Buying Rental Property With Existing Tenants
Buying rental property with existing tenants can be a dream come true for you as a real estate investor.
Ideally, the property is priced at a point where the rental income covers all expenses, with some change left over, leaving you cash flow positive.
It’s even better if you are buying rental property with existing tenants, and not having to do any additional work on the property.
Who would not want this golden egg?
Even if it seems like an awesome deal, there are some things you have to look for when buying a rental property with existing tenants, to make sure everything goes as smoothly as possible.
After all, some home sellers may be passing off their headaches to you!
Tip 1: Buying a Rental Property With Existing Tenants: The Lease Agreement
One of the first things you want to consider when buying rental property with existing tenants is to look at is the lease agreement that is currently in place.
The lease agreement will provide you with a wealth of information, that is imperative for you to know before making an offer, and ultimately before closing on the property.
Before you buy the rental property, some of the key things you want to consider in the lease are:
1. When is the lease set to expire.
2. Is there a clause in the lease that allows for the landlord to break the lease in the event of a sale of the property.
3. What is the location of the security deposit and amount of the deposit
4. What is the Monthly Rental Agreement
Now let’s take these one by one, so that you understand the full benefit of each.
When is the Existing Tenant’s Lease Set to Expire
This is an important consideration.
Not only when you are considering buying the rental property with existing tenants for cashflow reasons, but also in the event you want to get rid of the tenant’s quickly.
As a real estate investor, you approach things with a different set of eyes.
The ugly house that others walked away from can be flipped for a profit.
The graffiti in a neighborhood may someday be regarded as hip street art.
The same holds true when viewing tenants.
While, ideally, you want the awesome tenant in place who will keep paying their rent, and keeping you cashflow positive, you sometimes have a rental property with existing tenants who are a nightmare.
And you want to get rid of them as quickly as possible, to keep your positive cash flow.
You don’t have to walk away from the deal. Just look at the end date on the lease, combine it with your financial numbers, and figure out your threshold for when you need the tenant out of the property.
If it is longer than you are willing to wait, you could offer cash for keys to the tenant, and make the tenant’s vacating the property a condition for closing.
Remember, you always want tenants who will boost your rental value!
Do The Existing Tenants Have a Clause That Affects You as a Buyer?
Along similar lines as the expiration date, you should also see if there are any provisions in the lease which trigger, or provide you with rights upon the sale of the property.
In particular, you should look for a clause which states that the lease between the landlord and the existing rental property tenant, can be voided by the landlord upon a buyer purchasing the property.
This is referred to as a Termination in the Event of Sale Clause.
This is the type of language you are looking for in the lease agreement:
It is expressly agreed that Landlord, at its option, may terminate this Lease upon XX days notice to Tenant in the event of a sale of the building containing the Premises.
As you can see, this is a completely one sided clause. The tenant doesn’t have the right to terminate the lease, the landlord does.
What this means is that you now have the flexibility to keep a good tenant, or quickly get rid of a bad tenant.
At any rate, this out gives you a lot of options to choose from, to make the best possible decision for your buying a rental property with existing tenants.
Absent this clause, you would be stuck with the lease agreement and the tenants until their lease has expired.
Where is the Security Deposit for the Existing Rental Property Tenants
Ok. Let’s face it. Many landlords don’t keep the security deposit where it needs to be kept.
In fact, many of them engage in illegal activity with the security deposit.
Comingling of funds is probably one of the biggest one.
We won’t go into detail about how to handle a security deposit. You can check out our detailed blog if you would like more information.
For now, we want you to understand that you must know the amount of the security deposit, and where it is kept.
Don’t just take the property owner’s word for it. It should be in writing.
You also want to make sure the numbers match up with information from the trust account, the lease, as well as the Estoppel Certificate you get from the tenant (more on the estoppel certificate below).
What is the Monthly Rental Amount for the Property
While you may think this should be your biggest concern, it isn’t. You have to get through the first three things before you get here, because now you can put everything into perspective.
We are sure you had previous conversations with the current property owner about how much he charges for rent.
But, you have to always be aware that some property owners will inflate their rental earnings.
Not to the IRS mind you, because they want to keep taxes low.
The landlord will, however, give you the appearance they are bringing in more money than what they actually are.
To verify the rental amount when buying a rental property with existing tenants, you are going to want to look at the lease to establish the monthly rental amount.
But this is only the first step. Next comes the Estoppel Certificate.
What is an Estoppel Certificate When Buying Rental Property With Existing Tenants
In plain language as it applies to buying a rental property with existing tenants, the Estoppel Certificate is declaration by the tenant that more or less reiterates the relevant portions of the lease that you should be aware of.
In other words, the Estoppel Certificate is forces the tenant to verify the terms of the existing lease agreement, and protects you by making sure everything is correct, so nothing can catch you off guard.
Some important contents of the Estoppel Certificate include:
1. Names of all tenants and occupants of the unit
2. Lease term with both the start and end date
3. Rental payment amount and when it is due
4. Security deposit amount
5. Which party is responsible for utilities
6. Who owns the appliances in the rental property
7. Does the existing tenant have any pets
8. Does the property need any repairs
9. Does the existing rental property tenant have any other agreements with the landlord
As you can see, much of the content overlaps things in the lease. And this is a good thing.
Armed with the Estoppel Certificate, the lease agreement, and your conversations with the landlord, you now are in a better position to understand your bargaining power, or if you want to walk away.
Tip 2: Buying a Rental Property With Existing Tenants: The Walk Through
Yes, we know that you will likely do a walk through.
In fact, it wouldn’t be a great idea to skip it.
Aside from looking at repairs that may be needed, or determining an offer, you should be also looking closing at the tenants.
When buying a rental property with existing tenants, investors sometimes get caught up in the numbers, and not the people behind the numbers.
Your walkthrough is an opportunity to see how the tenants are living.
Are they treating the property well? If yes, and they are paying their rent on time, these may be keeper tenants.
If the house isn’t in the best shape because of the tenants, and even if they are paying their rent on time, these may be tenants you want to walk away from.
All money isn’t good money. Go find tenants who will treat your property well, and pay rent on time.
The walkthrough doesn’t only include looking at how the tenant’s live when you are considering buying a rental property with existing tenants.
You should also do a walkthrough of all of the documents related to the tenants.
You would want to look at the application of the tenants, including credit reports and background checks. This will give you some insight as to whether you would have rented to the tenants in the first place.
A caveat to this is that you want to avoid any discriminatory reasons if you decide to not renew the tenant’s lease agreement. There is no quicker way than a discrimination lawsuit to bankrupt you.
You also want to see a detailed payment history of the tenant. Ideally this would all be some electronic format, however, there are still landlords who take cash.
As a property investor, you have to do your best to trace the money from the tenant to the landlord. This way you aren’t left holding another landlord’s bag of poop.
Tip 3: Buying a Rental Property With Existing Tenants: Condition Everything in Order to Close
Now that you have all the information you need about your potential new tenants, if necessary, you should make certain conditions mandatory prior to closing.
You are probably aware that you should identify certain repairs that should be conducted prior to closing, but it is equally important that you make conditions concerning your tenants.
Wanting the tenants out of the property may be one of the things you should consider.
By making this a condition for closing, you now put the ball in the landlord’s court to get rid of the tenants, thus alleviating you of a headache.
The landlord can provide the tenant with incentives such as Cash for Keys, to get them out of the property.
If the tenants haven’t paid rent, or could be evicted for some reason, the landlord now has the motivation to get the ball rolling.
There is one big caveat to the eviction process.
MAKE SURE THE TENANT IS GONE FROM THE PROPERTY!!!
What this means is that you should makes sure that the landlord has not only filed the eviction, but the tenant has exhausted all appeals, and has been removed from the property.
You don’t want to take over ownership, only to find out that the tenant is still there, and a judge has overturned the previous ruling.
Wrapping Up Buying a Rental Property With Existing Tenants
While buying a rental property with existing tenants can definitely be financially rewarding, you must be aware of the pitfalls that you could also face.
As the only property management company in Fayetteville, NC led by a retired military attorney, and licensed North Carolina lawyer, we are in the unique position to ensure your asset is protected.
Don’t hesitate to reach out to us if you have any questions.
The Team at Linchpin Property Management
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P.S. We love to network. Send us a message, give us a call ,or stop on by if you are in the Fayetteville area.
The coffee is on us.
Linchpin Property Management
2529 Raeford Rd. Unit C-7
Fayetteville, NC 28305
(910) 236-9844
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