Lease Buyouts.
Lease Buyouts
It is often advantageous for a landlord to allow a tenant to buy out his lease.
Reasons for Buyouts
There are basically two reasons for a lease buyout. One is the tenant wanting or needing to break a long-term lease. The other is the landlord wishing to be rid of a tenant even though the tenant has not defaulted on the lease in a manner that
allows the landlord to terminate the lease for cause.
Examples of a tenant-initiated buyout are (1) the tenant needing to downsize to a lower rent or upgrade to more bedrooms (or larger commercial space), (2) the tenant being offered an improved employment opportunity in a distant city or another state, (3) a marriage requiring consolidation of housing, or (4) a married couple splitting up and needing separate housing. When the tenant approaches the landlord regarding early termination of a lease, the landlord has the option to refuse. Of course, in most states if the tenant simply breaks the lease and leaves, the landlord is obligated to minimize damages and re-lease the property as soon as possible rather than leave it vacant and require the tenant to continue paying the rent for the remainder of the lease term.
Examples of a landlord-initiated buyout are (1) a tenant who is often the cause of complaints from other tenants, (2) a tenant who regularly complains about petty issues, or (3) the landlord becoming aware of the tenant’s deteriorating financial situation that will likely result in default.
Advantages of Buyouts
A lease buyout can be primarily of advantage to one of the parties, but is often of benefit to both the landlord and the tenant.
The tenant is able to terminate his lease without financial penalties beyond the buyout fees and without risk of a lawsuit and/or damage to his credit record.
The landlord eliminates the need for eviction and/or other legal actions when the tenant eventually quits paying rent due to his financial situation. Depending on the amount of the buyout fee and market conditions, the landlord may be able to fill the vacancy without any loss of income. Departure of the tenant may also minimize the need for cleaning and repairing the vacant unit if the buyout agreement makes condition of the property a contingency of the deal.
Determining Buyout Fees
What might be considered a reasonable buyout fee to either the landlord or tenant or to both parties can vary widely depending on the reasons, the current rental market, and various other factors.
The landlord usually has the upper hand when a tenant approaches him regarding early termination of a lease. However, the landlord must temper his desire to maximize his profit by sticking it to the tenant. The maximum amount of
compensation the landlord can obtain for allowing termination of the lease depends on various factors including the tenant’s financial condition. If his condition is dire, he will likely leave anyway and may even be “judgment proof.”
The landlord must remember that although the tenant wishes to avoid damage to his rental history by simply leaving, the landlord may be stuck with a significant financial loss if the tenant stops paying rent long before giving up
possession, leaves the premises in bad condition, and “disappears” so that it is difficult to serve for legal action.
It is usually best to take the middle ground and calculate the fee based on a conservative estimate of the actual costs of an early vacancy, remembering that there would be a vacancy at the end of the tenant’s lease anyway. Items to consider usually include (1) costs of preparing the premises for the next tenant, (2) lost rent during preparation down-time, (3) marketing expenses (including advertising and commissions), and (4) lost rent during the marketing period until rent begins from a new tenant. Items 1 and 2 can be significantly affected by the condition that possession of the property will be returned to the landlord. Items 3 and 4 depend on current market conditions.
In an improving rental market it can actually be significantly advantageous that the lease be terminated early, particularly when the departing tenant was at a low rent and the lease still has a long time to run. This is of most importance for
commercial property where leases typically are multi-year in length, with limited increases along the way. Under such circumstances, the landlord might only ask for a token couple of weeks or a month of rent to cover item 4.
At the other extreme, in a deteriorating market one must make a guess at how many months will be required to find a tenant who will pay at least the rent that the departing tenant was paying. This might require many months of rent to cover item 4. One must also add in additional costs if the new rent is expected to be lower than that of the departing tenant.
The Buyout Agreement
The complexity of a buyout agreement depends on a number of things including the reason(s) for the buyout, but the thing common to all buyouts is that the agreement should be a written document that covers all material issues. Accordingly, as soon as agreement has been reached between the two parties regarding the terms, prepare a written document.
Among issues that should be covered in the agreement are:
State that the document is the full and final agreement regarding the lease.
State whether or not any part of the deposit will be applied against the buyout fee, whether or not any part will be refunded if the unit is immediately re-leased, or whether no credit for the deposit is to be given.
Most states require, at least for residential rentals, an accounting for any part of the security deposit not refunded within a specific time frame. The buyout agreement should cover this issue in a way that will eliminate the need for
further action regarding an accounting.