Lease Agreements – Part 1

Landlords and property managers utilize a large number of different documents. Some are used regularly, others only occasionally, and many landlords may never have need for certain documents that other landlords use regularly.

Unfortunately, most landlords do not utilize as many documents as they should. Use of adequate documentation is important for minimizing misunderstandings and the conflicts that often result from misunderstandings as well as for providing paper trails that provide proof of what really happened in case a tenant wishes to dispute a matter.

More specifically, a large percentage of landlords fail to use adequate lease agreements, resulting in unnecessary disputes and other problems. This should probably not be surprising, as the subject of lease agreements is a large and complex one.

We won’t attempt to cover all aspects of all types of leases here, as the subject of leases can be a book in itself. However, in a series of articles we will attempt to cover a wide range of topics in enough depth to provide a good understanding of lease agreements.

Lease Basics

A real property lease agreement is a legal contract whereby the owner (or his property manager agent) gives a person (or persons) the right to occupy and use a property for a specific period (the “term”). The contract sets out the terms and conditions of the tenancy, is legally binding and enforceable against all parties.

The lease governs the landlord-tenant relationship. It transfers possession, use, and enjoyment of the property from the landlord to the tenant for a specific period of time and for a stated amount of rent. To be enforceable, the lease agreement should cover a number of basic issues which help to protect both the landlord and the tenant from fraud or misunderstanding in the event of disagreements or disputes.

The owner is called the “Lessor” (or “Landlord”) and the person who occupies the property is called the “Lessee” (or “Tenant”). A lease agreement defines the rights of lessor and lessee that are not already defined by law. The lease agreement must conform to statutes and case law and the terms and conditions stated in the agreement must be acceptable to both parties.

Importance of Lease Agreements

The lease agreement is important not only for current operation of the rental property but also for maximizing the value of the property as an asset. This is true because the value of an income property is highly dependent on the lease agreement(s) for the property. While not as important for a single-family residence, value becomes increasingly more dependent on lease agreements as the number of units increases. In fact, lease agreements are a primary factor in the value of larger properties. A primary method for valuing a larger income property is the Income Approach wherein the net operating income is capitalized to calculate value. Accordingly, the value of a property can be significantly affected by both current and future rents as specified in the lease agreements for the property as well as by many other lease issues.

The terms of lease agreements are particularly important for non-residential properties for which leases tend to be long-term and often include cost-of-living adjustments, renewal options, and other terms that can significantly affect future value, sometimes for a decade or more.

Lease agreements must include tools for enforcing timely payment of rents, proper care of the property by the tenants, and other issues important to efficient and profitable operation of the property. For example, if default provisions aren’t adequately defined, the landlord may be unable to evict a tenant who defaults on lease obligations that are important to the landlord. There must, of course, be compromises when deciding the content of a lease. If it is totally iron-clad in favor of the landlord, no thinking applicant will sign it, whereas, if it’s a one page document purchased from the local stationery store, the landlord might be left at risk in many ways.

It is not enough to have a good lease agreement. A landlord must thoroughly understand his/her lease agreement and apply the terms uniformly and firmly to all tenants who have signed that lease.

Lease Agreement vs. Rental Agreement

It is our opinion that there is no legal difference between a “Lease Agreement” and a “Rental Agreement.” Some property management writers and document publishers use the term “Lease Agreement” for tenancies originally written for a term of more than one month and the term “Rental Agreement” for month-to-month tenancies. However, typical state statutes do not differentiate between the lengths of tenancy in choosing which term to use. Historically, legal references have more often used the term “lease agreement” no matter the length of tenancy specified in the document.

It is the content of a lease agreement that matters, not the title. In this article and in future articles of the series we will use the term “Lease Agreement” or simply the term “Lease” to mean a contract for tenancy of either residential or commercial income properties for any period of time.

Types of Tenancy

The landlord may offer one of four different types of “tenancies” or “leaseholds.” The type of tenancy can affect the parties’ rights to terminate or alter the landlord-tenant relationship.

The four types of tenancies are:

Fixed Term Tenancy – The fixed term tenancy is the most common type of leasehold and is usually an annual (12 month) lease. This type of tenancy has a fixed duration and terminates automatically at the end of the period. A fixed term tenancy can run for any period of time, as long as the lease terminates automatically at the end of the period. In some jurisdictions, it is important that the total rent for the entire lease period be stated in the lease agreement.

Periodic Tenancy – This type of leasehold runs for a fixed period of time (e.g., weekly, monthly, six months, one year, five years) and renews automatically at the end of the lease term. A month-to-month rental is the periodic tenancy most often used. A periodic tenancy does not terminate until the landlord or tenant gives notice of termination. Notice must usually be equal to the rental period term. If the agreement is weekly, a seven day notice would suffice; if it is monthly, the party who wishes to terminate the agreement must give at least one month’s notice. However, some states provide for longer notice periods by only the landlord or for both parties, sometimes depending on certain circumstances.

Tenancy at Will – A tenancy at will has no fixed duration and can be terminated by the tenant or the landlord at any time. In some jurisdictions, a tenancy at will is restricted, usually for benefit of the tenant, and in some jurisdictions this form of tenancy is not permitted.

Tenancy at Sufferance – A tenancy at sufferance occurs when the tenant wrongfully remains on the premises, or “holds over,” after the lease has expired. Unlike the other types of tenancy, the tenancy at sufferance is not the result of an agreement between the landlord and tenant. Therefore, the tenant should have no legal right to remain on the property and the landlord should be able to evict. However, some jurisdictions now address a hold-over tenancy by statute and conclude that by accepting rental payments the landlord is deemed to have entered into a new lease contract with the tenant. The laws of some states specifically say that if the tenant makes rental payments during the hold-over period, and the landlord accepts those payments, a new tenancy is created. Some states even make the renewal lease period equal to the previous lease. In other states a landlord retains his right to evict and, in fact, may be entitled to damages as well.

Question:

The tenant in one of my units is complaining that there is currently mold around a bath tub where the tile meets the tub. She wants me to clean it up. Who is responsible for cleaning up the mold?

Answer:

That might depend on what type of mold it is, the source of the moisture that results in mold, and/or whether there was evidence of the mold at the time the tenant moved in.

The type of mold that almost always appears around a tub at its interface with tile or other material is not usually of the type that the landlord must clean, at least not if mold was not there when the tenant moved in. In most, perhaps all states the tenant is legally responsible for keeping the premises in clean and safe conditions. This includes keeping the plumbing fixtures clean (and free of mold). Of course, if the problem is caused by a leak in the wall or from a unit above, the landlord should take care of the problem. Taking care of the problem includes repair of the leak source, not only because the mold is more the fault of the landlord rather the tenant, but more importantly because continuation of the leak will ultimately result in the landlord having to pay for very expensive repairs or rebuilding of walls, ceilings, and/or floor.

Question:

I own a 4-plex on which various improvements have been made during the 8 years I have owned it.  Many of these improvements were done without permits. Will this cause me problems when I sell, presently planned for next year?

Answer:

It would be best to correct this problem before marketing your property for a number of reasons and I will briefly discuss some of the issues.

Some jurisdictions now require a physical inspection and record search by the city or county building department before any escrow can close. Depending on the specific jurisdiction, the result may require getting the improvements
permitted at a cost that will include the current permit fees and may include penalties, sometimes the penalties accrue from the year when the improvements were made. Code violations found during the inspection must usually be corrected
and re-inspected in such jurisdictions. So, failure to take care of the problem before signing a contract can create significant problems when escrow is scheduled to close. At a minimum it will result in a significant delay while
getting permits, even a longer delay if the inspection discloses code violations that must be corrected. At worst, the seller may be sued by the buyer.

Sometimes an electrician, plumber, or other licensed contractor called in by a new owner long after close of escrow discovers code violations. Some unpermitted improvements could result in being sued. At the worst would be an improvement that was improperly done that results in injury or death following close of escrow, for which you would almost certainly be sued, possibly even criminally charged. or if the problem is only discovered when the buyer has a licensed contractor work on the property at some date after closing escrow and the contractor points out previously performed work that does not meet building codes.

Also, many states require sellers to furnish the potential buyer with a boiler plate disclosure document that will include a question regarding whether any improvements were made without permits, sometimes whether or not completed by
licensed contractors.

If you decide to market the property without correcting the problem, you should disclose the issues up front, at least before signing a contract, even if the location is in a jurisdiction that does not require building permits (as is true for some
rural counties) in order to reduce ramifications of any issues occurring at some future date. Not making a deal is far better than defending against a lawsuit for failure to do so when (probably not if) the buyer discovers the issue, particularly if discovered after closing escrow rather than in the course of performing due diligence. Even if discovered by the potential buyer’s due diligence and he/she invokes a contingency to cancel the offer, you may have a couple of angry real estate agents whose time you’ve wasted.

Question:

This is a follow-up question to the one I recently posted regarding holding deposits.

My intent is to have a holding deposit agreement from these potential tenants, as I want to be sure that these people are not going to back out if I take the house off the market for other potential renters.

I’ve written up a short agreement for myself and the potential tenants to sign.  Basically, it says that I am receiving a specific dollar amount from them to hold the house until they sign the lease and move in on a particular day in the future.  As long as they fulfill their agreement and move in, I will take those monies and apply it towards the security deposit.  If they, for whatever reason, decide not to sign a lease and move in, they forfeit those monies. I wanted to be sure that,
legally, I would be allowed to keep those monies since I took the house off the market, assuming that they were going to honor our agreement of signing a lease and moving in to the property.

I thought this was a fair and equitable agreement for both parties, but I don’t want to do anything that is not legal! Any further advice that you can provide me will be greatly appreciated.

Answer:

The following is a shorter version of an article I once wrote regarding holding deposits. In my efforts to reduce the article to a reasonable length within a reasonable time I may have ended up with something that is not as well organized, as I’d have liked, but I think it will be adequate for your needs.

Sometimes, when the rental market is tight, applicants may offer a holding deposit to take the rental unit off the market until the applicant’s screening and verification is complete. Other times, a holding deposit may seem appropriate when an applicant appears committed to the rental, but must make arrangements for the move-in funds. The holding deposit is not a security deposit, but is to compensate the landlord for damages suffered for holding a unit off the market in the event that the applicant fails to meet screening qualifications or rescinds his/her agreement to rent the unit.

It is best to avoid the use of holding deposits, particularly now that most verifications of qualification can usually be done within a relatively short time utilizing today’s technology. Although holding deposits may be legal in your state, they often lead to misunderstandings or even legal hassles. A major problem is that most states do not cover the subject adequately, if at all in their statutes and it is often unclear regarding how much of the deposit may be retained by the landlord in the event screening results are unsatisfactory or the applicant cannot come up with the necessary funds or simply changes his mind about wanting the unit.

Although holding deposits are best avoided, sometimes they are helpful because of market conditions. A landlord can take holding deposits in most states.  If allowed by your state, it might be better to utilize a holding deposit rather
than lower qualifying standards or reduce the rent. For the landlord’s protection, holding deposits should always be in cash, cashier’s check, or money order and for the protection of both parties there should always be a written agreement detailing the conditions related to the deposit even if not required by law.

When the landlord holds the rental unit for an applicant, it should be considered off the market and unavailable to other qualified prospective tenants who may have to be turned away. If the applicant later changes his/her mind, the landlord may have suffered financial harm. In such a case, the landlord is justified in retaining all or part of the holding deposit within the limits allowed by state law. However, be sure that this scenario is discussed in a signed agreement.

The written holding deposit agreement should be in accordance with any applicable state law and unambiguously cover the following issues:

• The address of the rental unit,
• The names of landlord and applicant,
• A clear statement that the deposit is a “holding deposit” rather than a security deposit.
• The amount of the deposit,
• The length of time (including exact ending date/time) the landlord is willing to hold the rental, taking into account the size of the deposit and other qualifying information,
• The basic terms of the lease agreement,
• The conditions under which the landlord will rent the unit to the applicant – e.g., verification of identity, a fully completed application form, satisfactory results on all applicable screening reports, verification of employment, and
  full payment of the security deposit and first month’s rent by the end of the holding period,
• What will happen to the deposit if the applicant signs a lease agreement – usually, that the full holding deposit will be credited to the security deposit,
• What will happen if the applicant decides not to rent the unit before being notified whether or not his/her application has been approved,
• What will happen to the holding deposit if the applicant fails to pass screening – usually the full deposit should be returned if the failure is evident within a couple of days after the landlord has accepted the holding deposit, and
• What will happen to the holding deposit if the applicant defaults on the holding agreement – specifically, how much the landlord will retain, this being in accordance with any applicable state law, and when and how the portion not being
  retained by the landlord will be returned to the applicant.

Some states that cover holding deposits by statute specifically allow a landlord to retain an amount related to the landlord’s cost of holding the unit. This might include the costs of additional advertising, prorated rent for the holding period, and perhaps a reasonable charge for the time related to paper work and inconvenience to the landlord.  Holding a larger amount puts the landlord at risk for a lawsuit. Some states specifically require that there be a written contract that states the terms and provides a receipt for the amount. The receipt can be included within the agreement, of which a copy must be provided to the applicant.

The amount of the holding deposit should be reasonably related to the rent of the unit and should take into account the potential inability of some applicants to immediately put up significant deposit funds in addition to application and/or screening fees.

In summary, landlords must follow any laws of their states and they should use good judgment and be fair in their holding deposit policy. An applicant whose holding deposit is retained without adequate justification may well have a cause of action for damages against the landlord which can result in more time and expense than the deposit was worth.