Archive for January, 2011

Buying a Small Retail/Office Strip Center…

January, 2011

We provide here a few questions that have been posted in the Community Forums and our answers to them.

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Q1

I’m considering buying a small retail/office strip center and am concerned about how to be sure the leases provided by the seller are legitimate?

A1

You should certainly study the lease agreements, but you should not depend upon only the documents provided by the seller, as there could be some missing documents. Some other scenarios include (1) a tenant has paid rent for months in advance, meaning the buyer won’t be receiving rents for those months, (2) a tenant’s security deposit has been applied to rent or damages, (3) a tenant currently has a larger security deposit than stated in the lease agreement, with the buyer being liable for the full amount even if not receiving escrow credit for the full amount, or (4) a tenant has oral agreements with the seller that have not been disclosed and, although such agreements may not stand up in court, it could be costly to resolve the matter. You don’t need to be dealing with a dishonest seller, only a forgetful or disorganized one, to potentially have problems after closing.

The best way to avoid such problems is to make sure that your purchase offer requires that Estoppel Certificates be executed by all tenants. Basically, an Estoppel Certificate is a document executed by the tenant wherein he/she verifies the terms of the lease as disclosed to you, including any amendments(usually best to have all relevant documents as attachments) and confirms the amounts of deposits currently held by the owner, the current rent amount, and the date to which rent is paid. For more discussions regarding Estoppel Certificates see our “Buying & Selling Income Property” eCourse (Lessons 5, 19, 20, and particularly Lesson 26).

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Q2

My tenants moved out and left big holes in 1st floor carpet. Also, they damaged a sink and other stuff. The house was brand new when they moved in 2 years ago. I have to keep their security deposit and bill them for another amount of dollars to cover the whole repairing cost as I estimated. The estimation is based on average market value.

1. Does landlord have obligation to provide detailed receipts and photos etc to tenant or their attorney? What if the carpet replacement has not been done yet?

2. Can I hold all the proof to present only in front of judge, since I have already gave them itemized descriptions of damages. Also I noticed them regarding the major damages the last time when I visited the house before the lease expires. They also signed a detailed Move-Out List where specific damages/charges cost are there.

3. The last question relates to legal. Their attorney sent me a letter. Do I have right to ask the attorney to give me a proof that he is authorized by ex-tenants to talk with me? Anyone has similar experience?

A2

My layman’s answers to your questions are as follows:

1.& 2. You probably are not required by law to provide receipts and photos before going to court, but you need to weight the cost (of at least your time) of going to court against your concern about providing such information ahead of time. You also need to keep in mind that the problem is more likely to go away if an attorney sees that you have irrefutable proof. In fact, it might be that the more the attorney sees of your proof, the more likely he will tell his clients that they’re wasting time and money to argue about the matter. If you have detailed move-in and move-out checklists signed by the tenants and photos of the condition at both ends of their tenancy, I don’t see how you can lose in court. You didn’t mention that you also had a signed move-in checklist, but if it was a brand-new never-lived-in house at the beginning of their tenancy and this fact is provable, not having a move-in checklist shouldn’t be an issue unless the law of your state specifically requires a move-in checklist.

3. You could certainly require proof of attorney representation, but I think it is just as important, perhaps more so, to verify that it is a real attorney who sent you the letter rather than the ex-tenant or a non-attorney representative. I would verify the name, address, and current licensing with the Bar Association of your state and check for a listing in the White Pages and an ad in the Yellow Pages. If those items check out compared to the letter you received from the attorney I would then call the listed phone number and see if they will confirm representation. You might even try to talk with the attorney in order to run up the tenant’s bill, assuming that the tenant is not obtaining free legal help from a friend or relative or from a tenant association. People who pursue obviously losing legal actions usually do so because of the availability of free legal help. Just be careful what you say and present yourself as the reasonable and knowledgeable landlord that you are.

If a lot of money is at stake, you should consider having a competent landlord-tenant law attorney (preferably one who usually represents landlords) answer the request, as a phone call or letter from your own attorney can have a lot of impact regarding such a matter. You should be able to get such minimal help for a reasonable cost, so it might pay to call a couple of attorneys.

If and when you provide info to either the attorney or the ex-tenant, provide only copies, retaining originals for your possible trip to court.

An important factor is whether or not you provided detailed accounting to the ex-tenant in full compliance with your state’s security deposit law, particularly that you can prove that you supplied the accounting within the required time period. Many states have serious penalties for failing to follow the law in all respects, including forfeiture of rights to the deposit and/or damages against the landlord for 2 or 3 times the amount of the deposit – although, depending on the state, you might still retain the right to file a lawsuit for the damages. Be sure that you take proof of doing so with you if you end up in court.

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Q3

In March, 2010 I gave 30 days notice to the tenant that her rent will be increased by 5%. She does not pay the increased rent consistently. From April to June she paid only the old amount. I gave her a 3-Day Notice to Quit or Pay the 5% and she complied within the 3-day limit. However, she paid the increase as a separate check. Then starting in July she started only paying the old amount again. She has been out of town on and off for the last few months and she promised to take care of any unpaid rents. She hasn’t so I finally gave her a 3-day notice again for the 5% not paid from July – September about 2 weeks ago. The 3 days has now passed and she has still not paid the increased portion.

Can I proceed with the eviction process for her not paying her 5% for the past several months? 

If I file the Unlawful Detainer because the 3 days has passed, should I not accept any rent from her, even if it is only the old rent (partial rent)?

A3

Based on my understanding of the matter, it is my opinion that you can proceed with eviction based on your most recent 3-day notice because the 3 days should be considered only to be a minimum. In hindsight, you might have been in a better position if you had served a notice when the July rent did not include the increase, as judges sometimes consider failure to proceed in enforcing lease terms in a timely manner to be a waiver. If your lease agreement has provision for late charges, you should have been collecting them along the way each time she failed to pay the new amount. Failure to do so may have set a precedent that might prohibit you from doing so now. However, it probably won’t hurt to add them into your unpaid amounts, as this may itself get her attention.

Under the circumstances the “waiver” issue would not likely be a problem if you can convince the judge that you postponed collection of the increases under mutual agreement as a favor to the tenant. For future reference, remember that any agreement to defer your enforcement of lease terms should be in writing and signed by both parties.

Whether or not you should accept payment may depend on the landlord-tenant law of your state. Some states require starting over with a new 3-day notice for the balance upon acceptance of partial payments. Other states allow the notice to remain in affect. Still others do not require starting over as long as the tenant signs an agreement to that effect. You need to check the law of your state. As a practical matter, you may be better off to accept the rent and serve another 3-day notice for the total of unpaid increases after her check has cleared. Since there has been a history of her paying the increase, even though late, a judge would likely not accept any claim that you waived the increase. Even if that happened, you’d likely be ahead of the game in having the old rent for October. Furthermore, you could give her a new 30-day notice of a significantly larger rent increase and proceed appropriately if she continued to play games.

If you have any worry about the 2-week delay you could give her a new 3-day notice for the full amount owed including all late charges accrued and the full proper October rent, as it will only require an additional 3 days and should avoid any issues regarding the old notice. If it were me, I would proceed immediately and not worry about the delay. Filing may get her attention because she will now owe you yet more because of your filing costs, assuming an adequate lease clause or state law regarding legal costs.

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Additional Information

Most of the issues discussed in these Q&A’s are covered in considerably more detail in our eCourses and/or in our Mini Training Guides.

Document Retention & Security

January, 2011

Document Retention & Security

In this short article, we’ll briefly discuss basic requirements for both the retention and the security of documentation.

Retention

Landlords need to keep records on all applicants, current tenants, and past tenants. Records should be kept that show periods when vacant properties were available.

Documentation related to all applications, whether withdrawn, rejected, or accepted, should be retained. Included are the following items:

Advertising copy, including flyers or other handouts related to marketing of vacancies

Phone logs for all in/out calls with applicants

Application forms and supplemental information provided with application forms

Third party screening reports

Written memorandums of all landlord conducted investigations

Screening criteria, checklists, and logs

Selection criteria, checklists, and logs

Contemporaneous memorandums or notes regarding oral conversations

Communications to and from tenants, including emails

Adverse action reports (rejection letters)

Lease agreements and amendments thereto

Move-in/out checklists

Maintenance requests, logs, and work done

Security deposit accounting records

In other words, absolutely everything related to every inquiry and application should be kept. While the retention period will usually be in the range of 2 to 5 years, depending on the possible future reason for which the information might be important in defending an action taken, the statute of limitations periods for potential litigation begins only on the date when the plaintiff discovers that he has been damaged rather than on the date when damage occurred.

The minimum retention period can depend on the content of the document. A landlord should consider the following guidelines for records retention:

The Federal Equal Credit Opportunity Act requires a creditor to preserve all written or recorded information connected with an application for 25 months. This is a minimum period which could be increased by technicalities related to a particular case.

Under federal law for fair housing discrimination claims, claims must be filed within 2 years of the claimed discriminatory action, but some states may have longer filing periods, so landlords should know the law of their particular state and, if the period is longer, keep records for a period of at least the greater of the two.

The best defense against a Fair Housing claim is being able to produce both documentation related to a particular person making a discrimination claim and a set of records that shows long-term consistent nondiscriminatory application of written screening and selection criteria.

Landlords who have or have had employees need to be concerned with many of the same items in the above list regarding employment, but must understand that the requirements for some items can be different for employees than for tenants.

The IRS can audit a return within 3 years after (1) the April 15th due date, (2) the date the return was filed, if filed later than April 15th, or (3) the date the return was last amended, whichever period is longer. However, the more prudent real estate investors will retain all documentation related to both the purchase and the sale of a property until at least the above-mentioned period after the sale of a property. This is because the taxable gain upon the sale is dependent on the purchase documentation and depreciation taken during the period of ownership. When a property is in a chain of tax deferred exchanges, this includes documentation for each property that was within that chain. There is no limit if fraud is involved.

Security

Just as important as the period for which a document must be retained is the security with which it is retained. FTC regulations under Fair and Accurate Credit Transactions Act (FACTA) require that landlords and employers must safeguard the use of and eventual destruction of all documentation containing information regarding applicants and tenants. This includes everything from application forms submitted by applicants to credit reports and any information obtained from credit reports or other screening processes.

Requirements include that records are secured under lock and that reports and information stored on a computer or portable devices must be secured by password protection. In all cases, access to records must be limited to trusted individuals and only on a need-to-know basis. For example, credit reports should not be available to every employee in the office of a landlord or management company, but only to the employees who are involved in obtaining the reports and making decisions based on the reports.

When there is no longer a legitimate business need to retain an applicant, tenant or employee’s credit report, FACTA requires disposal of the credit report along with any information taken from such report. The FTC refers to proper disposal as the discarding or abandonment of consumer information and the sale, donation or transfer of any medium including computer equipment in which consumer information is stored.

Adequate implementation of the disposal rule should include written procedures for determining when the sensitive information is no longer needed and a system for effectively purging it.

Deliberate refusal to comply with the law or even failure to take reasonable actions regarding it can result in costly fines and damages by the FTC and/or state agencies as well as lawsuits by tenants’ or employees’ for actual and punitive damages and attorney fees for each violation.

In spite of a landlord’s best efforts, it is possible that there will be a security breach. Many states require that anyone (including landlords) maintaining consumers’ sensitive information to promptly notify those consumers when there is a theft or loss of Social Security numbers, drivers’ license numbers, or other sensitive account information so that they can take action to protect themselves. Consult your state’s office of consumer affairs to determine if your state has such a law. Federal legislation regarding this issue is also expected.

Whether or not you are subject to such disclosure requirements, it is probably good business practice to provide disclosure of a security breach. FTC guidelines regarding alerting consumers in the event of a breach can be found at www.consumer.gov/idtheft.

Additional Information

For additional discussions regarding a wide variety of real estate investing and management issues see our other eCourses and our Mini Training Guides.

Help! We Changed our Minds about a New Tenant.

January, 2011

We provide here a few questions that have been posted in the Community Forums and our answers to them.

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Q1

Please help! We just signed a lease with a new tenant yesterday that is to begin in 2 weeks. We now have a gut feeling that we made a bad decision and we don’t know how long we have to cancel the lease. We have not deposited any money and want to tell the prospective tenant that we will not be able to go through with the lease agreement and void her check. What are the NJ laws regarding this? I haven’t been able to find anything. Please help!!!

A1

I can’t comment on specifics of NJ law, but to my knowledge no jurisdiction in the country has a law that allows either a landlord or a tenant to change his mind after he signs a lease. An exception would be if it could be shown that one or the other parties committed fraud. Some states have laws regarding rescission of a contract within a few days for contracts such as home improvement contracts. However, any consumer protection law that allows cancellation of a contract applies to the rights of a consumer, not the merchant, again unless the consumer committed fraud against the merchant.

Landlords should not make rent/not rent decisions based on gut feelings. Decisions should be made based on the results of a number of objective screening procedures, including identity verification and credit reports as a bare bones minimum. If possible, screening should also include verification of employment, eviction record checks, previous landlord checks, and criminal record checks.

You don’t say anything about the length of the lease. If a month-to-month lease you could immediately give a termination notice (30 days notice in most states) and you would likely find that the tenant would prefer to cancel the lease rather than again move in a month. Whatever the length of the lease, you could inform them that you will not be renewing the lease and perhaps the tenant would like to cancel, but this could also result in problems during the term of the lease if they don’t want to cancel because they would likely worry less about paying the rent on time or taking care of your property during their tenancy.

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Q2

What is the fastest way to get new tenants?

A2

The best way to find prospects and the lowest cost way is usually to use “For Rent” signs in locations that are visible to people driving or walking by the property. The fast way to get a prospect that has viewed the property to sign a lease is to offer good value. This includes providing clean, well-maintained, and safe units at or below market rent for the area. This can also help one get “good” tenants because those who are financially qualified and have a good rental history do not usually need to live in bad rentals.

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Q3

I have a husband and wife who signed a lease for 1 year on April 26th. They were not to move in until May 15th, a week from now. They just called me today to say that the deal on selling their house fell through and now they will not be able to rent our home (single-family residence). This is the only property that we are currently renting out. Do I have any recourse and can I keep a certain amount of money to cover me until we find a new tenant. Any advice would be appreciated.

A3

Tenants do not usually have the right to break a lease no matter what their problems might be unless that problem was a contingency stated in the lease agreement.

First, I recommend that you require them to put their intent into writing so that there is proof it is the tenants who want to break the lease.

Second, you have basically two choices. One is to negotiate a written cancellation of the lease whereby you let them out of the lease for some consideration, say a month’s rent. The other is to simply tell them that you intend to hold them to the lease. In the second case, the laws of most states require the landlord to make “reasonable” effort to find a replacement tenant. The landlord can charge the tenant rent from the commencement of the original lease until commencement of the replacement lease. In addition, any other actual expenses resulting from the tenant breaking the lease, usually including additional advertising and/or leasing commission, can be charged.

In the first case, the amount of negotiated settlement would cover everything. I would recommend the first choice unless you think that it would require more than a month to find a replacement tenant or such longer time that will be covered by the amount of settlement you can negotiate.

Third, be sure to follow the law of your state regarding returning any portion of the security deposit not being applied against allowed costs, provide a detailed accounting for any amount not returned, and do both within the time limit provided by the law of your state.

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Additional Information

Most of the issues discussed in these Q&A’s are covered in considerably more detail in our eCourses and/or in our Mini Training Guides.

Disposing of Income Property Part 1 Of 3

January, 2011

Disposing of Income Property

The Basics

Many of the aspects of buying an income property are also important when selling one. One just views things from the other side of the transaction. We won’t, in this article, try to discuss every issue from the other side. However, we will discuss some of the more important issues.

Why Do It?

There are, in general, two possibilities. First, because you have to do it. Second, because you want to do it. By “have to” we mean you need to sell because of health, financial, or other issue that limits your ability to pick the market conditions in which to sell. “Want to” covers all cases other than “have to” no matter what the reason. It might be that you’re tired of dealing with tenants, want to retire with the freedom to travel, or want to utilize your equities to enjoy the lifestyle of the rich and famous. The major difference from “have to” is that you have more flexibility as to when you do it.

When to Do It

Like many other things in life, timing the disposal of your property is important. The time to dispose of property is when it’s a seller’s market – that is, when the demand is higher than the supply. Unfortunately, real estate investors must often dispose of property under less than ideal circumstances for reasons of health, divorce, or general financial condition. However, even when you “have to” dispose of property, following the correct procedures will help you realize the highest possible return.

How to Do It

You have several options regarding getting rid of a property. You can give it away, you can sell it, or you can trade (exchange) it. There are also two other ways. One is to stop paying your loan payment or your property taxes and have it taken away, but this option doesn’t require instructions. The other is to die and leave it to your heirs, and, while no instruction is usually necessary for the dying part, proper estate planning is highly recommended.

Gift It

There are several reasons why you might consider giving it away. One would be to gift it to a family member or friend. Gifting to relatives or other individuals or entities (other than charities) can have an impact on overall estate planning. Another would be to donate it to a charity. There are even ways to put a property into a charitable trust that allow you to retain control even as to future use long after your demise. All of these possibilities have tax consequences and require that you seek competent professional help. Timing of a gift can be important because the stepped up basis for the recipient is related to the value at the time that the gift is made. Lesson 32 of our “Buying & Selling Income Properties” eCourse includes a discussion about charitable trusts.

Sell It

You can, of course sell the property, just as you can sell your personal residence. And, just as when selling your personal residence, you want to maximize the sale price. However, selling income property is usually more complicated and can have significantly more tax consequences.

Arguably, the most important tax consequence is that taxable gain will be based on sales price (less selling costs) less your basis at the time of sale. And, your basis is usually the net purchase price plus amounts added to basis during the period of ownership minus depreciation taken during the period of ownership. In other words you will pay tax on all the depreciation that you deducted during the years of ownership in addition to paying tax on the actual increased value, where there may be a difference in tax rates between the two. There are ways to somewhat cushion the tax blow, for example, by structuring the sale as an installment sale.

Timing is obviously important for selling a property because you’d like to sell at the top of the market or at least not at the bottom. If in an increasing market, you might want to delay the sale if practical and add more dollars to your price, using that time to maximize rents and minimize expenses where possible.

Exchange It

Unless you want to get out of the landlord business, it will usually be advantageous to exchange your income property under Section 1031 of the Internal Revenue Code. Section 1031 provides a way to exchange one property for another without paying income tax on gain and depreciation recapture on the property being exchanged from at the time of the exchange.

Although sometimes referred to as “tax-free” exchanges, remember that there is no such thing as a free anything. Section1031 provides a deferment of taxation rather than a waiver of it. However, if you die before selling a particular property, your heirs may receive a stepped up basis that makes the deferment permanent, depending on tax laws at the time of death.

Currently (2010), the Internal Revenue Code allows owners of certain types of like kind “real” and “personal” property to exchange like kind property without paying the capital gains tax. The Code lays out in detail the procedure for turning a sale and purchase type transaction into an exchange.

In general, no gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind which is to be held either for productive use in a trade or business or for investment.

Section 1031 provides a means of trading your existing real estate portfolio for one that is less management intensive when you want to slow down, but not entirely retire from the rental business. The main advantage of a tax-deferred exchange is that it allows you to trade up to larger property or higher quality property after your previous property has increased in equity in order to improve your leverage position, utilizing untaxed dollars to do so. As indicated by the word deferred, you will eventually have to pay the piper if you wish to cash out and retire from the landlord business.

Additional Information

Additional discussions regarding several issues related to disposing of income properties will be provided in future articles. Currently, significantly more detailed discussions regarding a wide range of issues can be found in our “Buying & Selling Income Properties” eCourse.