Purchasing a Multi-Family Home with Existing Tenants

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When purchasing a multi-family property with tenants that are already living in the property, there are some particular issues that a landlord needs to watch out for.  Multi-family housing can be an excellent investment, particularly when there are already tenants in the building who will provide steady cash flow from the property from day one after the transaction closing.  Nevertheless, a potential purchaser also needs to be careful and perform the proper due diligence before purchasing a multi-family property.  This includes verifying that all tenants are up to date on their rent, ensuring all leases can be assigned to a new owner, and a number of other necessary steps.  The existing tenants are living in that building pursuant to written leases that provide the tenant with specific rights independent of whoever owns the building.  The leases in effect at the time the purchaser acquired the property typically will allow the new purchaser to assume those lease obligations, but the purchaser must honor them just as if the new owner had entered into them in the first place.  The purchaser also needs to ensure that he or she ensures that all of the tenants are current on their rent and other obligations on the lease and that the tenants are actually paying their rent as well as that the transfer of all security deposits is handled appropriately.

 

Existing Residents’ Rights Upon Sale of a Property

A lease is a type of contract that runs with the land, meaning that it is tied to the property itself rather than being tied to the individual or corporate entity that owns that property.  Therefore, a purchaser of multi-family property must ensure that he or she has the ability to legally assume the lease contracts between the tenants and the property’s previous owner.  Most leases will have specific provisions that permit the assumption of the leases if the property’s ownership changes hands.  However, the leases may have specific notice provisions that a new property owner must ensure to meet in order to validly assume those leases.  The first hurdle is therefore ensuring that existing tenants acknowledge and accept you as their new landlord and effectuating that in the manner provided for in the tenants’ respective leases.  One of the most common and efficient ways to accomplish this is to have each tenant sign a letter of attornment.  This document is a written agreement pursuant to which the seller advises the tenants that the property is being sold and advising the tenant to pay his or her rent to you as the new owner.

 

Review of Existing Leases

Reviewing the existing leases is the next big hurdle for the purchaser of a multi-family property.  There may also be tenants in the building who have different lease forms depending on how long they have been living in the building.  The purchaser will need to understand and be familiar with each tenant’s particular lease and the material terms of same.  The lease terms and when they expire is a key consideration given that a new property owner wants to minimize vacancies as much as possible.  Therefore, it is important to know before purchasing a property if all of the tenants’ leases are going to be up for renewal at the very same time.  The purchaser needs to know going into the transaction if he or she is going to have 10 of the 12 units in the property all potentially coming vacant at the same time.  Reviewing all leases before the transaction closes also will ensure that the purchaser understands whether existing tenants have the right to renew their leases and, if so, what terms the tenants are permitted to renew their leases on.  This could interfere with planned rent increases if the purchaser wants to get the rental rates for the unit up across the board, for instance.

 

Protecting Yourself from Non-Paying Tenants

Purchasing a multi-family property with existing tenants can be an excellent means to acquire a solid, income-producing asset.  However, before purchasing a property, you need to ensure that the tenants are current on the rent and that the seller is not selling the property to you because none of the tenants are paying their rent.  The prudent means to ensure this is to require both the seller as well as each of the existing tenants to execute a legally binding document known as an estoppel certificate.  This requires the seller as well as the tenants to make a representation that the tenants are each in good standing and the terms of the leases are being complied with by the tenants and enforced by the seller.  It also helps to verify that all tenants are current on their rent payments.

 

Tenant Security Deposits

Upon the sale of a multi-family property, the landlord also becomes responsible for ensuring that any security deposits are properly handled.  Many states require landlords to keep security deposits in a separate, interest-bearing account so the funds are segregated from working capital or other funds in the landlord’s possession.  Ensuring that security deposits are appropriately handled when a property is sold is of the utmost importance given that there can be serious legal ramifications for failing to do so.   The seller and purchaser will often execute an assignment of security deposits by which the seller transfers the security deposits to the purchaser.  The purchaser then needs to ensure those funds are placed in a segregated account according to the relevant laws in the applicable jurisdiction.

 

Conclusion: Multi-Family Properties Can Be an Excellent Asset, But Pay Attention to the Details Before Closing

Purchasing a multi-family property can be an excellent investment and can provide a purchaser with steady income.  However, before purchasing any property, there is a large amount of due diligence the purchaser needs to perform.  Doing so can pave the way for a smooth acquisition of an important asset for the purchaser.

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