Buying or Selling Rental Property

One to four family residential investment properties are commonly bought or sold in transactions in which a Texas Real Estate Commission (TREC) Contract form is used. Often these properties are leased to third party tenants at the time the contract is signed and at the time the transaction is closed. However, the TREC contracts do not address the many issues that may arise in buying and selling leased properties. This article will address some of those issues.

Rent

The TREC contracts contain a proration provision that calls for rents to be prorated through the closing date. This is the only provision that addresses any issue involving leases. An issue arises if a tenant has not paid rent that is due prior to the closing date. Who will have the right/duty to collect the past due rent? The seller loses the standing to evict the tenant when the transaction closes. If the buyer has the right to collect the rent, will the buyer have a post closing duty to deliver a prorata portion of the collected rent to the seller or will the buyer per permitted to keep the rent? Should a buyer have the right to terminate the contract and receive a refund of the earnest money if the status of the leases changes between the date of contract and the date of closing? These issues should be negotiated and the contract should include provisions pertaining to these issues.

Copies of Documents

A prudent buyer would want to receive true and correct copies of any leases affecting the property during the buyer's option period. A buyer might also reasonably request rental payment histories, management agreements affecting the property and copies of any correspondence between the seller or management company and the tenant. If a buyer wants to make delivery of all or some of these documents a requirement of the transaction, the contract should contain language regarding this requirement.

Security Deposits

Security deposits are typically transferred from the seller to the buyer at closing. However, the TREC contracts do no specifically require this. Sellers should be aware of Section 92.105(b) of the Texas Property Code which states "The person who no longer owns an interest in the rental premises remains liable for a security deposit received while the person was the owner until the new owner delivers to tenant a signed statement acknowledging that the new owner has received and is responsible for the tenant's security deposit and specifying the exact dollar amount of the deposit.". A prudent seller might consider preparing such a notice to be signed by the buyer at closing. The seller could then see that the notices were mailed to the tenants. Again, this requirement should be set out in the contract.

Assignment of Lease

It is best practice for the seller and buyer of a leased property to execute an assignment of the leases. This assignment might include provisions calling for the seller to indemnify the buyer for pre-closing landlord defaults and the buyer to indemnify the seller for post closing landlord defaults. A buyer who later needs to evict a tenant under a lease the predated the closing would be able to use the assignment to establish the buyer's standing to enforce the lease.

Security Devices

The Texas Property Code Sections 92.151 through 92.170 set out requirements for security devices in residential rental properties. A prudent buyer should have the property inspected to determine if the statutorily required security devices are present and working. This is outside of the scope of a normal property condition inspection.

What is an agent to do?

An agent representing a prospective buyer or seller of a rented one to four family property should discuss these issues with their client and advise the client to have an attorney draft an addendum to be attached to any offer or counteroffer on the property. This addendum would address the issues discussed here and any others that the party and their attorney feel are important. By having such an addendum made part of an offer or counteroffer these issues may be addressed in the negotiation stage of the transaction and the likelihood of surprises at closing can be substantially reduced.