When you purchase a rental property, it may come with tenants in place, and those tenants will suddenly become YOUR tenants. These tenants are known as “inherited tenants.” Inherited tenants can be beneficial, as you will not need to immediately spend time filling the vacant unit, and you’ll be receiving income from day one. However, inherited tenants can also be risky, as they were not put in place by you, and you don’t have a clear indication of how well they were screened or what type of tenant they are.
Furthermore, they may have been poorly trained by the last owner and will need to be re-trained to follow your rules and way of doing business. Or maybe those tenants will be absolutely perfect, and you’ll be thankful to have them.
The truth is, you won’t really know for sure until you begin dealing with those tenants. However, there are a few things you can do to increase the chance of a successful acquisition of inherited tenants. But before we get to that, understand that legally, the leases go with the property, which means everything about the lease stays the same when you take over. For example, if you purchased a property and the existing tenant was three months into a one-year lease, you would be required to abide by the terms of their lease for the next nine months. Again, the leases go with the property.
Review Existing Leases
Before closing on the property, you will definitely want to review the leases for each existing tenant to verify the income and what expenses are the tenant’s responsibility. Do they match the financials that the seller provided?
For example, let’s say you purchased a triplex and the seller claimed to get $500 per month, per unit. If the lease shows just $400 per unit, you have a problem. This is actually not as rare as you might think, as sellers like to talk about their opinion of “fair market rent” (what they think it COULD rent for) rather than what they are actually receiving. This is known as the “pro forma” rental income. If this is the case, start asking questions and be sure to run your numbers with accurate data, not pro forma numbers.
Verification doesn’t end with comparing the leases to the financials. Leases can easily be altered or forged. Imagine purchasing a property, only to find out (after closing) that the lease was changed by a shady landlord. This kind of thing does happen, so you must verify the terms of the lease with each tenant before purchasing the property. This is done through an Estoppel Agreement.
An Estoppel Agreement is a simple, one-page form that the tenant fills out letting you know the terms of their lease to the best of THEIR knowledge. If the seller of the property will not let you speak with the tenants and get Estoppel Agreements, you might be dealing with a seller who is trying to hide something. If you do get the Estoppel Agreements signed and discrepancies are found, you’ll want to make sure they are cleared up before closing.
Sometimes it could be an honest mistake, sometimes a tenant might be lying to try to get lower rent, or sometimes the seller might be a liar. You don’t want to buy a property until you understand exactly what you are getting.
An Estoppel Agreement should contain at a minimum:
- The tenants’ names and who resides in the unit
- The lease term (including start date)
- The rental amount due each month and the due date
- The security deposit amount
- Who pays which utilities
- Who owns the appliances
- Whether there are any pets in the property
- Whether there are any problems or repairs needed
- Whether there are any other agreements with the landlord
Make sure both you and the tenant sign this agreement, and keep it in their “tenant file.” This way, if a tenant tries to tell you later on that their deposit was actually $1,000 instead of the $500, you can back up your claim with their signature on the Estoppel Agreement. It’s hard to argue with that.
Put Yourself in Their Shoes
When purchasing a property that has inherited tenants, keep in mind that they are likely aware of the sale and are concerned about the unknown. They probably have a lot of questions, like “Who is this new owner,” or “Are they going to kick us out,” or “Is my rent going to be raised?” This uncertainty for the tenant can lead to a frustrating start to your relationship, so put yourself in their shoes and try to make the process as easy as possible on them.
We like to send a letter to the tenant on the day we take over a property, introducing ourselves and the company, letting them know we are the new owners and will be responsible for taking all phone calls, maintenance requests, lease-related questions, and anything else involving their tenancy. In this letter we like to let the tenants know about some of the improvements that will be taking place at the property in the coming months. This can help reassure the tenant that you are not a slumlord, but someone who takes pride in your work
Raising the Rent on Inherited Tenants
Perhaps you purchase a property with existing tenants and you know that the rents are far too low. This is common, as many landlords are reluctant to raise the rent even as the market rate climbs, leaving long-term tenants with leases far below market rent. When we purchased our 24-unit apartment complex, this was the case. Most units were renting for $475 per month, when the market rent was a full $50 per month higher than that at that time. All the tenants were on month-to-month agreements, so we could raise the rent with just a 30-day notice.
But should we? Do we tear the band-aid off right at the get-go in one swoop, or do we raise the rent slowly or only on a few units? If we suddenly raised the rent on all the tenants, it’s likely many of the tenants would move, and we’d be left with a lot of units that needed to be rehabbed and very little income coming in to help with those expenses. On the other hand, if we let the tenants stay at that $50 per month difference, that is thousands of dollars in potential rent we would not be receiving each year.
There isn’t always a clear-cut answer on whether or not you should raise rent. We personally didn’t have a lot of capital to handle that storm so we opted to keep the rent the same for most of the tenants for the first year, only raising the rent as we fixed up units and moved new tenants in. Another investor, someone with a lot more capital, may have decided to raise everyone’s rent and accept the immediate loss, choosing instead to rehab multiple units and get new tenants in quickly. It’s a balancing act and something only you can decide