Rental Income
Security Deposits
One to Four Family Homes
How does one draft a contract for clients desiring to buy a one to four family home with tenants?
For our discussion, let’s assume that there are two rental units (a two family home); Upper Unit rents for $1200.00 per month with a $1,200.00 Security Deposit and a one year written lease with 6 months remaining on the lease term; Lower unit rents for $1,400.00 per month with a $1,400 Security Deposit; no lease, month to month tenant. Owner/Seller provides a copy of the lease for the Upper Unit at time of contracting and advises as above regarding the Lower Unit. So, you go to contract with both tenants staying (of course you could ask Owner/Seller to have Lower Unit tenant vacate before closing if your client/Buyer wants to live in Lower Unit).
What happens when you get to closing to learn that the Lower Tenant (month to month) is planning to vacate at the end of the month – just after your client’s purchase;
Then you learn that the tenant under lease never made their Security Deposit and you learn that the month to month tenant has not paid rent in three months and, the Owner/Seller/Landlord has applied that tenant’s Security Deposit to offset unpaid rent!
Now Buyer’s got a tenant that is leaving, for which there will be no rental adjustment in Buyer’s favor – as rent is unpaid – and, should tenant vacate and do damage, there is no security deposit to offset damage. Plus Buyer has Upper Unit tenant with no Security Deposit. Probably not what Buyer bargained for… or is it?
Does security deposit transfer to Buyer? Are rent adjustments forthcoming? What if the contract is silent on these issues – perhaps the Buyer is getting what they bargained for, because they didn’t address at time of contracting?
I just had this scenario, this is not a made up this couldn’t happen kind of scenario. Seller refused to provide the security deposit (it was utilized to offset rent or not collected), Seller refused to adjust for rent, Buyer might have to evict non-paying tenant if tenant doesn’t go voluntarily (Buyer couldn’t hold off on buying because rate lock extension would have cost over $1,000.00).
If Buyer does not wish to be subject to whether Seller/Landlord collects rents from tenant, and wants to assure that Security deposits transfer (or their equivalent) at closing, perhaps, instead of contracting that “both tenants to remain or upper tenant to remain and lower tenant to vacate prior to closing”, maybe we could do better. How about contracting as follows: “Tenants to be current on rent at time of closing; adjustments for rent shall be made as if tenants current on rent. At closing, Seller to transfer the sum of $1,200.00 to Buyer as Security Deposit (regardless of whether Seller is in possession of such funds) for the Upper Unit and shall transfer $1,400.00 to Buyer as Security Deposit (regardless of whether Seller is in possession of such funds) for the Lower Unit. Buyer is relying on these representations in entering into this contract.”
If a tenant to vacate perhaps we could contract: “Seller to have lower unit vacant prior to the closing date in the contract> Seller to make all necessary repairs and have vacated unit clean and ready for occupancy prior to the closing date in the contract. Seller shall meet statutory obligations to return or account for tenant’s security deposit and shall indemnify and hold Buyer from any claims of tenant regarding the security deposit (this paragraph should survive the closing). In the event Seller cannot provide a vacant, ready for occupancy unit by closing date Seller will pay for any reasonable mortgage rate lock extensions incurred by the Buyer.”
Just some food for thought… We were able to negotiate holding of $ in lieu of security deposit transferring in my scenario – it remains to be seen if that will fully protect my buyer. But, with the contract silent about this – it was the best we could do.
Thanks for listening.
Jeff
