the close of escrow or completion of the sale, is the time to ask tough questions and make sure that you verify everything you have been told and are counting on getting in writing. (
Escrow is an account for funds and documents held by a neutral third party in a real estate transfer until all the conditions have been met, per the written instructions of the seller and buyer.) Don’t be shy. To be sure that you know what you’re getting, talk to the tenants; the neighbors; any homeowners’ association; local government agencies, including law enforcement and any rent-control board or similar organization; and the property’s contractors or suppliers. Search the web for public information such as code violations, police reports, and registered-sex-offender tenants. When you’re in this situation, remember my favorite motto:
no surprises.
Don’t underestimate the importance of this step. This review of the books and records, along with the physical inspection, reveals the actual operations of the property and allows you to determine whether the property is suitable, fairly priced, and meets your financial goals. When the property sale is complete, it’s too late to ask the seller to fix the leaky roof unless they engaged in an intentional effort to cover up the true condition of the property. Your remedies may come only in court, which can be costly and reserved only for the most serious or expensive issues.
Most sellers are honest and don’t intentionally withhold information or fail to disclose important facts. But the adage “Buyer beware” rings particularly true in the purchase of residential rental real estate. Resolving questions and issues now through regular communication with your seller eliminates some very unpleasant and possibly contentious disagreements with your tenants in the future.
The due-diligence period may be your best or only opportunity to seek adjustments if the seller misrepresents any important issues. What if you weren’t aware that this property is subject to onerous rent-control limitations? When you sign your name on the dotted line, the deal’s done. You can’t go back and ask the seller where the tenant’s security deposit is. So even though taking over your new property can be chaotic, don’t fall into the trap of verifying the facts verbally. Confirm all information in writing, and begin setting up a detailed filing system for your new property.
“As is” sales are common in many areas of the country. Many sellers simply prefer to put as much of the onus as possible on the buyer to perform a very comprehensive and diligent pre-purchase due-diligence investigation of the property. But that preference doesn’t change the legal disclosure requirements of sellers to fully disclose any and all known material issues with the property, particularly those related to its current physical condition, and/or a complete history of maintenance and repair issues.
In the following sections, I cover some items that you must have in writing before the deal is final. At www.wiley.com/go/propertymanagementkitfd4e, you will find a Property Takeover Checklist for small and large properties.
A comprehensive list of personal property included in the sale
Take an inventory of all the personal property included in the sale. This list may include appliances, equipment, and supplies owned by the seller.
Don’t assume that anything is included in the sale unless you have it in writing, and be sure to verify that all items indicated are physically at the property before you close the deal. A significant dispute can occur if a misunderstanding arises about who owns the fixtures or appliances in the rental unit. If the seller says that all the refrigerators belong to the property owner (as opposed to the tenants), for example, you want to verify ownership in writing with each tenant. Otherwise, you run the risk of a serious dispute or loss in future years; tenants might take appliances when they leave, claiming that those fancy fridges belong to them.
Some ingenious tenants have been known to sell the new appliances in their rental unit and replace them with used appliances when a change in the property’s ownership or management occurs, so be sure to take photos and collect a list of all your appliances’ serial numbers during your due-diligence period. Then make sure that your lease reflects accurate ownership of all appliances.
A copy of the entire tenant file of each current tenant
Make sure that you have all the appropriate paperwork in the tenant files. These documents include rental applications with the credit screening and criminal-background reports, current and past rental contracts, move-in inspection checklists, full payment history (and any rent-increase documents), all legal notices, maintenance work orders or service requests, current contact information, a tenant complaint or communication log, and all written correspondence (letter/email/text) sent to or received from each and every tenant.
A seller-verified rent roll and list of all tenant security deposits
A rent roll is a list of detailed information about every rental unit at the rental property, including the tenants’ names, current and market rent, any additional fees (such as for parking, pets, and storage), rent due dates, move-in dates, lease expiration dates, past-due rent, prepaid rent, rent concessions, and security deposits. Be sure that you get a written seller statement that no undisclosed verbal agreements or concessions have been made with any tenant regarding any aspect of the tenancy, including rent security deposits, unit upgrades, renewal options, payment of utilities, or any other aspects of the financial terms of the lease or rental agreement. Ensure that when interest must be paid on security deposit balances, you collect the deposits (plus all accrued interest to date) at closing.
When acquiring an occupied rental property, be sure to follow state or local laws in properly handling the tenant’s security deposit. Most state laws require the seller and/or purchaser of a rental property to advise the tenants in writing of the status of their security deposit. These laws usually give the seller the right to return the deposit to the tenant or transfer the deposit to the new owner. Here’s why you want the latter to happen:
If the seller refunds the security deposits, you have to collect them from tenants who are already in possession of the rental units. Avoid this scenario by strongly urging the seller to give you credit for the full amount of the security deposits on hand in escrow, and have each tenant agree in writing to the amount of the security deposit transferred during the sale. Close the loop by sending each tenant a letter confirming their security deposit amount.
If the seller transfers the security deposits to the buyer — rather than returning the deposits to the tenants — make sure that you receive in cash (or as a credit in escrow) an amount equal to all the security deposits held (plus all accrued interest owed to the tenants, if any). Remember that if you do get a credit in escrow, you must have available funds be able to refund the remaining balances (after taking proper and legal deductions) of any tenant security deposits when the tenants move out.
Without written proof to the contrary, dishonest tenants may later claim that they had a verbal agreement with the former owner or manager for a rent credit or discount for maintaining the grounds or doing light maintenance, or that they were promised new flooring or another significant unit upgrade. If this scenario happens to you, offer to contact the former owner or manager immediately to verify the tenant’s story. In my experience, when you offer to verify the story, the tenant typically begins to backpedal, and the truth comes out. But to avoid any surprises, obtain a written statement from each tenant indicating that no such verbal agreements exist
