Archive for April, 2011

Disposing Of Income Property Part 3 Of 3

April, 2011

Disposing of Income Property

Some Often Ignored Issues

There are many issues that can cause problems when selling an income property, some of which are not always considered even though quite basic. Attention to the following issues can reduce the number of potential delays and conflicts during the sale process.

Some Contract Issues

Illogical Contingencies – Do not accept any contingencies that are likely to affect the closing or will cost you more than you are willing to spend to in order to close. For example, do not accept a contingency that all air conditioners be in operating condition when you know that some are not, unless you are prepared to repair them. In this case you should have done so before even putting the property on the market.

Escrow Length – Be sure that the requested closing date is realistic based upon the time required to complete all contingencies including financing. Although you, as seller, want to close as soon as possible, it is extra hassle to grant extensions because the original date was unrealistic and you will likely be unwilling to cancel the deal after being into it for a significant period.

Restrictions during Escrow – You should not worry about restrictions regarding what you can do during the escrow period unless the buyer does. In the case he does, try to limit the restrictions to the degree possible, remembering that you don’t want to limit your control more than necessary when there is never a guarantee that the deal will close.

Estoppel Certificates – be sure to require estoppel certificates. Although it is usually thought to be for the buyer’s benefit that estoppel certificates be obtained, they can also benefit the seller because they eliminate potential disputes by buyer or tenants as to rents, deposits, and other lease terms. You don’t want a tenant arguing the terms of his lease or some other matter after close of escrow because you will almost certainly be involved in the dispute and, for a serious issue, could suffer financial repercussions.

Disclosure

Failing to disclose material facts in the beginning is dangerous, both because failures may create legal problems and because the facts will likely be discovered by the buyer later anyway. Discovery late in the deal can result in an upset buyer who will want to use his discovery as a reason to kill the deal or to at least renegotiate the price.

Is the property in a Superfund site? Was it the site of a dry cleaners or auto repair shop? If so, disclose it up-front and then don’t allow the fact to be a contingency except as regards inspections or assessments that might be desired. Do you have a previous Phase One Assessment Report? If so, provide a copy and require the buyer to accept it without contingency if possible.

For a residential property built before 1978, provide copies of executed lead-based paint disclosure forms for each tenant. Also, provide the buyer with the legally required lead paint pamphlet and disclosure form and any required related documentation. This is in addition to providing him copies of the tenant-signed forms.

If you’ve had radon testing performed and/or abatement done, provide the appropriate documentation. The same goes for mold. Regarding any issue, keep in mind that failure to disclose is much more dangerous when there are records proving that you had knowledge of a problem and failed to disclose compared to being truly ignorant of the problem.

Tenant Notification

Since you will want cooperation of tenants regarding buyer inspections and estoppel certificates, it is recommended that you notify tenants of the pending sale as soon as there is a fully executed purchase contract. You should explain that the buyer or his agent will be making inspections and thank them in advance for their cooperation. Keeping tenants in the loop and remaining on good terms with them may reduce the chance of them voicing complaints about the property to the buyer or his agent. Not only does this reduce the chance of defects becoming more important, but it also is best that the tenants appear to be happy when meeting the potential buyer. Disgruntled tenants may concern the potential buyer enough to kill the deal or at least affect the price he will pay.

Contingency Cooperation & Assistance

Although you might resent the need to assist in getting access for inspections, it is again to your advantage to cooperate and even assist in getting the contingencies out of the way as soon as possible and with the least amount of trouble. Again, your presence when the buyer or his agents are interfacing with tenants may reduce the chance of the tenants voicing complaints about the property to the buyer. You might even want to be the one to get signatures on estoppel certificates so that you can deal with any misunderstandings or disputes yourself rather than have the buyer or his agent involved.

Transfers & Terminations

Failure to make sure that all necessary transfers and terminations of services are done can result in problems for the seller after close of escrow, including possible financial liability regarding ongoing services.

Licenses, Permits & TaxesBe sure that you inform the relevant governmental agencies – e.g., the office that collects rent taxes – about the sale so that you don’t end up being liable for the new owner’s failure to pay fees or taxes or for some other ordinance violation.

Insurance – You will want to cancel insurance coverage after closing escrow. Pro-ration of insurance premiums are usually to the effective date of sale of the insured property rather than to the date when notice is given, so there is no reason to jump the gun and risk cancellation prior to the date of ownership transfer. Doing so could result in an uninsured loss resulting from either a physical loss or a liability claim because closing was delayed and the insurance agent didn’t get the word that coverage needed to be continued beyond the previously scheduled closing date.

Utilities & Miscellaneous Services – While you don’t want to discontinue utilities or other services prior to closing escrow, you do want to be sure to do so immediately thereafter. You should coordinate this with the buyer to avoid disruption of services to tenants and it can be beneficial to even cover this issue in the purchase contract. It’s a good idea to follow up with phone calls after the discontinuance date to verify that it actually happened.

After Closing

Send written notice to all tenants that escrow has closed and provide the name of the new owner and his address and phone number. You might also state that they should contact the owner regarding the exact payee for future rent checks unless you have agreed to pass that information to them for the buyer.

Check the closing statement carefully. In particular check pro-rations of rents, property taxes, and interest and be sure that you are correctly debited for deposits and that the loan payoff amount is correct.

File the closing statement and related documentation where you will be able to find them when it’s time to prepare income tax returns for the year of sale.

Additional Information

For more detailed discussions regarding disposal of properties see our “Buying & Selling Income Properties” eCourse. For additional discussions regarding a wide variety of real estate investing and management issues see our other eCourses and our Mini Training Guides.

A Future Tenant Made A Deposit On A Unit, But…

April, 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

A future tenant made a deposit on a unit, but now says she will not move in because the schools aren’t good enough for her kid. I have waited over a week for her to come up with the rent before she finally told me. Can we keep the deposit?

A1

You can likely keep some of the deposit, but not necessarily all of it. What you can do will depend on a number of factors not mentioned in your question. Although I’ll mention a few issues, I can better answer your question after you answer the following questions:

Had the applicant and you signed the lease agreement? If not, you probably can’t keep any of it if she took you to court unless the deposit was actually a holding deposit for which you had a written agreement or could otherwise prove the terms of the deal.

If it was a holding deposit without a signed lease, is there a signed agreement that specifies what happens to the funds in the event of default by the applicant?

Has the applicant been given possession of the unit (been given a key) or been allowed to put any belongings there?

What date was the lease term to commence?

By what date was the rent to have been paid?

What date did the applicant tell you she didn’t want to move in?

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Q2

How many people can live in a studio?

A2

That might depend on a number of factors including the city and state of location, the size of the unit, the floor plan of the unit, and, if you end up fighting the issue in court, the opinion of a judge.

Occupancy limits are potentially a problem. Landlords may set their own reasonable occupancy standards for their rental properties and there are a number of reasons why landlords may want to restrict the number of occupants in the dwelling unit, including health and safety considerations or property component issues that might create a physical limitation (e.g., water supply or septic tank capacities).

However, unreasonable or overly restrictive occupancy standards may be in violation of federal, state, or local fair housing laws.

Federal fair housing law covers 7 protected classes, of which the most obvious issue related to occupancy limits is “familial status.” The familial status protected class is to prevent unfairly limit housing options because of children in any “family group” with potential groups not related to marital status or biological children. Even pregnancy or pending adoption can qualify the person as being of the protected classes. Some jurisdictions have even more restrictive laws regarding children. A landlord’s occupancy policy that directly or indirectly excludes or even restricts children could be a violation of fair housing laws. A better occupancy policy limits the number of people per unit rather than the number of children per unit.

In all cases, anything that is applied to one unit of a property must be applied to all similar units and to all occupants. For example, a landlord can’t limit a two-bedroom unit to a couple and one child rather than allow two children, no matter what the ages and sexes of the children. Also, you can’t charge more rent for an adult and one child than for two adults who are applying to rent a similar unit at about the same time.

A commonly utilized standard for rental occupancy limits is the Department of Housing and Urban Development (HUD) guideline that “an occupancy policy of two persons in a bedroom, as a general rule, is reasonable under the Fair Housing Act.” However, landlords should note this was intended as a guideline, not as the rule, for maximum occupancy of the dwelling unit. In fact, HUD directives for investigating discrimination complaints regarding occupancy limits, take into account other limiting factors such as the size of bedrooms, size of the dwelling unit, the capacity of sewer, septic, and other building systems, and any state or local occupancy requirements. Additional information can be found at www.hud.gov.

Consideration must also be given to state and local laws regarding occupancy standards. Some states have more lenient occupancy standards than federal guidelines. For example, California statutes allow two persons per bedroom plus one more. When there is a conflict between federal, state, and local laws, landlords are safest by utilizing the least restrictive standards.

There may be local zoning or building occupancy limitations that apply to rental units. Some localities have based guidelines on the Uniform Housing Code (UHC) model code standards. The UHC standard provides occupancy guidelines based upon square footage rather than the number of bedrooms.

Another standard sometimes mentioned in landlording articles references the BOCA codes for occupancy standards. Building Officials and Administrators (BOCA), a national nonprofit member service organization publishes a series of model local building and construction codes. A maintenance code established by BOCA for guidance to municipalities for health and safety issues on existing properties has sometimes been referenced as a safe harbor standard for setting occupancy limitations. The code provided guidance on the maximum number of persons who could safely occupy a building without overcrowding, however the code was not created to use for habitability purposes.

Landlords are advised to perform their own research on applicable occupancy laws and formulate policies according to law and local court interpretations, business necessity, and without discriminating against members of any protected class. Failure to do so will result in defending against a discrimination claim under fair housing laws.

I realize that for the specific case of your question, a studio apartment, it might be impossible to apply any standards that mention number of bedrooms. For a studio, the main considerations other than any explicit laws at each level of government and absent any service limitation (e.g., water or sewer) will usually revolve around the size and layout of the unit.

To be safe, you need to first verify that there are no state or local laws that are more restrictive than HUD occupancy guidelines and federal fair housing laws. You should also consider discussing the matter with any local rental housing agency having jurisdiction regarding the the property.

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Q3

If I am managing a rental property for someone else, what do I do about the property tax statement or deed showing ownership of the rental property not being in my name?
A3

I will assume that you or your firm is licensed to do property management in accordance with the laws of your state. If not, there would be additional issues to discuss.

The issues you mention should never be a problem. Most, perhaps all states require that property management firms have a written management agreement executed by the owner and the management firm. Most states specify what issues must be covered in the agreement and/or what cannot be in it.

With such a document, a property manager should be able to do anything on behalf of the owner that is allowed by the agreement. Obviously, the agreement would not allow the manager to sell or encumber the property, but it would usually allow the manager to execute contracts for utilities and all vendors (e.g., repair and maintenance services) and to appear in court on behalf of the owner for evictions or lawsuits (not all states will allow court representation by other than an attorney for all forms of vesting or for all matters). As a practical matter, few if any vendors will ever ask for such proof of contracting authority because the management firm will be liable for any bills in the firm’s name anyway.

Regarding property tax statements, the owner, if he chooses, can have the tax assessment notices and tax bills mailed to the property management firm. However, for numerous reasons it is usually of benefit to both the owner and the management firm to not do so. For example, the assessment notices going to the management firm might make the firm liable for failing to notify the owner of suspicious assessment increases and/or the firm failing to file an appeal of valuation in a timely manner. As an owner, I would prefer to have all tax information sent to me to make sure that I was aware of issues and to eliminate the extra work and potential problems if I wanted to change management firms.

For similar reasons, it is usually best for both parties that insurance policy documentation and billings go to the owner. A failure of the management firm to note important changes in coverages or to pay a bill could result in substantial claims against the firm if a major loss occurred after an important coverage had been eliminated by the insurer or after the policy had been cancelled due to non-payment of premiums.

Finally, for reasons similar to those for property taxes and insurance, it is usually best that the mortgage company mail all correspondence to the owner.

If the owner prefers that the management firm pay the three items – often of importance to the owner because it will then appear on financial statements provided by the management firm – the owner can provide copies of the relevant documentation to the firm. Providing the necessary billing documentation to the management company for its payments in a timely manner should never be a cause for problems if the owner is reasonably organized.

The firm can also keep track of due dates for payment and remind the owner of the issues. It is not unusual that, because cash flow from operations does not cover one or more of the three items, the owner would have to provide additional funds in order for the firm to make such payments.

A deed is an ownership document, so, unless the property manager had an actual ownership interest in the property, the manager’s name should not be on the deed. Creating a new deed with the manager’s name on it would open up all kinds of legal issues, many potentially serious.

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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.

Pet Agreements

April, 2011

Pet Agreements

Ownership of pets is becoming increasingly important to people. Because such a large percentage of potential tenants have pets, allowing pets in rental units significantly increases the size of the applicant pool when it’s time to fill a vacancy. Also, since pets are not allowed in a significant percentage of rental units, tenants with pets are often more likely to remain for longer terms. These factors can lead to shorter vacancies and fewer vacancies, respectively. Accordingly, more landlords are beginning see a benefit to allowing pets in their properties.

On the downside, allowing pets in a rental property can involve additional risks, including additional property damage and injuries caused by tenants’ pets. However, landlords can reduce the potential risks associated with pet-friendly rentals. The most important factor in doing so is utilizing a good pet agreement. The pet agreement can either be incorporated into the lease agreement itself or be a separate document that is referred to within the lease agreement in a way that makes it a part thereof. Having a pet agreement that is a part of the lease agreement provides notice to the tenants and increases the landlord’s legal power to deal with pet problems, including termination of tenancy.

Pet agreements should executed by all tenants, even those who do not have pets at the time of their move-in, to be sure the tenants know the rules and have already agreed to abide by them in the event they later acquire a pet.

There are a number of issues that should be covered in the pet agreement.

List Allowed/Disallowed Pets – The pet agreement should specify which types of pets are allowed (e.g., dogs, cats, birds, fish) and disallowed (e.g., chickens, pigs, snakes). Neither list need be all-inclusive, just representative. In order to avoid wasted time by both the applicant and the landlord, this information should also be provided with the application form. The agreement should also specify any limit to the number of pets allowed.

Some landlords ban certain dog breeds that many people believe have a propensity toward violence, such as pit bulls and Rottweilers. Landlords can legally ban these breeds even though the question of whether certain breeds are truly dangerous is debatable. Before allowing such breeds, landlords should check with their insurers. Some companies won’t issue liability policies or will issue the policy with excluded coverage for incidences involving certain so-called “dangerous breeds” kept on the property. A landlord cannot prohibit “dangerous breeds” that are bona fide service or companion animals.

Some landlords limit the weight of dogs, although small dogs can cause more damage than large ones.

No Pet Sitting – The pet agreement should make it clear that only tenants’ pets are allowed and the tenants are not to care for other pets. The agreement should specify whether guests are allowed to bring their pets with them while visiting tenants.

Require Approval of Pets – Require that tenants get approval for any pet that they have when applying to rent the unit or at any later date when they wish to acquire one. Approval should be contingent on the owners stating, as part of the pet agreement, that the pet has no record of damaging property or injuring people or animals belonging to others. Landlords should ask about this issue when checking with previous landlords.

Conditional Approval – Finally, state that the agreement should state that approval is conditioned upon the tenants’ continued compliance with the terms of the pet agreement. The agreement should make clear that the landlord has the right to ask the tenant to remove the pet from the property or terminate tenancy in the event of violations of the agreement.

It is also important that landlords enforce their pet policies to avoid the risk of creating a waiver because of ignoring known violations. This means giving written notices of violations and a termination notice when a problem is not corrected, subject to any related rent control restrictions. It is extremely important to deal with violations where the animal was a threat or appeared to be a threat to others in order to minimize liability for a future injury by the animal.

Identification, Licenses, Vaccinations – Require that all dogs and cats wear identification collars or tags, are properly licensed and vaccinated as required by local ordinances, with proof of compliance being provided to the landlord.

Responsibility – Tenants must agree to always control their pets, insure that they don’t disturb or annoy others, clean up after them in the tenant’s private area and in common areas, not leave pets unsupervised for extended periods, and keep pets in appropriate contained areas within their unit.

Pet Fee or Deposit – Expecting that pets may cause damages or additional wear and tear, many landlords impose a “pet fee” or “pet deposit” in addition to the normal security deposit. Think carefully before implementing such a policy.

First, landlords must be sure they know of any statutes or ordinances governing such items. Many states do not allow non-refundable fees or they specifically define which types are allowed. Many states consider any funds collected in addition to rent, whether called fees or deposits, to be part of the maximum allowed security deposits that are defined by statute in a majority of states (typically one to two months rent). Therefore, if the total amount of the deposits that are required from a tenant has reached the maximum, the tenant cannot be charged a pet deposit on top of that in many states. Controlled housing may have different restrictions.

Second, be sure to consider that there can be downsides to such funds. For example, calling something a “pet” deposit may mean that the amount can’t be applied to damages not done by a pet. This is particularly disadvantageous when the security deposit is reduced in order to allow a pet deposit when the state limits the total of all deposits. For this reason, in many states it’s better to impose a non-specific deposit.

Third, there can be issues regarding pet fees and deposits even in those dates that allow such items in addition to a maximum security deposit. If a pet fee or deposit is considered by a judge to be unreasonably high the judge may not enforce it.

Finally, do not impose a pet deposit or fee for a tenant who keeps a service or companion animal. Such animals aren’t pets — they are animals needed to accommodate a disability.

Fair Housing – Keep in mind that even if landlords don’t wish to have pet friendly rentals, they cannot prohibit service animals.

Make Agreement Changeable – Landlords may find it desirable, even necessary to change their pet policies at sometime in the future either due to experiences related to a certain type of pet or, particularly for dogs, a change in their insurer’s breed exclusions. Accordingly, the agreement should state that the landlord has the right to amend the rules by giving tenants a reasonable notice, e.g., 30 days. Landlords should consider grandfathering existing pets (but not replacements for them) except when the need for a change is related to insurance or governmental action. Requiring removal of existing pets will likely result in serious deterioration of landlord-tenant relations, even potential legal actions.

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.

I’m Looking For The Legal Limits When Raising The Rent..

April, 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 looking for the legal limits when raising the rent on lease renewal and anything specific on that issue within the state of AZ.

A1

Except for properties subject to rent control or rent stabilization laws or otherwise restricted (e.g., Section 8 or other type of subsidized housing) or otherwise specified in the lease agreement, one can raise the rent by any amount desired.

In general, one cannot raise the rent during the term of a lease unless allowed by the lease agreement or agreed to by the tenant. For month-to-month leases, most states require 30 days advance notice and that is the period for AZ. However, a longer notice period can be specified in the lease. Whether a month-to-month tenancy or the end of a long-term tenancy, it is best to give notice of a rent increase somewhat more than the minimum required by law in order to avoid arguments regarding whether or not the minimum notice requirement was met. As with most things related to landlording, it is best that all such notices be in writing

Unless otherwise specified in the lease agreement, an increase need not be effective on the 1st of the month or on the day of the month that the current lease expires – you would simply pro-rate accordingly. A lease clause specifying the rent upon renewal or extension is binding on both parties. In general, the landlord is not required to offer renewal or extension of a lease unless the lease states otherwise. If the lease will not be renewed or extended, it is best to provide notice of such plans well in advance of the termination of the current term, preferably more than the 30 days usually required. It is best to not give reasons for not extending or renewing, particularly any reason that could be somehow interpreted as a violation of fair housing laws.

When considering whether to raise the rent for existing tenants, whether for extension or renewal of a long-term lease or with proper notice for a month-to-month tenant, there really can be no specific criteria, but there are some basic principles.

For a tenant that a landlord would like to retain, the most basic thing that must be considered is what amount of increase would motivate the tenant to move. Vacancies are costly for a landlord – with zero-rent downtime, repairs and redecorating, utilities, advertising expense, and a lot of time required of the landlord and/or manager. It would require that a replacement tenant remain for over 2.5 years in order to make up for a one month vacancy on a $900/month unit, with preparation costs of $600, if the new rent were $50/month higher. The time spent on the vacancy and the possibility of major expenses related to correcting just normal wear and tear can make the event even less attractive.

Tenants will usually not leave over a reasonable increase that still leaves the rent slightly under market because moving is costly in a number of ways. It is better to give regular annual small increases rather than large occasional ones.

The decision for a specific case must be based on a number of factors, including the condition of the unit, local market conditions, the current rent compared to market, and the known history of the existing tenant compared to the uncertainty of the next one.

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Q2

Why does my commercial lease contract – for a business that occupied the space when I bought the building – read “minimum monthly rent” $2500. Why does it say minimum?

A2

A typical commercial lease agreement is much more complex than a typical residential lease agreement and what is legal for commercial leases is not nearly as regulated as for residential. There may be no reason for it to say “minimum” other than whoever wrote the clause wanted to use that term. There may also be an important reason to have used the term because of one or more other clauses, particularly clauses related to options to renew or extend and to cost of living adjustments. Without reading the entire lease there is no way for me to know whether there is any real reason. Practically speaking, unless there are clauses such as previously mentioned, I do not think it matters whether the word minimum is used or not. In either case, the monthly rent would be the same and that amount would be the minimum amount payable. Absent some unknown other clause, it would also be the maximum rent payable until the existing lease term expires.

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Q3

Our tenant has not paid rent for 3 months, we have asked him to move out and he is taking his time. The house is dirty and there is still stuff there. We have already filed for eviction once. What can we get if we file a complaint in court for abandonment of the property and not paying rent? Is it worth it to go to court and spend a lot of money, do we have right to enter their house and throw away his stuff? Please help. Thanks.

A3

Until the tenant gives up possession, you have NO right to enter a tenant’s unit except for purposes allowed by law and in accordance with the notification period required by the law of your state (except for a bona fide emergency). You have NO right to touch his stuff unless you have good reason to believe that he has purposely abandoned the stuff.

Some states’ laws include specific procedures that must be followed in order to consider that a tenant has abandoned the premises and lost the right to possession. Such laws enable the landlord who follows the procedures to safety take possession of the unit even though the tenant has not demonstrated intent to terminate tenancy. Absent such defined procedures and absent specific things that would otherwise be certain to satisfy a court regarding evidence of abandonment, landlords must proceed carefully.

Even then, you must follow any abandoned property laws of your state in order to minimize risks, laws which vary significantly among the states. A few states allow landlords to dispose of abandoned property in any way they see fit. Some states have very complicated requirements regarding abandoned property including that it must be stored in a secured manner, notice of the matter being provided to the ex-tenant as required by the state law, notice of a public sale of the property published in the manner required by state law, and the proceeds of the sale must be applied against amounts legally owed the landlord, with any balance being paid to the ex-tenant. The laws of other states fall somewhere between those two extremes. Failure to follow abandoned property laws can result in lawsuits in which the ex-tenant may claim that his property included jewelry, antiques, or other valuable items.

You state that you filed for eviction once. However, you do not say why the tenant is still in the property. Did you actually process an eviction through the court or only serve a notice? Did you not follow through with the process, win a judgment, and have the tenant legally removed via the proper officer of the court? In many states, completing an eviction can simplify the personal property abandonment issue.

For future reference, I recommend that a “pay or quit” notice be immediately served on a tenant the day after the rent was due (including any grace period required by state law or the lease agreement) and, if the rent is not received within the notice period required by state law, immediately start the eviction through the court. It is sometimes a good idea to proceed to completion of the eviction even when the tenant  leaves voluntarily after being served with the complaint and summons. Whether the extra cost of completion is cost effective depends on issues beyond the scope of this reply.

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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.