you and your new tenants are on the same page. Treat this like any other lease signing, and carefully go over the lease terms to verify that your tenants do not engage in any lease-breaking activity under the premise that it was previously allowed.
Existing Tenants: The Good and The Bad
In theory, purchasing an investment property with existing tenants is ideal. This means immediate cash flow, no downtime searching for the right renters to occupy your new property, and (if the tenants have lived in the property long-term) you have a limited risk of the property becoming vacant in the near future.
Tenant screening is vital to ensuring that your investment is protected. Poor tenants can create havoc through unpaid rent, property damage, and drawn out eviction cases. Unfortunately, inheriting existing tenants means that you are forced to rely on the previous landlord’s tenant screening process–which may be lacking. The seller could have accepted any applicant (regardless of qualifications) simply to list the investment property as occupied, or they may have a long-term tenant who simply refuses to pay rent on time or at all. Buyers beware– a landlord could simply be selling their property to offload the problem tenants onto an unsuspecting investor.
Other roadblocks can occur with existing tenants. You may find that the current occupants are dream tenants, but they are unprepared to continue to occupy the rental under a new landlord. The sale of a property is a big change for a tenant, and if your new tenants have lived in their existing property long-term, they have likely settled and become comfortable with their current rent price and lease allowances. If the previous landlords were not increasing the rent yearly or were not performing regular seasonal inspections, you may find that your new tenants balk at the changes you must make to protect your investment.
Before The Sale is Final:
Whether your inherited tenants are currently on a month-to-month agreement or a termed lease, there are a few tasks you must perform before closing on a renter-occupied property to ensure the process runs smoothly. First, consider introducing yourself to your new tenants via a landlord introduction letter. (You can find a sample landlord introduction letter here.) This will make your tenants feel more comfortable during the transition and put in place the foundations of a great landlord-tenant relationship. Additionally, it will allow you to include important information such as where and how rent is to be collected, and how tenants may make maintenance requests.
Finally, since you will be assuming the responsibilities of the previous landlord, it is imperative that you fully protect yourself. Reduce your risk by instructing your tenants-to-be and the seller (current landlord) to fill out an estoppel agreement along with transferring the security deposit over to you. An estoppel agreement allows your future tenants to spell out any current lease terms or property allowances that are in effect. While, in general, the lease agreement will cover a lot of these areas, there are circumstances that only an estoppel will address. For instance, if the tenant makes a claim upon move-out that they paid a larger security deposit than you have a record of, or that the window AC units are theirs and do not stay with the property. In these cases, you can refute untrue claims with the estoppel agreement. Knowing the current property owner will see the Tenant Estoppel Agreement should prevent the tenant from providing false information.
Purchasing a renter-occupied investment property is an exciting opportunity for investors who want to begin collecting rental income immediately. Before closing on a renter-occupied property be sure to consider the lease agreement and review the tenant screening criteria the seller used to qualify the current tenants. If you can agree to the lease terms and feel confident with the current renters, continue with a landlord introduction and creating an agreeable estoppel agreement. If the current tenants are month-to-month renters, you have more options for modifying the current lease and tenancy as long as they meet state and local laws. Check in with local property managers and real estate investment groups for more advice on rental properties in your area.