While many of the closings you work on as a Realtor involve owner-occupied properties (and you know exactly what to do), do you know how to approach one that is tenant-occupied? In situations where a property is tenant-occupied and the tenant will remain in the property after closing, the contract must be handled a certain way to ensure that your client, whether it’s the buyer or seller, is protected throughout the transaction (and after closing). This article will touch on some of the more important aspects from contract to close when a tenant will remain in the property after closing.
I know this sounds a little crazy, but if there is nothing in the contract to address that there is a lease and the parties don’t share that information with the closing attorney, we will have no idea that a lease is involved. That would be a disaster! There is nothing in the public record or our title search that would alert us to a tenant-occupied property. The fact that there is a lease in place must come from the parties involved with the closing.
Pre-Contract – Listing Side:
If you are listing a home that is tenant-occupied and the tenant will remain in the property after closing, the first thing you must do is obtain a complete copy of the lease. Oftentimes your seller-client will tell you that there is no lease. Most of the time that is just not true. What a landlord doesn’t always appreciate is that if there has EVER been a written lease (even if the initial lease term has expired), that lease is still valid and controls the relationship between the parties.
If there is no amendment extending the lease term or a provision in the lease that automatically extends the same, then it is a month-to-month lease. A month-to-month lease can be terminated by the landlord with a 60-day notice to vacate and the tenant can terminate with a 30-day notice to vacate. Proper delivery of said notice should be set forth in the lease agreement.
If there was a written lease, but the seller cannot locate it, that can create issues down the road. I would recommend you ask your client to reach out to the tenant to ask if he or she has a copy of the lease. If neither the seller nor tenant can find a copy of the lease, have your client email the tenant confirming the following: (1) neither party can locate the written lease and (2) the basic terms of the lease arrangement (i.e., monthly rent amount, security deposit amount and any other unique aspect of the lease). In addition, please have the tenant confirm that there is no pre-paid rent. Pre-paid rent is rent paid in advance (i.e., the tenant paid rent six months in advance). Having this information confirmed by the tenant will protect you, the buyer and the seller.
If there NEVER was a written lease, you should still have your client confirm with the tenant in writing the same information set forth in the preceding paragraph.
As a listing agent you want to ensure that you are prepared to provide a copy of the lease to the selling agent (and ultimately the closing attorney) at the time of binding agreement or shortly thereafter. In the event the written lease cannot be located or there never was a written lease, you want to be able to explain that to the selling agent and provide both the selling agent (and ultimately the closing attorney) the details governing the lease arrangement.
Lastly, you must confirm with the seller that the lease terms are in fact what is shown in the lease. The most common problem we encounter is when a lease sets forth a term like the rent or security deposit amount, but the seller tells us around closing time that it’s actually less than the amount stated in the lease. I’ve also had a situation where the security deposit was used by the seller for late rent. Under either of those circumstances, the seller must have an amendment drafted and signed by the tenant acknowledging the change before there is a binding contract. If that does not happen the buyer will expect the written lease terms to control for both pro-ration of rent calculations and the amount of the security deposit transferred at closing.
Offer Time! – Selling Side:
You finally found your client the perfect home! But there is a tenant occupying the property that will remain in the home after closing. While your approach to the offer will be the same whether your buyer is purchasing the property as a primary residence or second home, it will be a little different if it’s being purchased as an investment property. Also, if it’s a cash transaction (meaning no lender is involved with financing the purchase), your approach will be a little different as well.
Standard Offer Language Regardless Of The Type of Transaction:
It is critical that the buyer has an opportunity to review any existing lease during the due diligence period to ensure that he or she is comfortable accepting the lease as is. The buyer has no unilateral right after closing to renegotiate the terms of the lease unless the lease will terminate shortly after closing. In that case, and after closing, the new buyer and tenant can renegotiate the lease or, if the negotiations fail, the buyer has the right to terminate the lease pursuant to the lease terms or a 60-day notice to vacate, whichever the case may be. While I don’t see it often, some leases give the landlord the right to terminate a lease early. When that occurs, the lease generally requires the landlord to pay the tenant a sum certain if the landlord terminates the lease early.
Why is it so important to review the lease? What if the seller entered into a five-year lease with her nephew at $100 rent per month. Your buyer would never accept a lease under those terms. Also, if it’s a loan transaction for a primary or second home, the existence of a long-term lease will prevent your client from qualifying for the loan. No matter the reason, if your client is not satisfied with the lease currently in place and he or she does not terminate during the due diligence period, your client will be in breach of contract if he or she does not close on the property (assuming your client doesn’t have another right to terminate the contract).
You should include the following (or something similar) in the special stipulations section of the purchase and sale agreement:
***The information contained in between the *** is commentary and not to be included in the special stipulations.***
1. All parties understand and acknowledge there is a tenant (or tenants) in the Property who will remain in the Property after the Closing Date.
2. Within __ days after the Binding Agreement Date, Seller shall provide to Buyer complete copies of any and all leases associated with the Property, including any amendments thereto.
***Obviously you need to fill in the number of days.***
3. Monthly rent collected for the month of closing (and any pre-paid rent) shall be pro-rated between the Buyer and Seller at closing on the settlement statement. If a lender is financing the transaction, all parties agree that if the lender will not allow the pro-ration of rent on the settlement statement that the Seller shall provide Buyer a certified check at closing for the pro-rated rent for the month of closing (and any pre-paid rent).
4. Security deposits (including non-refundable pet deposits) shall be transferred from Seller to Buyer at closing on the settlement statement. If a lender is financing the transaction, all parties agree that if the lender will not allow the transfer of a security deposit on the settlement statement that the Seller shall provide Buyer a certified check at closing for the security deposit.
***If the property is currently managed by a property management company and the buyer will NOT be using the same property management company, then it is the seller’s obligation to get the security deposit held by the management company back after closing. The buyer and seller’s property management company have no contractual relationship.***
***If the property is currently managed by a property management company and the buyer will be using the same property management company, then it is not necessary to transfer the security deposit at closing (assuming the property management company is holding the security deposit). The buyer, however, will need to have a new management agreement in place prior to the closing date.***
5. Seller shall not have the right to modify the lease without the prior written consent of the Buyer.
*** This is really important. If the seller modifies the lease after the buyer has reviewed the same it can create all kind of legal issues. I had a situation where the lease expired after due diligence and before the closing date. Without the buyer’s knowledge, the seller renewed the lease with the tenant for another year and lowered the rent amount that was in the original lease.***
6. Buyer and Seller shall execute a lease assignment agreement at closing. Said lease assignment shall be prepared by the closing attorney.
***A lease assignment is a document that, among other things, transfers the written lease from the landlord-seller to the new buyer.***
Additional Offer Language For Financed Transactions For A Primary Or Second Home:
When a lender is financing a transaction for a primary residence or second home, the buyer must take possession of the property within 60 days of closing. How does that happen if the property is tenant-occupied? First, the lease term must be expiring within 60 days of the closing date OR the current lease is a month-to-month tenancy. Either way, with proper notice to the tenant from the seller that timeframe can be achieved. Second, the lender will require proof that a notice to vacate was timely sent to the tenant by the seller (when there is a month-to-month lease) or a notice that the lease term is expiring and the lease is not being renewed (when the lease term in the lease is set to expire within 60 days of the closing date). The lender may also require that the tenant acknowledge receipt of said notice and confirm that he or she will vacant the property by a date certain.
Providing notice to the tenant prior to the closing date is certainly a risk for the seller in the event that the closing does not occur. The seller, however, will have no choice to issue the notice under lending guidelines.
You should include the following (or something similar) in the special stipulations section of the purchase and sale agreement:
7. Buyer and Seller acknowledge and agree to cooperate with all lender requirements relating to the lease and tenant, including, but not limited to, seller’s obligation to timely provide a notice to vacate to tenant or a notice that the lease term is expiring and not being renewed, whichever the case may be.
Financed Transactions For An Investment Property:
When a lender is financing an investment property (defined by the lending world as a non-owner-occupied property), the 60-day timeframe for an owner-occupant to reside in the property after closing is not a requirement. Please understand, however, if the buyer is purchasing a duplex and will reside in one of the units, this type of transaction is considered a primary residence and not an investment property for lending purposes. I know that may be obvious but I wanted to mention it nonetheless.
Review The Seller’s Disclosure:
The last thing you and your client need is trouble when the tenant moves out. The buyer must review the seller disclosure carefully to ensure that he or she understands which items will remain with the property. More specifically with tenant-occupied properties, you must confirm that everything checked on the seller’s disclosure is in fact owned by the seller. I had a situation where the seller stated that the refrigerator was included in the sale. When the tenant moved out a year later, he took the refrigerator. Why? Because it was owned by the tenant, not the seller.
After Binding Agreement:
So you completed negotiations, confirmed everything with the lender regarding the tenant and are waiting for the closing date. We all know how much is left to do with inspections, financings, etc. before the big day. One of the most important things you can’t forget is to send the lease agreements to the closing attorney. The closing attorney must have the information contained in the lease as soon as possible to accurately draft a preliminary settlement statement that is sent to the lender generally two weeks before closing. And this is also the time the closing attorney confirms whether the pro-ration of rent and transfer of the security deposit can be included on the settlement statement.
Short-Term Vacation Rentals:
A short-term vacation rental (STVR) is handled differently than a lease agreement. While STVR reservations, security deposits, etc. must be addressed in the purchase and sale agreement, the stipulations are not exactly like the ones discussed above. Obtaining all of the information regarding current and future reservations during due diligence is just as important as reviewing the terms of a lease during the same time. Also, the closing attorney generally is not involved in any way with pro-rations of rent, security deposits, etc. for STVRs.
Conclusion:
Simple right??? It really is, but where things go sideways is when the issues above are not addressed at all or not addressed timely or completely. Happy house-hunting! I know the inventory is not where you or your buyer clients want it to be, and your client may fall in love with a home that has a tenant in the property. While not ideal, your buyer may have to be a landlord for a little while to ensure they get the house they want.
As always, if you need help with anything at all please call me on my cell anytime (even nights and weekends and even if the closing is not in my office) at 912-484-1996 or email me at jgerber@brannenlaw.com.
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