Friday, December 11, 2009

Avoiding minefields in the purchase of investment real estate.

I previously wrote about hidden landmines in the purchase of investment properties. Unwary buyers often walk into the middle of legal disputes with existing tenants. These landmines can be avoided by obtaining a few simple representations when closing on an investment property.

Many buyers obtain a copy of the leases at settlement, at which time the seller writes the word "assigned" on a corner of the leases. This practice is insufficient.

A buyer must obtain a complete Assignment of Leases at settlement. This assignment must specify the following:

  • The identity and unit number of each tenant.

  • The monthly rent for each tenant.

  • The expiration date for each lease, including a statement as to whether each lease is month-to-month.

  • A representation that there are no disputes between the seller and any of the tenants.

  • The amount of each tenant's security deposit (which amount should be specifically credited to the buyer).

The parties should include language that the document "survives closing," so the buyer can enforce it later against the seller. This document will be a starting point to discover and avoid future legal disputes with the tenants. If any of this information is inconsistent with the written leases, the buyer can ask questions before settlement is complete.

  • If the seller is crediting the buyer a smaller security deposit than is specified in the lease, the buyer might learn at that time that the seller has already used some of the deposit to repair damage caused by the tenant or offset unpaid rent, none of which the seller has previously reported to the buyer.

  • If the name of the tenant on the Assignment is different from the name on the lease, the buyer might discover that the original tenant has moved out, leaving a new tenant with only an oral lease.

  • If the rental amount listed on the Assignment is different from the amount specified on the lease, the buyer might discover unwritten oral arrangements between the seller and tenants (or at least that the seller has raised the rent since the lease was signed).

  • Before signing the Assignment, the seller often "remembers" that one of the tenants hasn't yet paid this month's rent (yet he will expect to be reimbursed for a pro-rated portion of this month's rent since the buyer will undoubtedly collect it soon).

As I wrote, this document is only a starting point. It helps identify issues that the parties can then resolve prior to completion of settlement. There are additional documents for the tenants to sign, particularly in the case of commercial real estate purchases and particularly in cases where the Assignment of Leases has raised red flags.

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