Buying property: is it too good to be true?
December 1, 2008
How to keep from getting ripped off and sued when you buy investment property. What you thought, or at least wished and hope, would be a terrific investment, could turn into a little (or big) house of horrors if you don’t protect yourself.
You don’t know for sure when you make an offer on a property with any certainty what the situation is with the tenants. All you have are some representations from the seller which may or may not be entirely factual or complete.
The things you need to be concerned about are length of residency by the tenants, amount of rent they’re paying, promises the landlord has made to the tenant. Some sellers have been known to actually forget about side agreements they have with tenants and use creative accounting methods to make their rental income look better than it actually is.
What you need to find out is the truth, and you can do that with what is known as an “estoppel certificate.” This certificate will help you determine the following:
1. That the tenant does indeed live in the property and how long
2. What the actual rent payments are
3. What utilities and services the tenant is responsible for and landlord is responsible for
4. Who the occupants of the property are
5. If the landlord is in default of the lease or has promised something to the tenant
The first four items are checking up on the representations the seller has made about the tenants and the leases. The last one is protection for you. If the tenant certifies that the landlord has not promised anything to him or her, you do not have to worry about getting sued by a tenant for breach of lease or contract after you take possession.
The landlord promises to replace the existing refrigerator in the unit with the new, super-duper XYZ model. He promised that because he knew he was going to sell the property and so knew he could conveniently forget about his promise and let the buyer worry about it.
Sure enough, after you buy the property you have something to worry about. You get a letter from the tenant saying that the previous owner promised the new refrigerator and the tenant wants it right away. You reply that you never heard of such a thing, and regardless, any agreement the tenant had was with the old owner and not with you. Oh, no, the tenant says, he has this signed agreement that attaches to the lease (it says right on the agreement) that the refrigerator gets replaced. Moreover, the refrigerator in question is $1,500.
Then you have a choice: buy the refrigerator or get sued. If you get sued in the above situation, you will almost certainly end up buying a refrigerator anyway.
But suppose the seller and tenant had cooked up a scheme to get the buyer to pay for the new refrigerator by having the tenant claim there were no other agreements outstanding, then spring it on the new landlord. If the tenant certified that there was no side agreement on the certificate, you are in the clear. The tenant can claim all he wants that there was a deal, the estoppel certificate supersedes any existing agreement between the previous landlord and the tenant.
However, had you obtained estoppel certificates from every tenant, you would probably have learned of the side agreement the tenant had.
Once you have information from tenants that differs from what the seller has told you, you have a couple of options. One, you can go back to the seller and demand a renegotiation of the sales agreement, not the overly-rosy picture the seller painted. Or two, you can back out of the sale completely, since the seller was less than forthright with you. What else didn’t he tell you?
When you write an offer for a property, you provide a time frame inside of which you will have the due diligence on the property completed. The bigger the property, the longer the due diligence period. For example, a single-family dwelling or small-plex could be seven days. A 500unit apartment complex could be several months. Other investment properties will be somewhere in between.
The problem you will run up against is getting all the estoppel certificates from the tenants inside the time frame for the due diligence. If you only have a week or two, you could run into people on vacation, who are never home, or who just don’t want to sign anything without talking to their attorney, who is on vacation in Tahiti until next July. There is a way around that problem.
You can require that the seller provide the estoppel certificates and that they all must be in your hands and approved by you before you close. You can also put an ending date by which the seller must have them in your hands, in addition to having the seller do it before closing.
“Seller will provide estoppel certificates from every tenant prior to closing. In addition, if the buyer has not received all certificates by June 1, 2001, he will not be required to proceed with the closing and the seller will return all earnest money, deposits and reimburse any moneys the buyer has expended in due diligence and on legal fees.”
The last clause protects you from the seller getting a better offer and then stalling with the estoppel certificates until he can get you out of the deal. What happens is this, for example.
If the seller does the estoppel certificates, he will probably want to use one of his own creation or his attorney’s creation. Thus you also need to have a clause in the sales agreement to the effect that “the form and content of the estoppel certificate must be approved by the buyer before proceeding.”
There is no standard form for these certificates, they can be whatever someone wants to dream up. There might even be more information you would want the tenants to certify.
Whatever investment property you buy, go to great effort to be sure that the seller has told you everything, from the condition of the premises to the condition of the tenancies. Using an estoppel certificate is one way to make a real estate transaction less stressful and more in your control.