Tenant’s Rights Prevail: Buying a Tenant-Occupied Indianapolis Rental Property
If you are like most investors out there, my guess is you spend a lot of time reviewing MLS listings.
I’ll also guess that you’ve run across some language in an MLS description that includes a phrase, “Tenant’s rights prevail.”
Here’s an example of a description I found on our local MLS system…
“Investor alert! Check out this spacious and updated ranch on Indy’s west side. Home went through a complete remodel 6 months ago, including new roof, HVAC, kitchen and bathroom updates. Home is Tenant occupied. Tenant’s rights prevail.”
Now, as you know, or as you should know, Tenants do have certain rights when living in a property, including…
- The right to quiet enjoyment
- The right to occupancy
- The right to a habitable home
TENANT’S RIGHTS PREVAIL DEFINED
In the context of an MLS listing, the term “Tenant’s rights prevail” simply means that, if you buy the home, you are likely inheriting not only the the Tenant, but also the terms of any existing Lease.
Meaning, you can’t, without the mutual consent of the Tenant, automatically make Lease changes, or get rid of the Tenant, just because you own it.
Bottom line: in these scenarios, you are likely going to be stuck with the terms of the Seller’s Lease and stuck with the Tenant, no matter how well, or poorly, they are performing.
Realtor tip: For you Realtor’s out there, who may service Owner occupant types, this is especially important for you. While your Buyer can own the home, he/she may not be able to occupy until the existing Lease is over, or you can negotiate a cash for keys scenario.
Inheriting and Tenant and a Lease may or may not be bad news. Obviously, the key here is to carefully review the Lease and the Tenant’s performance.
There are two major points of the Lease you will want to review:
- Rent Amount – Obviously, how much rent the home is currently generating will play a major factor in how much you’ll offer for the home. In nearly every scenario, when evaluating a property for purchase, you start with income.
- Term of Lease – Coupled with the rent amount is the term of the Lease; i.e. how long the lease is effective. The Lease could be month-to-month or it could extend for another several months or even years.
Knowing both the rent amount and the term of the Lease will allow you to make better buying decisions.
For example, let’s assume the home is rented for $900, but you and your Realtor feel like the fair market rent is closer to $1,100. Let’s also say the Lease term is month-to-month.
In this case, you might agree to pay a little more for the home (than you would if the lease was locked-in for several months), knowing that you can justifiably raise the rent with a 30-day notice, or find another Tenant at the fair market rate.
Now, if the Lease terms extends another 12 months, at the $900 rate, it could dramatically affect what you’ll agree to pay for the home.
Landlord Tip: As a Landlord, getting fair market rent for your home, and not always renewing at the current rent rate, will not only put more money in your pocket along the way, but will also allow you to sell the home at a higher price. Most Tenants expect a rent increase. Don’t be afraid to ask for one if market conditions justify it.
Other Lease Considerations
While rent amount and lease term are probably the two biggest items to review, there are other key points of the Lease to consider, including:
1) Maintenance responsibilities – As we’ve written in other blogs, Landlords have certain statutory requirements when it comes to maintenance. However, there’s a lot of maintenance items that could be either the Landlord’s or the Tenant’s responsibility. These include:
- Landscaping – Who mows the yard, pulls weeds, trim bushes, etc.?
- Furnace filters – Some Leases require the Tenant to change the filter on a regular basis.
- Pest Control – Who is responsible for controlling spiders and ants? Who is responsible for the treatment of Bed Bugs?
- Maintenance Cost – Some Leases (some Lazy Landlord Leases) require the Tenant to pay for all maintenance costs below a certain dollar amount. Be careful, since some maintenance items are, by law, the responsibility of the Landlord, regardless of cost.
- Smoke Detectors – Some, if not most Leases, require Tenants to change batteries and to routinely check that the Smoke Detectors are working.
- Plumbing – Some, if not most Leases, require Tenants to address any minor plumbing issues after move-in. This generally includes clogged drains.
2) Payment Terms – This may include the date the rent is due, forms of payment required, where rent is paid, etc.
3) Late Fee Schedule – Most Leases have a specific date when rent is due and then when late fees kick in. There are a myriad of late fee schedules. Be sure to understand yours and set-up these dates in your system accordingly.
4) Notice Requirements – Your Lease should include when the Tenant is required to provide notice. In Indiana, most Leases generally require a 30-day notice at the end of the Lease. However, you may run into some Leases that require 60 or even 90 days to provide notice.
5) Security Deposit Amount – This is important. We always require at least one month’s rent as a security deposit, oftentimes more. However, a lot of PM companies and individual Landlords offer reduced security deposits. That means you have less protection when the Tenant vacates.
Landlord Tip: Be certain that you receive the full security deposit at closing. If you fail to obtain the security deposit, you may be stuck with funding it when the Lease ends.
TENANT PAYMENT PERFORMANCE
Clearly, besides the actual Lease document, you will need to determine how the Tenant is performing.
This is typically done by requesting a current copy of a Tenant ledger.
A ledger will tell you if any balance is currently owed and should provide the exact dates that the Tenant made rent payments.
If you see a history of late payments, or a passed due amount, you could have a cause for concern.
Along with the Tenant’s payment performance, you should also be able to request a maintenance history on the property. This may not be available if the home is managed by the Owner, but a home managed by a quality Property Management Company should be able to provide all work orders associated with the home.
WHAT IF I HATE THE EXISTING LEASE?
OK, so let’s say that you really want to buy a property, but you’re going to be bound by a Lease for the next 12 months that, well, stinks.
Again, you can’t simply force the Tenant to change terms.
But, you can negotiate.
And you should, and you may be successful, as long as both parties agree.
Here’s a scenario.
You do research and find that the Tenant is paying at least $100 per month below market. The Tenant’s rent is due on the 1st of the month, considered late on the 2nd, and the Tenant is required to change the furnace filter each month.
You may offer the following: a $25 rent increase each month, in exchange for a due date of the 5th and a quarterly, not monthly filter change.
Using this quid-pro-quo approach, you may be successful.
You WILL NOT be successful keeping all the terms the same but asking for the $100 rent increase, no matter how many comps you throw at the Tenant. You have to offer something in return.
T&H REALTY’S EXPERIENCE
It’s remarkable how much business we take on from other Property Managers in Indianapolis. It seems like every week we’re in another PM’s office picking up keys, Security Deposits and, yes, Leases.
Some of these Leases are horrific. It’s no wonder the PM Company is struggling to keep business.
And the trouble is that we have to live by the terms, at least in the near-term.
Our goal is to convert these Tenants to our Lease ASAP and many are perfectly willing to do so.
Leases need to be fair. Otherwise, they won’t ever work in the long-term.
But, over the years, we have adjusted to this reality and, with lots of good documentation and processes, we can manage multiple versions of Leases very effectively.
Buying occupied homes is sometimes very appealing to Investors.
It means instant cash flow and takes away the cumbersome tasks of prepping, marketing, showing, screening, etc.
However, very much like a home inspection, you need to properly vet the Lease terms to ensure you understand exactly what you are inheriting.