Hiring a Contractor

Adequate property management can be labor intensive, with significant demands on resources. Some tasks require specialized skills, licensure, and compliance to regulatory standards. The landlord/property manager must understand the nature of the work, the best resources to accomplish the task, and regulatory requirements.

Even the smallest of jobs requires the landlord/property manager to assess the issues of the work being performed by employee vs. independent contractor and by licensed contractor vs. unlicensed tradesman. There are also issues regarding liability insurance coverage, workers’ compensation, city or county building permit/code requirements, and possible other federal, state, and local regulations. Failure to act regarding any of those issues and others could result in legal problems and financial losses. The correct decision may save time, money, and equally important reduce exposure to liability from claims of negligence, discrimination, injury or failure to comply.

For many landlords, outsourcing a job is the more efficient way to produce the desired work result, particularly when the work should be/must be done according to licensure and code standards. Most often this is the case for extensive property repair or remodeling work. A landlord may need to select a general contractor for a major remodeling project or a specific skilled trade contractor such as an electrician or plumber.

Without first-hand knowledge of a tradesperson’s skills or a trusted referral, how can a landlord determine the qualifications of the would-be hire? Even more so, how can a landlord assess the risk as presented by the individual regarding quality of work, on-time completion, contractual authorities and responsibilities, financial stability, professional standing with state boards, and general reputation within the community?

The basic rule before starting any project is to define and analyze the project. Obviously the type and size of the project, the requirements of the state and county or city building standards and codes, and resource availability will be major considerations.

The following questions, while not all inclusive of every issue, may help you decide which items are important for a particular project and set of circumstances, taking into consideration your experience and your tolerance for risk.

• Is the project allowed by zoning, building codes, CC&Rs, and association bylaws?
• Is the estimated cost within my budget?
• What levels of skills and experience are required?
• Is a license required by law for certain aspects of the project?
• Should I hire a licensed contractor even if not required by law?
• Is a building permit required?
• Will the project require the services of an architect, engineer or designer?
• Is the percentage of cost that would be recouped from increased rents and/or reduced expenses and/or from increased sale value make the project cost effective considering the expected holding period?
• What efficiencies might be gained by doing more than initially considered?

You want to make sure that your remodeling or construction project doesn’t turn into a nightmare, with liens or lawsuits in addition to bad work.  Some knowledge, some research, and some probing questions can help you make the right decision, save you time and money, and help you avoid problems.

Employee vs. Independent Contractor

A previously published article discussed the issue of classifying workers as employees or independent contractors. Before hiring an individual to perform work, the employer must weigh the potential advantages and disadvantages of each classification. Needs of the business, employer preference, resource availability, and regulatory requirements will be factors in determining the best course of action. The nature of the work must be balanced against the potential issues of control of work product, exercise of right to termination of work services, potential labor costs, and exposure to liability.

An employer must correctly define the business relationship that will exist between the employer and the individual performing the work before the employment offer is made. Once hired, the worker will legally be classified as employee or independent contractor based on set criteria and it may be difficult to change the assumed status to the actual legal status after the fact.

Whether you are hiring a licensed or unlicensed worker, it is very important that the worker be legally an independent contractor rather than your employee – unless you do in fact intend for him to be an employee.  The fact that a worker possesses a contractor license does not per se make him an independent contractor.  It depends on the relationship, not the license.

Additional information regarding classification of workers can be found in Internal Revenue Service Publications 15, 15-A, and Circular E. There may be differing requirements under state laws and the appropriate state agency should be contacted for specific requirements.

Licensed vs. Unlicensed Contractor

There are several extra precautions to take when using unlicensed workers who you assume to be independent contractors compared to using licensed contractors.  First, it is more important to be sure of the employee/independent contractor status if you desire to have the worker considered an independent contractor because licensed contractors are more likely to satisfy the government’s criteria than unlicensed contractors.

Second, it is even more important to verify that the contractor has liability insurance and provides worker’s compensation coverage for any employees because unlicensed contractors are less likely to have either, whereas most state licensing agencies require proof of both insurances for licensed contractors in order to remain licensed.  Finally, it is more important to require the unlicensed contractor to sign an independent contractor agreement that covers the issues of concern to the IRS.

One added advantage of using licensed contractors is that stating licensing agencies will generally assist consumers who have problems with the contractor.

Liability Insurance

Liability insurance is an issue of concern whether the worker is an employee or an independent contractor.   No matter what the assumed status or the actual legal status, you the owner will be sued if the worker causes injury or property damage while working for you.

You must carry adequate liability insurance to protect you from such events.  Furthermore, when you hire an independent contractor, you should require proof that the contractor carries adequate liability insurance that covers you because doing so provides another layer of protection. This is particularly important if your rental insurance does not adequately cover all of the possible risks.

Workers’ Compensation                                                                                                                             

Workers’ compensation is meant to provide replacement income and pay medical expenses for employees who incur work-related illness or injury.  Each state has its own system for workers’ compensation.  Most owners know that workers’ compensation insurance is required for employees.

However, you should also be aware that an independent contractor who is not covered by workers’ compensation insurance can sue you if your negligence caused or contributed to his/her personal injury.  Even more important, you need to require proof that the independent contractor provides workers’ compensation coverage for any employees that might work for him/her on your behalf.  Otherwise, you may become liable in the event of injury to those workers.

Some states do not require workers’ compensation for employers with fewer than some number of employees.  The minimum number is usually in the range of 3 to 5.  Most states do not require workers’ compensation for casual labor.  The definition of “casual” varies from state to state, but basically is considered for a brief period of time and is labor that is outside the employer’s normal course of business.  However, because state law doesn’t require coverage for those classes of workers does not prevent these workers from making claims against you and filing lawsuits related to illness or injury alleged to have resulted from working for you.

OSHA Regulations

OSHA covers all private-sector employers and their employees in the 50 states and all territories and jurisdictions under federal authority.  OSHA covers employers and employees either directly through federal OSHA or through an OSHA-approved state program.  OSHA requires record keeping of work related injuries and illnesses and, in some cases, requires formal reporting of them to OSHA.

When using true independent contractors, OSHA will normally be the responsibility of the contractor.  If using unlicensed “independent contractors” and there is a chance that they would not qualify as independent contractors if their hiring status were closely examined, as for workers’ compensation insurance, you need to be concerned about OSHA.

Local codes

Zoning laws and building codes can both determine what repair/rehab you can do and what repair/rehab you must do.

When planning significant physical modifications to a property – whether adding rooms, changing design, re-painting, re-roofing, or otherwise modernizing – you must be sure that your plans are not affected by architectural or landmark preservation restrictions. These restrictions may be in addition to building codes and zoning laws.

Risk Assessment

Due diligence is required in all phases of a work relationship as well as the construction process itself. You will need to analyze the skill set and the legal requirements required to meet the needs of your business and the scope of the project.

Deciding If Refinancing Is Beneficial – Part 1

So, your current loan has an interest rate of 7.5 percent and you think that you can now refinance your property at 6.25 percent. Should you refinance now? How does one decide when it’s time to consider refinancing, knowing one must take into account the points and other loan costs and the tax considerations? If it isn’t advisable to refinance at 6.25 percent, how much below the old interest rate must rates fall before it’s beneficial to refinance?

Although there can be different factors involved in refinancing your personal residence compared to a rental property, the discussions and analyses in this series apply to either case for most issues.

Is it advantageous to refinance when rates drop by one-percent as many “experts” claim or is some lesser reduction enough or some greater reduction required?

These days, property owners are often bombarded by advertising urging them to refinance their property or take out an equity line of credit or equity loan. The advertising is on millions of Web pages, in the newspaper, flyers delivered to your door, and mail in your mail box. The advertising often fails to provide adequate disclosures, is sometimes downright misleading and, even when adequate disclosures are provided, it’s in less than “fine” print.

When hearing from the “experts” that one-percent is the point at which to refinance, keep in mind the following two important basic points:

• First, most of these “experts” work for banks or mortgage companies and anticipate refinancing income when making the pronouncement.
• Second, knowing the rate drop alone is usually seriously inadequate for making a decision and most of those giving such advice do not take into account many of the various factors that should be considered, including some that affect each borrower differently.

In this first part of the series we’ll mention some of the basic factors related to refinancing. In future parts of the series we’ll delve into ways to perform detailed analyses that take into account some of the factors. One will not usually need to do such detailed analyses, particularly for 1 to 4 unit properties, where the amounts involved are relatively small. Furthermore, there are numerous short-cut methods that provide adequate results for such loans. Although the detailed procedures shown are not often necessary, investors in larger properties may save significant amounts by utilizing the procedures and it is instructive for investors in smaller properties to understand the issues involved.

The Basics

Factors that should be considered when deciding whether it is beneficial to refinance include the following:

• The real total cost of the potential refinancing including your time and that of any others involved.
• Expected future rates and costs compared to at present.
• Your current marginal income tax bracket and what it is expected to be over the term of the loan.
• Whether or not you want to pull out cash.
• How long you plan to own the property.
• Whether or not you might want to do a Section 1031 exchange in the near future.
• Long-term goals and objectives, such as:
  • Whether you prefer high leverage for maximum return on investment or low leverage for more cash flow.
  • Whether you want to pay off the loan by a particular date because of retirement plans or for other reasons.

Discussions can be divided into two parts – the short-term and the long-term. For the short-term, we’re usually most interested in knowing how long it takes for the reduced interest rate to pay the costs of refinancing, including the time and trouble required to obtain the new loan. This is particularly important when the property might be sold in the near future, as there is usually no advantage to reducing interest costs for less time than it takes to recoup the costs of refinancing. For the long-term, we’re usually more interested in knowing the effect over a period of many years. It can often be of benefit to pay some additional cost up front in order to obtain significant savings over a number of years.

In order to do analyses similar to those that follow, one must be able to determine the values of various loan parameters for various points in the lives of loans having various interest rates and terms. This can be done by direct calculation, by utilizing printed amortization tables, or by using various computer calculators. The last method is the easiest and calculators are available on many Web sites.

Over the past half-century, real estate long-term loan interest rates have varied widely, from a low of around 4 percent, even lower for owner-occupied single-family residences, to a high of about 18 percent, even higher for less than prime properties. Although for much of the past decade rates have been lower, we will use rates in the 7 to 8 percent range in most of our examples because this is probably close to the average of rates for typical residential and commercial rental properties over the five decades.

Loan Type Considerations

There are basically two types of interest rates – fixed and adjustable (ARMs). Although we think that advantages and disadvantages of each of the two types are known to most readers, we will briefly review the two types.

Fixed Rate

A fixed rate mortgage is one in which the interest remains the same for the term of the loan. It could be a short-term interest-only loan with the entire principle due at the end of the term (a balloon note) or an amortizing long-term loan where each payment includes the interest due and some amount on the principal.

It is impossible for a lender to predict where interest rates will be 10, 20 or 30 years from now, so lenders are likely to quote higher interest rates for a fixed rate long-term mortgage to offset the risk to the lender.

While various other costs can vary among lenders, the variances of those items are insignificant compared to the two most important issues in a fixed rate loan – points and interest rate.

Points and interest rate are intertwined. Accordingly, it is possible to minimize the points with a higher interest rate or reduce the interest rate by paying more points (buy down the interest rate). The benefit of one or the other depends on the borrower’s cash availability and the expected period of the loan.

The payment amount for an amortized fixed interest loan is the same for each period, usually one month.

Adjustable Rate Mortgages (ARMs)

Adjustable Rate Mortgages (ARMs) have interest rates that are tied to some kind of financial index. This results in mortgage interest rates that can vary over a specified range. A portion of the long-term rate risk is transferred to the buyer so the lender is willing to accept lower initial interest rates on the loan. Usually, mortgage payments are adjusted as well, but not for all types of ARMs. In any event, the due date of the loan usually remains the same, meaning the loan is not fully amortized for all types.

The various indices used include U.S. Treasury Bills (T-bills), Certificates of Deposit (CDs), London Interbank Offered Rate Index (LIBOR), and Eleventh District Cost of Funds Index (COFI). Each of these indexes has different ranges and rates of potential movement and vary with different aspects of the economy and world events.

Because the lender’s risk is less, interest rates are lower for ARMs than for fixed rate mortgages.

There are essentially infinite potential varieties of ARMs, with more features and options, and a number of additional terms than associated with fixed rate loans. The initial interest rate of the mortgage is known as the “start rate”, applicable for a specific period determined by the terms of the mortgage. The period of time that the rate is fixed can range from one month to several years. Once this initial period expires, the interest rate can begin to vary. The interest rate will rise, fall, or remain the same depending on the long-term rate to which it is tied. The overall change is usually limited annually, and over the life of the loan, by a cap. Typically the annual payment increase cap is several points over the index.

Some adjustable rate mortgages have an annual interest rate adjustment cap instead of a payment cap. That sets a limit on the maximum amount of interest rate adjustment. For example, if the loan has a 2% annual interest rate cap, a loan with a start rate of 8% can then only grow to 10% at the beginning of the second year.

ARMs typically have a lifetime interest rate cap as well, which sets the absolute maximum interest rate allowed for the mortgage. If the financial index to which the interest rate is tied reaches the cap, the mortgage basically becomes a fixed-rate mortgage until the financial index drops enough for the mortgage interest rate to drop below the rate cap. There is usually a minimum interest rate required by the lender as well.

When the interest rate changes without like changes in monthly payments, it is possible for the loan amount to actually increase as the deficit in the payment amount is added to the principal. This is known as negative amortization.

Competition among lenders has resulted in a great many real estate financing options. The fixed-rate mortgage is fairly straightforward and the conservative selection for both borrowers and lenders. Nothing should change during the 15 to 30 year term, except for the property taxes and insurance amount that may be collected in the payment.

ARMs can vary in many different ways and lenders offer a number of different options to deal with changes in the interest rate index. In addition to an annual rate adjustment, some lenders offer a fixed rate for a specified period of time, like five to seven years. At the end of that initial period the rate can vary annually.

Unlike fixed rate mortgages, most ARMs are assumable. That can be a benefit to your future buyer. However, assumption usually requires financial qualification and can also require payment of fees. It is often more desirable to obtain a new loan rather than to assume an existing one.

Choosing between a fixed and variable/adjustable rate mortgage can be difficult and depends on both your expectations for the future of interest rates and your investment comfort level. If security and predictability are most important to you, then the security of a fixed payment long-term loan will be attractive. If you expect to sell within the next five years or are willing to gamble that interest rates will go down or at least remain stable, the variable/adjustable rate mortgage could be a much better deal.

In order to keep the complexity of the analyses that will be studied in future parts manageable, those analyses will only consider fixed interest rates. However, analysis for a variable rate loan is easily performed by breaking the period of time for which an analysis is desired into smaller periods during which the rate is constant.

Question

I did my quarterly safety inspection on a unit last week, the first for this tenant, and found that the tenant has an unusual amount of junk throughout the unit – my newest tenant appears to be a “hoarder.” I couldn’t see the floor in many areas of the unit. What if anything can be done about a tenant that has so much junk? I am particularly concerned about flammable items near the wall gas heaters. Also, they have ants that are probably because of food items left out and we cannot call in the pest control because of all the stuff.

Answer

First, I congratulate you on doing regular inspections of your units, as too few landlords do so. Hopefully, your inspections are for more than safety related, as inspections can also catch unreported maintenance problems that, if not corrected, can become costly (e.g., leaky plumbing). Regular inspections can also uncover lease violations and other potential problems (e.g., unknown pets and prohibited smoking, even illegal activities).

You can certainly require that a tenant maintain his unit in a safe and healthy condition. If it is your opinion that the “clutter” creates a dangerous situation you can serve a notice to correct. If you have a clause in your lease agreement that deals with the way the unit must be maintained (a common clause in a good document), refer to the specific clause as well as general safety principles. If there is no clause in the lease, refer to general principles. Many states include such issues in their landlord-tenant statutes and some local governments have their own requirements.

However, keeping both legal and landlord-tenant relations in mind, be absolutely sure, before pursuing any action, that the clutter really represents a true safety hazard or other problem rather than housekeeping practice that is beneath your standards. A tenant who pays the rent on time and causes no other problems except having a cluttered apartment interior that really doesn’t bother anyone except you is far preferable to a neat-freak tenant who is always late with the rent or is selling drugs from the unit. Other than if the clutter created a true danger to my property, I would not hassle an otherwise acceptable tenant.

You might consider seeing if the fire department for the location will do an inspection of your units in order to have an official opinion one way or the other regarding the issue. Fire departments will often do such voluntary inspections free of charge with no penalties for violations found. Some insurance companies will provide a similar service. Such inspections provide additional liability protection for a landlord as well as provide ammunition for pursuing your complaint regarding housekeeping.

Regarding the ants, even if the clutter does not represent a safety issue you would have the right to require that the floors be cleared of clutter on the day when pest control treatment is scheduled. You should provide written notice of the treatment the number of days in advance required by your lease agreement or state law, whichever is greater. If the pest control person must make a separate special trip because the stuff prevent treating the unit, you could probably bill them for it. Failure to cooperate might provide grounds for eviction, but it might depend on the judge. However, keep in mind that such actions will not likely improve landlord-tenant relations.

If you decide to serve the tenant with a notice, LandlordOnline.com has one available titled “Warning Notice To Resident Re: Housekeeping.”

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Question 2

I am a relatively new landlord who has not previously experienced the issue of my question.

A tenant gave notice more than a week ago via my cell phone message service that she would vacate the unit by the end of her lease this past Sunday. It is now Friday, 5 days later, and she has not yet turned in the keys and does not return phone calls or respond to messages left at her work place. Looking through a window I can see that there is still some of her furniture and other things in the unit. What must I do before entering the unit and what do I do with things left there?

Answer 2

You did not provide the name of the state for your rental property, so I can only answer in generalities.

The most basic issue is whether or not possession has been returned to you. This in turn depends on the intent of the tenant, clauses in your lease agreement, the law of the state, and what events have occurred that might indicate the tenant did not plan to return to the property.

Events that prove that the tenant intended to return possession to the landlord can include (1) termination of the lease term where the lease agreement does not provide for automatic renewal or the tenant did not meet the conditions stated in the lease agreement for staying beyond the term end, (2) and what the tenant stated when giving notice of intent to have vacated, with the latter being provable, and (3) return of the keys and other such items such as garage door openers.

Some states have statutes that specify procedures the landlord should follow when not certain that the tenant has abandoned the rental premises. This may include posting of a notice on the property for a certain period before taking possession.

When you can remove personal property left by the tenant and what you can or must do with the property depends on the intent of the tenant, perhaps the clauses in your lease agreement, and the specific laws of your particular state. Laws related to abandoned property vary considerable among states. A landlord should not be in a hurry to donate, sell or otherwise dispose of any items without knowing the relevant laws of the particular state.

At one extreme, a state does not have a specific law regarding abandoned property. At the other extreme, a state has a statute spelling out detailed procedures for dealing with abandoned property that must be followed even when the lease has expired, all personal property except for a few items has been removed, and the tenant is almost certainly no longer occupying the premises. These procedures often include the requirement of putting the belongings in secure storage, providing notices to the tenant in accordance with that state’s law, holding a public sale of the abandoned property, and providing an accounting of the sale proceeds to the tenant, along with giving the tenant any funds in excess of what the tenant owed the landlord for rent and damages.

Some states do allow a landlord to keep or sell abandoned property if the tenant owes the landlord money. This is known as an automatic lien on the tenant’s possessions. The landlord should keep in mind that he may be seizing possessions that may not be paid for and the merchant for those items has a superior lien ahead of any lien interest the landlord may have.

In order to reduce the uncertainly regarding items left on the premises in spite of the above discussion, it is of benefit to include a lease clause stating that any items left on the premises beyond the date of termination of tenancy shall be considered abandoned and may be disposed of as the landlord sees fit without contact with the tenant. Abandoned property laws of many states might have priority over such lease clauses, but such clauses can still have value before some judges. Even if that isn’t certain, the clauses will likely discourage tenants from pursuing the matter to begin with.

Information regarding both possession and abandoned property for your state can likely be easily found by searching the Internet. However, I advise that you both (1) view multiple search results and (2) consider as most reliable those Web sites of the state governments (usually a consumer protection or specific landlord-tenant law related site) and/or landlord or tenant association sites.

However, if the landlord is uncertain regarding the issues he/she should consider consulting a competent attorney who is knowledgeable and experienced in the particular subjects of possession and/or abandoned property laws.

Lease Agreements – Part 11

Some Miscellaneous Issues                         

This final part of our Lease Agreements series will provide brief discussions regarding several miscellaneous issues.

Rent Control

Only a small number of jurisdictions (usually cities) have any form of rent control and rent control laws vary significantly among those jurisdictions. Rent control was arguably established to prevent or stabilize increased rent. It may affect how a landlord manages his property compared to non-stabilized jurisdiction; as examples, regarding the handling of security deposits and evictions. If your property is located in a rent control jurisdiction, be sure to read and thoroughly understand the law of that jurisdiction.

If a property is located in an area that has, or is considering rent control, the purchase price of the property must reflect the impact rent control has on income, additional management requirements, and the economic feasibility of maintaining or improving the property.

Section 8

Participation in Section 8 (Housing Choice Voucher Program – HCVP) can affect your lease terms. While participation in Section 8 is voluntary in most jurisdictions, some jurisdictions currently do not give landlords the right to refuse Section 8 applicants and it is likely that this trend will continue in the future.

If the selected rental unit is approved, the housing subsidy is paid directly to the landlord by the local Public Housing Authority (PHA) that administers Section 8 funding on behalf of the participating family. The family is responsible to pay any difference between the actual rent charged by the landlord and the amount subsidized by the Section 8 program.

There can be no difference in the amount of security deposit requested from an assisted family than from a non-assisted family. State landlord tenant statutes regarding security deposits are applicable to Section 8 tenants.

The lease agreement signed by the landlord and the participant family should have standard practices listed for damage charges beyond normal wear and tear. If the landlord determines after the family has vacated the rental unit that damages by the family have occurred, those damages may be compensated from the security deposit held by the landlord and the landlord may attempt collection for any amount that exceed the deposit.

The lease agreement between the landlord and the participant family must be for a term of one year and must be in written form. HUD’s Tenancy Addendum must be attached to the lease agreement. At the end of the lease, the landlord may renew the lease for a new one year term or offer a lease for a different specified time period.

Evictions, collections, and other issues are the responsibility of the landlord just as they are for any other tenant.

For detailed discussions regarding the Section 8 issues see our “9 Steps to Understanding Section 8” Mini Training Guide.

Co-Signer/Guarantor

While the terms co-signer and guarantor are often used interchangeably, they are significantly different.

A co-signer is the same as a signer, being simply a signer on the lease agreement. Accordingly, the co-signer may have all the same rights as a tenant who resides in the subject unit unless the agreement states otherwise. Accordingly, it is extremely important that all co-signers for a lease agreement be served all notices that are served on those signers who are occupying the unit. If a co-signer of proven identity does not sign the lease agreement in person (e.g., the out-of-state parent of a college student) it is very important that the signature be notarized in order to avoid the possibility of forgery.

A guarantor is someone who assumes certain financial liabilities for a lease, but does not actually sign the lease agreement and, accordingly, has no rights to the premises. There are basically two different types of guarantees, broad and narrow. The broad form of guaranty makes the guarantor liable for all financial matters including rents and damages. The narrow form limits the guarantor’s liability to the rent.

Agreements can be written to cover only an initial lease term or to include future extensions and renewals. The agreement should include any assignee of the lease during the term of the original guaranty.

Each co-signer and/or each guarantor should be screened in the same way and required to meet the same standards as any tenant.

Landlords in community property states should try to have both husband and wife execute a co-signer or guaranty agreement in order to be certain of binding both spouses. It is best to have both signatures whether or not this is an issue in a particular state because it eliminates potential disputes regarding liability for a lease. The same recommendation applies whether the co-signor or guarantor is guaranteeing a commercial lease for a limited liability entity or parents are guaranteeing a residential lease for a student child.

If a lease is modified in any way during the guaranty period, the co-signer/guarantor should be required to sign a new document related to the modified lease.

Security Deposits

Most states have requirements related to security deposits, including:

• The      maximum amount that can be required,
• Interest      that must be paid on the deposit,
• Where      the deposit must be kept,
• What      can be deducted from the deposit,
• When      the deposit must be returned and/or an accounting of amounts not returned      provided, and/or
• Penalties that may be      imposed against landlords who do not comply with return and/or accounting.

Maximum Amount – A majority of (but not all) states limit the amount of security deposit a landlord can require. In states that specify a maximum, the amount typically varies from one to two times the monthly rent. Some states allow higher amounts for furnished units and/or for waterbeds. Some states specifically do not allow landlords to collect greater amounts by calling the additional amounts cleaning or redecorating deposits or fees. Some states allow for an additional amount as a pet deposit, while most states do not consider this issue. If the state’s law is not clear on such issues, it is usually safest to consider the maximum as including everything except the first month’s rent.

Interest – There is a wide variety of specifications for calculating interest among states that require payment of interest on deposit. Some states specify a fixed rate; others tie the rate to an index. Some states require payment of interest only after a certain length of tenancy, for example, one year. Many states require annual or other periodic payments of accrued interest.

Depository – While some states allow conversion or commingling of security deposits, many do not and many of those specify where deposit funds must be kept, including the type and/or location of institutions in which funds may be deposited. Some states require that information regarding location be provided to the tenant.

Deductions – Most states specify the items for which funds can be deducted from deposits. Most, perhaps all prohibit deductions for normal wear and tear.

Return/Accounting – Most states require that landlords return the security deposit and/or a detail accounting for any portion not returned and to do so within a certain period following departure of a tenant, whether the departure was voluntary or non-voluntary. The period varies from 10 days to 60 days among the states.

Penalties – Many states impose significant financial penalties on landlords who do not perform in accordance with the law if the ex-tenant pursues the matter in court. Penalties in various states include loss of the right to keep any part of the deposit and double or treble damages payable to the ex-tenant plus Court costs and attorney fees.

Record Keeping

Landlords need to keep records on all applicants, current tenants, and past tenants. This obviously applies to lease agreements. The time required varies because the time allowed for filing of a suit varies among states. It can depend on a specific state statute or by the general statute of limitations laws applicable to the potential cause of action. The length of time typically varies from 2 to 5 years among the states.

For property managers, who are regulated by a state licensing agency, the records which must retained and the period of time for which various records must be retained are defined by state statutes and/or regulatory agency regulations and the periods may be different than for landlords managing their own properties.

Sources of Lease Agreements

It sometimes appears that there are almost as many lease agreement formats as there are landlords. When deciding which lease agreement to use, you must consider (1) does it provide all the clauses necessary to adequately protect you and your particular property, (2) does it meet all federal, state, and local laws, (3) is it iron-clad enough to provide sufficient protection without being so tight that no applicant will sign it, and is it available in a digital format that can be edited by the landlord?

Adequacy of a lease is best decided by knowing what should be in a good lease. Knowing this comes from experience and from knowledge gained from study of the subject, for example, by having read this article and the first 10 parts of this series and from other educational materials found on LandlordOnline.com.

The adequacy of a particular lease agreement can be determined by (1) checking it against the current version of your state’s statutes, (2) obtaining it from a reliable vendor who warrants that the lease was vetted by a competent attorney such as LandlordOnline.com, or (3) having it vetted by your own competent law attorney.

Lease agreements are available from a variety of sources including:

• Office supply stores
• Property management companies
• Landlord associations
• Trade associations
• State Association of Realtors
• Legal forms vendors
• Custom-made by landlord’s attorney
• Created      by the landlord

The adequacy and legality of forms vary significantly among the sources. For most landlords, the most convenient and best source of forms will be from a qualified forms vendor that provides state-specific versions that are vetted by attorneys. Attorney-approved state-specific lease agreements are available from LandlordOnline.com. However, as for any “off-the-shelf” document, modification of a lease agreement is often required to make it adequate for a specific property. The Word version of a lease agreement for any state can be modified as desired by addition of clauses relevant to specific properties or desired by the landlord for any other legal reason.

Keep in mind that, no matter where the form comes from, it is the landlord who bears final responsibility for using a form meeting the legal requirements of the specific state and providing the terms that are adequate for the particular properties for which it is used. Accordingly, it is advisable for a landlord to always (1) read through the landlord-tenant law of his state, making notes about important issues; (2) be knowledgeable about important issues such as maximum security deposit and when a deposit of a terminating tenant must be returned and/or accounted for; and (3) keep abreast of changes in the laws. Unless the lease agreement is provided by a reliable source, a landlord should personally check it against his state’s law or have it checked by a competent landlord-tenant law attorney.

Regular Inspections Are Important

The upkeep of rental property is vital to its continuing economic viability. Property that is inadequately maintained is not able to compete effectively for new tenants except with discounted rents. Taken to an extreme, a practice of deferring maintenance and the resulting need to lower rents and/or accept less qualified tenants, leads to a downward spiral that is hard to reverse.

Failing to stay on top of needed maintenance and repair, failing to perform preventive maintenance, and/or failing to make repairs when requested, is one of the most shortsighted and costly mistakes that landlords make. If the property is not kept in good repair, the tenant may have the right to withhold rent, sue for any injuries caused by defective conditions, or move out without notice. And who could blame them?

To help protect his property and his investment, a smart landlord makes regular periodic detailed inspections of his properties. Periods between inspections that are adequate will vary with the type and age of the property and the condition of the property when the current tenant moved in. Typically, inspections should be done at quarterly intervals.

Property inspections are a positive way to build strong relationships with your good tenants. Tenants who call with small problems are often viewed as pesky tenants. Inspections performed quarterly or at least semi-annually will likely make your tenants more interested in helping to properly maintain the property.

It is a good idea for the lease agreement to include a section regarding maintenance and another regarding inspections. The section regarding maintenance should include a list of the tenant’s responsibilities, including the duty to report problems requiring landlord action. The section regarding inspections should state that there will be periodic inspections by the landlord or by his/her agent, the approximate frequency of inspections, and the manner (method of communication and amount of advance notice) in which the landlord will schedule a proposed inspection date.

The periodic inspections will allow the landlord to inspect the property for a variety of maintenance issues, including those that may not be reported by the tenant but would be costly for the landlord if not taken care of. Inspection items usually include plumbing, furnace and air conditioning problems, roof or gutter repair and also for housekeeping items that need attention to maintain health and safety conditions.

These scheduled visits also alert the landlord to potential problems such as trash and garbage accumulating on the property, cracks in windows panes, or leaky faucets.

Rather than a nuisance, regular inspections can provide an opportunity to correct problems before they become disasters as well as create goodwill.  Too, any tenant communication can open further dialogue to correct or prevent misunderstandings of any nature.  Such interaction (1) allows the landlord to reinforce their concern for the tenant’s safety, security, etc. and (2) protects the landlord’s interest in the rental investment.

Preventive maintenance will save money in the long run.  If needed maintenance is deferred, costs multiply when the repairs are finally made or replacement becomes necessary.  The adage of penny wise and pound foolish is true.

Failure to take care of repairs, particularly those related to health or safety can result in withholding of rent, a government inspection, and/or citations with fines.  You are guaranteed that an inspection will result in a number of items needing attention besides the one the tenant complained about.  At a minimum, failure will result in a disgruntled tenant.

Inspections can result in catching other problems which might require a warning notice, a decision to not renew a lease, or an immediate eviction. Issues sometimes uncovered during inspections include (1) undisclosed pets or particular pets prohibited by the landlord or by the insurance policy, the latter being potentially worse because it might eliminate landlord protection upon damage or injury to other tenants or to the general public, (2) poor housekeeping to the degree that it can cause damage, (3) conditions that attract insects, mice, roaches and other vermin that can become an expensive problem, (4) unusually hard use by the tenant that is causing significantly more damage than “normal wear & tear,” (5) smoking in “smoke free” units, (5) smoke and carbon monoxide detectors with dead batteries, (6) running toilets or leaky faucets when water cost is paid by the landlord, (7) evidence of illegal drug use (resist the temptation to look into closets or drawers), (8) improper storage of dangerous chemicals, and (9) tenant-caused conditions that are potentially dangerous such as storing flammables near a gas appliance.

There are numerous ramifications related to inadequate maintenance.

First, the best tenants will not want to live in poorly maintained property. Prospective tenants who must accept such property often do so because they do not qualify to rent better quality properties where landlords use adequate screening and selection procedure. The same landlords who do inferior maintenance often also use inferior screening.

Second, tenants, like most of us, will usually take better care of something that is valued and it is human nature to value good things more than junk. When it appears to the tenant that the landlord doesn’t care about the condition of the property, how can the landlord expect that the tenant will care about it?

Third, if the property is not kept in good repair and the problems are not repaired during a vacancy, the new tenants will start out having a bad experience. Also, the fewer defects for a property when a tenant moves in, the less argument the tenant can have when the tenant moves out. Damage to a door or wall found at move-out is obviously the fault of the tenant if the door and wall were in excellent condition at move-in.

Fourth, many types of maintenance items that are not taken care of when initially discovered, not only become worse as time passes, but can eventually be the cause of other problems that are substantially more costly to correct.

For example, a small leak in a roof can often be repaired in 30 minutes using a few dollars-worth of patching materials. If not fixed, however, the leak will often eventually lead to discoloration of ceiling drywall. If still not fixed, one should expect eventual sagging of the drywall, then, finally, complete collapse of an area of the drywall. This can even cause damage to the carpet and/or damage to a tenant’s personal property. The cost of replacing the drywall, texturing, priming, and painting can easily run into hundreds of dollars. Damage to carpet can add many hundreds more. There is also the potential for creating mold problems. While landlords are not usually liable for loss of or damage to a tenant’s personal property, a judge may rule otherwise if it is the result of the landlord’s gross negligence and award substantial damages if the falling drywall broke the tenant’s valuable Ming vase.

Fifth, without a maintenance plan in place, you have less control over your expenses. Unplanned emergency repairs will almost always be more costly and be more stressful for both the landlord and the tenant.

It is important to maintain a detailed up-to-date maintenance log which provides information about every tenant request for service, the results of each inspection in detail, and what was done to correct any issues discovered.

Keeping a maintenance log helps to eliminate most problems associated with tenant maintenance complaints and it is powerful evidence if you end up in court or before a housing agency in spite of always attempting to provide safe and comfortable housing.

In summary, the positive benefits of good property maintenance include better tenants, increased tenant satisfaction that can lead to longer tenancies for good tenants, improved landlord-tenant relations, higher rents, less likelihood of complaints to regulatory agencies, and reduced costs for vacancies.

Question

I recently purchased a duplex in LA. It is my first purchase of rental real estate. I live in the top unit and rent out the lower. The units have two separate street addresses. I understand the basics of the 1031 exchange, but since this property is my home, is it still under the guidelines as “investment property” when I go to sell? Do I have to live here for a set amount of time to change the situation, or does that matter? Will a 1031 exchange be required to avoid taxes? What if I want to buy a single-family home for myself to live in as my primary residence?

Answer

First, as you would expect, when trying to minimize income taxes, there is a difference between income property and a personal residence. In the limitations of this format, I will only speak in abbreviated general terms, so you should (1) read relevant discussions regarding Section 1031 provided by various LandlordOnline.com resources, (2) consult a CPA or other tax advisor, (3) read some books, and/or (4) read the relevant IRS publications regarding the details of your particular situation.

During the period when you use one of the units as your personal residence you will treat your duplex as part personal residence and part investment property regarding its purchase and if you still reside there at the time of sale you will do the same. Terminating your residence during the period of ownership will require changes regarding tax issues. The fact that there are two different street addresses should not matter.

If the units are essentially identical, it will probably be half-and-half. Otherwise the allocation will be based on some material fact(s) such as the relative sizes of the units. This means that all expenses of the rental half are deductible, whereas, only interest and property taxes are deductible (if you itemize) for the personal half. Costs of depreciable items (for example a new roof) would be depreciated for the rental half, whereas, those costs would be added to basis for the personal half.

Section 1031 of the IRS code provides that 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 a business or for investment. The definition of like kind property is very broad. One can exchange an apartment building for a retail center or either of those for a piece of land. One can even exchange a rental property for a timber lease. There are a number of possible types of exchanges and some potential pitfalls, but the basic restriction regarding a 1031 exchange is that the seller cannot have constructive receipt of funds. One should usually involve competent and experienced professionals when doing an exchange.

Section 121 of the IRS code allows a taxpayer to avoid taxation of gain on the sale or exchange of a property if, during the 5-year period ending on the date of the sale or exchange, such property has been owned and used by the taxpayer as the taxpayer’s principal residence for periods aggregating 2 years or more. The amount of gain that can be avoided is $250,000 for a single taxpayer and $500,000 for a married couple filing jointly.

The gain from properties that have more than one use can usually be divided between Section 121 and Section 1031 so as to realize the benefit of the applicable law for each part. Accordingly, if you meet the requirements of both Code sections, you should be able to exchange the rented unit of your duplex into another rental using Section 1031 and avoid taxation on the unit you occupy under Section 121.

Both Section 1031 and Section 121 will likely change significantly if Congress ever undertakes a major revision of the IRS Code.

Lease Agreements Between Landlords and Tenants – Part 10

Part 10 of our Lease Agreements series will provide discussions regarding two specialized types of agreements that have the word “Lease” in the document titles.

Lease Option – An “option” is a right given a person to buy, sell, or lease property at a specific price within a specified period of time. A valid option must name a valuable consideration.

A “lease with option to purchase” (often called “lease option” or “rent to own”) is an agreement between a seller and a buyer wherein they simultaneously execute a lease agreement for a specific term, with the agreement giving the lessee an option to purchase the property, but not the obligation to do so. The term of the option need not be the same as the term of the lease, although the option period will usually be less than or equal to the lease period, with less than usually being preferable. For example, the buyer agrees to lease the property for one year and to purchase the property by a certain date before the end of that year.

Lease Purchase – A “lease purchase” is an agreement between a seller and a buyer wherein they simultaneously execute a lease agreement and a purchase contract for a particular property. For example, the buyer agrees to lease the property for one year and to purchase the property at the end of that year. The lease and purchase terms may be contained in a single document or in two separate documents that are cross-referenced.

Lease Option & Lease Purchase

The “lease with option to purchase” or the “lease purchase” can be of value to both a tenant/buyer and landlord/seller. Although some issues are the same for tenant/buyer or landlord/seller, other issues of importance are different depending on whether one is tenant/buyer or landlord/seller. Although the terms “lease option” and “lease purchase” are sometimes used interchangeably, there can be a significant difference between a lease purchase and a lease with option to purchase even though each employs both lease agreement language and purchase agreement language. The usual major difference is that the tenant/buyer in a lease option contract can fail to complete the purchase without risk of a lawsuit for breach of contract, whereas, the tenant/buyer in a lease purchase contract can be held liable for failure to complete the purchase of the property. This difference could be negated by clauses in the contract.

Unless the lease agreement and the purchase agreement parts of the deal are properly written, serious problems can result. While there are many possible problem scenarios, consider the following questions. What would happen if the landlord/seller must evict the tenant/buyer having a lease option? Does the option to purchase survive the eviction? Can the property now be rented to a new tenant or tenant/buyer?

From the point of view of a landlord/seller advantages can include the following:

• The landlord/seller can (at least theoretically) generate extra income because a lease option or lease purchase is usually written with an above market monthly rent with the excess usually applied to the option purchase price.
• Brokerage commissions and other marketing costs related to the sale are usually avoided.
• Because the tenant/buyer expects to end up owning the property, he will (in theory) take better care of the property.
• If the market declines, the landlord/seller may be able to sell at a higher-than-market price, if the tenant/buyer still wants the property.
• In many, perhaps most cases, the tenant/buyer will not exercise the option because he/she won’t have saved the necessary cash for closing the sale or won’t qualify for the necessary mortgage loan. So, if the landlord/seller obtained premium rent, had a good tenant/buyer, and it was not important that the property be sold, the landlord/seller can be ahead of the game.

From the point of view of a landlord/seller, disadvantages of the lease option or lease purchase can include the following:

• The lease option is essentially a unilateral contract      unless and until the tenant/buyer elects to exercise his option. That is,      the landlord/seller must sell if the tenant/buyer decides to exercise the      option, but the tenant/buyer need not buy.
• If the      market unexpectedly improves, the landlord/seller may end up locked into a      lower-than-market price. This disadvantage can be minimized by limiting      the option period, say to one year or, at most, two years.

From the point of view of a tenant/buyer, advantages of the lease option can include the following:

• The tenant/buyer can “try out” the property before      committing to owning it.
• The lease option is a unilateral contract unless and      until the tenant/buyer elects to exercise his option. That is, the landlord/seller      must sell if the tenant/buyer decides to exercise the option, but the tenant/buyer      need not buy.
• If the market unexpectedly improves, the tenant/buyer      will benefit from buying the property for under-market price.
• Brokerage      commissions and other marketing costs related to the sale are usually      avoided.

From the point of view of a tenant/buyer, disadvantages can include the following:

• The tenant/buyer will likely pay higher rent because      a lease option is usually written with an above market monthly rent with      the excess usually applied to the option purchase price. However, the      higher rent is not a problem if the excess is credited to the purchase      price and the tenant/buyer.
• If the      market declines, the tenant/buyer may end up buying at a      higher-than-market price, but the tenant/buyer needn’t exercise the      option.

Items of Importance

There are a number of issues that must be considered when writing a lease option or a lease purchase contract. Included are the following:

• Both a lease option and a lease purchase must be in compliance with the landlord-tenant law of the state where the property is located.

• Obligations regarding inspection issues – The      landlord/seller can reduce risk by requiring all inspections that are a      contingency be performed prior to move-in. However, since the tenant/buyer      can fail to exercise the option for no reason, this doesn’t guarantee that      an inspection issue won’t be the cause of no sale, but it may reduce the      probability.
• Maintenance obligations should always be adequately      defined in any lease agreement, but it is much more important that all      details be covered when doing a lease option or lease purchase, including      who is responsible for major repairs during the term of the lease. Be sure      to cover such items as replacement of heating/cooling equipment and repair      of major damage act-of-nature not covered by insurance.
• There      are numerous issues to consider in determining the option price as well as      a number of related issues including the rent premium, the portion of rent      to be credited toward purchase price, and the length of the option. It is      a matter of negotiating mutually acceptable terms.

Both agreements must include all terms related to purchase of the subject property, including the following items:

• Execution date
• Agreed price
• All contingencies being waived by seller (e.g.,      physical condition  at close of      escrow) and those not waived (e.g., sale is contingent on adequate lease      performance)
• Dates and procedures related to exercise of the option      and the purchase for a lease option agreement and for the purchase for a      lease purchase agreement
• Type of deed to be given
• All “subject to” items
• Closing      costs and adjustments and how to be apportioned

Who Signs

As is important for any legally binding contract, for both lease option and lease purchase agreements it is important that all signatories have legal standing to sign the documents. This means that each signer is of legal age and has mental capacity. It is also important that any addendums or amendments to the original agreement be signed by all parties that signed the original. Finally, when any legal entity such as a corporation, LLC, partnership, or trust is a party to the document being executed, it should be verified that those signing on behalf of the entity be authorized to do so by appropriate entity documentation.

Professional Advice

If structured improperly, a lease option or lease purchase could be considered a sale with possible negative consequences, including but not limited to the following:

• The transaction might trigger the due-on-sale clause      of a loan secured by the property,
• The IRS could deny tax benefits of deductible      expenses and depreciation and gain would have to be realized in the year      of the option rather than the expected year of sale,
• The landlord/seller could be prevented from evicting      the tenant/tenant/buyer because the Court considers the transaction to be      a contract to purchase rather than a lease option or lease purchase,      and/or
• The landlord/seller      might become liable for violation of landlord/seller disclosure laws.

As lease option agreements and lease purchase agreements are in some ways significantly different than regular lease agreements, the parties should seriously consider having a competent real estate attorney or a real estate broker with experience in lease purchases and leases options review the transaction documents to be used. If the transaction might involve unusual income tax issues, the parties should consider discussing the transaction with competent tax accounting professionals.

However, although consulting professionals is advisable, the parties must themselves consider all the issues as they relate to the particular property and other circumstances and utilize the professionals as a check that the documentation is legally adequate and that the parties have not forgotten an important issue. The parties should not depend on the professionals to adequately consider every possible issue that might be important to the parties’ situations and desires.

Rent Payment Options For Landlords and Tenants  – Part 1

Rent payment options can encourage timely rent payment and help in reducing late rent or no rent.

Landlords should eliminate any obstacles to or excuses for tenants failing to pay the rent on time by making it easy for tenants to pay rent.  However, making it easy for tenants to pay rent should not come at the expense of the landlord’s business.

Rent payment policy decisions should be made after careful research and analysis of available options and the true cost to the landlord’s business operations. There are many innovative and interesting rent payment services now available for property management but they may not be cost effective for independent landlords. The degree of risk as expressed in each payment service option should be acceptable to current business operations. Sufficient landlord resources of time and money will be required to support rent payment management systems.

While a landlord’s rental policies may express his preferred method of rent payment, a landlord in some states is legally obligated to provide alternative payment methods. While a landlord does not have to offer every type of payment option available, he does have to make available his payment options to each and every tenant. The landlord cannot selectively offer different options to different tenants.

The lease agreement should clearly state rent payment policies including amount, due date, payment method, late fees, dishonored check fees, etc.

Traditional rent payment options of cash, money order, or personal check are now supplemented by technology-based options for multiple devices’ platform applications. For many landlords, tenants pay rent by check. Other tenants prefer to use rental “apps” to schedule and pay rent electronically.  What method tenants use to pay rent must conform to the rental agreement and the rental agreement, in turn, must comply with landlord-tenant statutes.

It can hold true that the simplest solution is the best solution. If adequate safeguards for safe handling of funds are in place and rental policies are enforced, any one of a number of payment methods could serve as the simplest and best solution to meet the needs of independent landlords.

In this part one of a two-part discussion on rent payment options the traditional rent payment methods of cash, check, and money order are discussed. A future article will discuss other options such as credit and debit card payments and electronic processing payment options. As technology changes, the marketplace changes, and such discussion of the so-called “apps” or other forms of online payments will necessarily be limited to those types of service available at the time.

Cash

Cash may be a simple method of rent payment but there are inherent risks for both landlord and tenant in cash payments. A cash only rent payment policy may not be allowed in some states by landlord-tenant statutes. There can be also be certain specific circumstances in some states that allow a landlord to require that rent must be paid in cash. If a tenant has presented a dishonored check (insufficient funds or stopped payment) for example, within the past three months, the landlord, with proper notice and documentation of a change in rent payment methods, can require the tenant to pay his rent in cash for a specified number of months before allowing the tenant to return to his former status.

A signed receipt for any amount of cash payment should always be given to the tenant with receipt detail documenting date received, tenant’s name, rental unit address, amount received, description of payment (rent, security deposit, late fee, etc.), and the time period covered by the payment.

Accepting cash for rent payment can make the landlord a tempting target for criminal activity. Care must be taken to protect the individual receiving the cash and procedures put in place to safeguard cash until deposited. A note of caution to landlords – if a tenant gives cash for rent and the cash came from an illegal act, such as drug dealing, under federal and state forfeiture laws, the government could seize the cash.

Likewise, there is risk to tenants when unscrupulous landlords accept cash for rent but “forget” the payment in an attempt to extort more money from the tenant. Without a signed, dated receipt the tenant has only his word against the landlord’s claim of non-payment.

A cash transaction for rent payment is a personal interaction between landlord and tenant, usually requiring a face-to-face meeting. Few tenants would mail a cash payment to the landlord or deposit cash in the landlord’s drop box. However such actions should not be discounted. A rent payment policy should clearly state the particulars of payment and the consequences of non-payment, including the burden of proof on the tenant for payment.

For cash payments, the landlord receives the benefit of ready money but must expend time and incur expense to meet with the tenant. These costs should be taken into consideration when developing payment policy.

Personal Checks

Accepting a personal check for rent payment has customarily been the simplest and most often used payment method. A check provides a clear record of payment. Account information contained on the check may also prove useful if the tenant defaults on his lease. Checks can be mailed or dropped off, limiting the amount of landlord-tenant interaction which some landlords may perceive as a benefit.

However, there is some risk when accepting rent payments in the form of personal checks.  If the tenant has insufficient funds in his account, the check “bounces” causing additional work for the landlord in collecting his money. In addition, a bounced check creates additional bank fees for processing overdrafts which must be added to the amount the landlord will need to collect. If the tenant orders the check to be stopped (even if already deposited) the landlord now has to start over again in rent collection. Bank fees for stopped payments may also be incurred and will need to be included in past due amounts. Tenants should be aware that passing a bad check is a criminal offense that is aggressively prosecuted in all states. This provides significant leverage with a tenant when collecting on a bad check.  A state’s Attorney General’s office can provide information on procedures to report bad checks.

Landlords should not accept post-dated checks.  A landlord can immediately cash or deposit a check having the current or a past date.  A post-dated check cannot be cashed or deposited until the date on the check.  Not only can the landlord not obtain the funds on the date the check is received, but the longer period increases the landlord’s risk of never obtaining the funds.

A post-dated check takes on the properties of a promissory note.  Accordingly, a bad post-dated check does not usually result in the writer being charged with a crime and the payee only has the recourse of serving a “pay or quit” notice or of suing for payment just as would be necessary to collect any other unpaid debt. This could mean in some states that a landlord has no legal to file an eviction action while the note is pending.

Cashier Checks

As a safeguard, some landlords require certified funds for move-in fees, deposits, and first/last month rents. A cashier’s check or a bank “counter” check is drawn made payable to the landlord that, when presented for payment, allows immediate collection of funds.

Third-Party Checks

Third party checks (even paychecks or IRS refund checks) and temporary or out-of-state personal checks should never be accepted for payment of rents or deposits. It is a better business practice to require the tenant to cash the checks and pay the rent in cash.

Money Order

A money order given for rent payment is processed in the same manner as a check payment. Money orders can be purchased from many retail outlets and government post offices. A financial institution may offer an equivalent service but use a different term to describe the money instrument. A signed and dated receipt with all pertinent details should always be provided to the tenant for his payment.

Conclusion

While easy and simple payment methods may enable tenants to pay rent timely, the landlord must ensure such payment methods are reliable and provide an efficient, quick transfer of funds into business accounts.

In Part 2 of this series we will discuss the efficiencies and effectiveness of credit/debit card payments and electronic processing transactions that can meet the needs of tenants while supporting business operations.

Question

I had a tenant evicted recently and the judgment was made for the outstanding rent plus expenses. I am still holding the tenant’s deposit. The tenant is demanding the deposit back. Can I hold back the deposit until the back rent is paid?

Answer

For most (perhaps all) states, unpaid rent and damages (not normal wear & tear), and costs of the eviction can be deducted from the security deposit. If the amount of the judgment is more than the deposit amount, you would then seek collection of the rest from the ex-tenant. If the amount of the judgment is less than the deposit amount, you would refund the difference to the ex-tenant.

Although not required in some states when a money judgment was obtained, you should, however, be sure to provide an accounting for any amount of the security deposit not returned to the ex-tenant and do so within the time allowed by your state’s law unless you are certain of your state’s law on the subject. Among the states, the time varies from 10 to 60 or more days. Some states require the tenant to provide a forwarding address and/or to formally request the accounting, but many do not. Some states have yet other variations. When not covered by state law and the tenant didn’t provide a forwarding address, mail it to the address the tenant had at your property. Accordingly, you need to check and follow the law of your state.

Failure to provide the accounting and the return of any balance of the deposit not consumed by unpaid rent, damages, and/or other expenses within the specified time can result in serious penalties in many states, some states potentially awarding the tenant damages of two or three times the amount of the deposit.

The fact that a landlord has a judgment of more than the amount of the deposit may not matter in in some jurisdictions when it comes to the penalty for failure to follow the deposit return/accounting law.

Lease Agreements Between Landlords and Tenants – Part 9

In Part 8 of this series we discussed some aspects of and issues related to commercial property lease agreements. In this Part 9 we’ll discuss some issues regarding termination of lease agreements.

Termination                                               

Termination procedures vary somewhat, depending on whether a month-to-month (or other periodic) tenancy or a fixed-term lease tenancy is ending. There are times when the landlord is prohibited from ending a tenancy. First, rent control laws in a small number of jurisdictions, of course, restrict termination. Second, landlords cannot end a tenancy in retaliation for the tenant exercising any right under the law. Third, landlords cannot end a tenancy because of discrimination against any classes protected by fair housing laws.

Month-to-Month

Month-to-month tenancies can be terminated by either the tenant or the landlord by proper notice in accordance with a state’s law. In most states, landlords do not have to provide a reason for termination, but there are some states or local jurisdictions that require otherwise. For most jurisdictions the notice period for terminating a month-to-month lease is 30 days, although some jurisdictions require more notice from the landlords, for example 60 days.

Most states require that the tenant provide 30 days of notice for termination of a month-to-month tenancy. However, some states have different requirements under certain circumstances. The lease agreement should include your state’s notice requirements for terminating tenancy and require that the tenant provide written notice to the landlord.

Check state and local laws where your property is located to confirm the correct notice periods and whether or not a reason for termination must be given.

Fixed Term

Usually a lease for a fixed term simply ends at the end of the term unless a new lease, a lease extension, or a lease renewal is executed prior to that date or the lease provides for an automatic renewal clause if not otherwise terminated by the landlord or the tenant.

Failure to Vacate

It is not unusual that tenants fail to vacate when they should. When this happens, the landlord has two choices: (1) continue renting to the tenant or (2) remove the tenant through eviction.

In most states, if a landlord allows the tenant to continue paying rent, a month-to-month tenancy with the same terms as the previous lease will be created. This means that the landlord must provide proper notice in order to change the terms of the continuing occupancy. It is best to include a lease clause that discusses conversion to a month-to-month tenancy whether or not state law covers the issue.

Landlords should notify the tenant that the tenant is expected to vacate the premises by the termination date. The notice should be provided at least 30 days or more if required by state law ahead of time and 60 days is better. If the tenant must remain a few extra days, the landlord and tenant should execute a written agreement regarding the matter.

The potential for a tenant failing to vacate as scheduled is a major reason among several reasons why it can be risky to execute a new lease with a replacement tenant prior to the landlord gaining possession of an indisputably vacant unit.

Eviction

A tenant who refuses to vacate at the end of a fixed-term lease or upon termination of a month-to-month tenancy or who fails to correct a noticed default on a material term of the lease (including non-payment of rent) can only be removed through the judicial procedure of eviction. For detailed discussions regarding the eviction process see our “9 Steps to Eviction” Mini Training Guide.

Early Departure

When a tenant leaves before the end of the lease term and without paying the amount remaining under the lease, he is considered to have “broken” the lease. The landlord has the right to re-take possession if/when it is certain that the tenant intended to depart for good and to rent the premises to another. In general, the tenant is liable for rent for the remaining months of the lease. In turn, the landlord has a duty to mitigate damages, that is, make reasonable effort to find a replacement tenant. Recovery for any losses from unpaid rent, property damages, and/or certain other expenses incurred due to the default by the tenant that are not recoverable from the security deposit may be sought through a lawsuit.

Extended Absence

In order to avoid questions of whether a tenant has made an early departure, the lease should have a clause requiring the tenant to notify the landlord of planned extended absences, with “extended” typically defined as more than 2 weeks. The landlord should also regularly view his/her rental property and note any things observed that might indicate that the tenant has “skipped.”

Other Issues

Termination of tenancy sometimes results in other problems for the landlord even when the tenant created no serious problems along the way. Potential problems include the following:

• Riding      down of deposit.
• Uncertainty      of possession.
• Abandonment      of personal property.
• Security deposit disputes.

Most of these problems can be avoided or at least greatly simplified by having the right clauses in the lease and following the law.

Riding Down Deposit

Some state laws expressly prohibit tenants from trying to use their security deposits as last month’s rent. However, whether or not the issue is covered by statute, lease agreements should prohibit riding down the security deposit rather than paying rent in advance for the final month of the tenancy. It should furthermore state doing so will subject the tenants to late charges for unpaid rent, to eviction proceedings, and a potential blemish on their credit records. If your state covers the issue by statute the statute itself should be referenced.

Uncertainty of Possession

Landlords should not take possession of the leased premises unless and until certain that the tenant has relinquished possession of the premises. Although this is only occasionally an issue, when it is, it can cause delays of at least a few days, and delays in collecting rent from a new tenant means lost income. It can even result in being sued by the ex-tenant.

The question of whether the tenant has actually given up possession usually becomes an issue when either (1) the tenant appears to be holding over after the expiration of a lease even though the tenant has not given notice of intent to do so or (2) the tenant appears to have abandoned the property in the midst of the lease term without have previously indicated that being a possibility. In the first case, the tenant has not (1) turned in keys, (2) written or phoned to confirm a planned departure, (3) given any other indication of vacating, or (4) removed all belongings from the property. In the second case, the tenant appears to no longer reside at the property even though months remain on the lease and some of his/her personal property remains on the property.

Minimizing questionable vacancy issues begins with including in the lease agreement clauses regarding procedures for vacating. That is, words as to what the tenant must do when vacating and what will happen if the tenant fails to act as agreed.

For example, in order to provide definitive knowledge of when possession has transferred, one clause could state that all belongings must be removed and keys must be returned when the tenant has vacated and that failure to do both will result in (1) continued accrual of rent, (2) charges for all costs related to disposing of the belongings, and (3) a locksmith charge and/or a new garage door opener if all items are not returned. Regarding the last item, landlords should always re-key all locks when the rental unit becomes vacant, but requiring return of keys can provide proof that possession had been returned to the landlord and allow the landlord to charge the departed tenant for rekeying and/or replacement of door openers when those items have not been returned.

Abandonment of Personal Property

Each state has its own laws regarding how a landlord must handle property that appears to have been abandoned by the tenant without any certainty that such was the intent. These laws vary from essentially no rules to extensive procedures that include secure storage and certain legal notices and the procedures requiring several months to complete.

In order to reduce the uncertainly regarding items left on the premises, a lease clause could state that any items left on the premises beyond the date of termination of tenancy shall be considered abandoned and may be disposed of as the landlord sees fit without contact with the tenant. While this is not certain to avoid liability in all states, it should at least provide some protection against the ex-tenant pursuing the matter.

Move-Out Letter

No matter how the tenancy is being terminated, a landlord should provide a letter to the tenant a couple of weeks ahead of the termination date. The letter should remind the tenant of a number of issues including reminder of certain ones specified in the lease. The letter could include the following:

• Expectations      regarding condition upon vacating including any specific items the      landlord wishes to list.
• Inspection      and move-out checklist procedures.
• Items      that can result in deductions from the security deposit.
• Need      to provide forwarding address for any potential deposit refund.
• What else must be done to      complete vacating – e.g., turn in keys.

Reminding tenants of what they agreed to when they signed the lease is particularly useful in avoiding disputes. Even when an eviction is underway, with the judge having given the tenant a period of time to vacate, a notice which reminds the evicted tenant that costs may increase if certain procedures required by the lease agreement (e.g., return of keys, cleaning, removal of all belongings) are not followed.