As investors, we often come across properties that seem to be good deals, but there’s one big issue: the current tenants.
It becomes obvious that the current owner isn’t managing professionally, they didn’t screen properly (or at all), and they’re selling because they’ve created a major issue with the current tenants. They aren’t paying rent. Even if they did, it’s half of current market rates.
The landscaping has been neglected for decades. There is stuff piled floor to ceiling, and the last time the carpet was vacuumed, Richard Nixon was president.
On paper, it’s a good deal—the numbers could work—but who wants to deal with that mess?
Someone Else’s Problem Can Be Your Opportunity
Well, maybe you do. In real estate, we get paid to solve problems. The neglected property with the problem tenant is one of the most lucrative problems you can solve, but you wouldn’t know it if you think of it as a major problem rather than as the opportunity it truly can be.
Tired and inefficient landlords sell because they don’t want to deal with the problems they created, but they’ll pay you to take it on. As a matter of fact, they have to pay you to take it on because those issues directly influence the marketability of the property but not necessarily the value.
That’s where you come in. If there’s a tenant in place, in most cases, an owner-occupant cannot or will not purchase the property, so that eliminates 90% of your competition right there.
If you are a buy-and-hold investor, every tenant is temporary, but the returns from that property could last indefinitely. This is why it’s vital that investors don’t miss the forest for the trees—taking these deals on can be an excellent way to build equity and a performing portfolio.
Four Terms to Include in the Offer
If you want to take advantage of these opportunities, you need to be proactive in how you underwrite and offer on these deals. It is imperative that you have a thorough understanding of the landlord-tenant laws in your area, the existing lease, and how to deal with the situation once you take ownership of the property. If you don’t have confidence in your ability in any of those areas, you’ll need to find a savvy agent who has a team that can support you.
When you make an offer, you’ll need to include terms that address the current lease, the tenant, the property condition, and your ability to do proper due diligence. This will vary by market, but here are the boilerplate terms that we include in every offer for a property with an existing tenant in place.
1. All fees, deposits, and prorated rents are to be conveyed directly to the buyer’s property manager at the close of escrow.
BiggerPockets forums are filled with posts from new investors who are about to, or have, closed on investment properties and are scrambling to figure out who has the deposit and when they get it. Technically, the deposit is the tenant’s property, and the landlord must keep it in escrow. However, that doesn’t keep people from trying to hold on to those funds along with prorated rents after a transaction closes. Don’t give them the opportunity.
2. Seller to provide current leases and all applicable addendums and other lease/tenant-related documentation within three business days of acceptance. Seller’s preliminary due diligence period shall not begin until all of this documentation is received.
Many investors insist on an estoppel certificate, but I prefer seeing the binding agreements from the start, knowing what has been agreed upon without interpretation. Estoppel isn’t a bad thing, but I want these documents, and I don’t want to waste any of my due diligence time waiting for them.
3. Buyer to perform satisfactory walk-through of all occupied units within three business days of acceptance.
In my market, most sellers won’t let you view a tenanted property without an accepted offer, so I want my offers (and my client’s offers) contingent upon them giving us timely access to all units. This gives us an opportunity to get a better feel for the property’s condition before we pay for a professional inspection. We always schedule the inspection for the day after and simply cancel it if we terminate the contract based on the informal walk-through.
4. Seller will not extend, alter, or amend any current lease agreements or enter into any new lease agreements before the close of escrow without the buyer’s agreement in writing.
Real talk: I learned this one the hard way a couple of years ago. I got a property under contract for under-market value because there was a long-term tenant paying way under-market rent. The week before close, all of my contingencies had timed out, and the seller sent me their new lease—with the old rate.
I was stuck. It was still a good deal, but I lost the opportunity to raise rent for a year rather than 30 days. That cost another $5,000 or so. We wouldn’t have lost the money if we included this contract term.
These terms will generally protect the buyer and give them time to understand what they are getting into before they have to pay for an inspection or appraisal. As a buyer, you want to be able to do as much due diligence as possible before you hand over any of your hard-earned cash.
Also, in some states, verbal leases are considered binding—they are in my state of Idaho, thankfully, so I’ve never had to deal with that issue. However, if a tenant or seller wanted to claim that they had a verbal agreement, that could make things much more interesting.
Another thing to consider when using these strategies: Just how landlord-friendly is your state? If you are in a very landlord-friendly state, getting a problem tenant out can be very difficult—it can cost you quite a bit of time and money, so be sure to factor those things in. If you aren’t sure what that investment might look like, book a consultation with your favorite REI attorney, who should be able to give you a good idea. You can factor those numbers into your budget.
If you are in a more landlord-friendly state, this would likely be less of an issue. Our market is quite landlord-friendly, and depending on the type of eviction and how much the tenant fights back, it can generally take three weeks to three months or so. This is generally not a big deal when you are buying to hold indefinitely.
Of course, cash for keys (or paying tenants to leave) is almost always the best place to start. Using this method, you are likely to get better reception from the tenant, shorten your timeline, and potentially save yourself money. By putting a few dollars in tenants’ pockets, they are in a better position to have a fresh start—a win-win. This is generally a much better solution for all parties if you can work things out.
The Bottom Line
Don’t let bad tenants or low rents scare you away. As real estate investors, our profits come from solving problems that other people don’t want to deal with. Tenants and intrapersonal issues are huge for many people. If you can get into some of those deals with your eyes wide open, you can leave with big profits.
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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.