1. Purchase and Sale Agreement Conditioned On Tenants Signing New Leases
If you find a property that is perfect except for the fact that the tenants are paying below market rent, this strategy may be effective for you. An investor in this scenario should consider including a provision in the purchase and sale contract that gives them thirty days to negotiate new leases with the underperforming tenant(s) that include higher rents that are consistent with market rates. If the investor is successful in negotiating new leases, then he/she may move forward to closing and the new leases become effective upon closing. Therefore, when you close, you will have tenants that are on better leases and paying market rents. If the investor is not successful negotiating new leases on acceptable terms, then the provision will give you the right to terminate the contract and not move forward.
So, how does an investor sign a lease with a tenant when the investor has not even closed on the property? Is this possible? Sure. With careful drafting and lawyering, this is feasible. The new leases will be expressly conditioned on the closing occurring. Therefore, if the closing occurs, the new leases become legal and binding documents. If the closing does not occur, the leases do not become legal contracts, and the tenants have no obligation to pay a higher rent and remain on the original arrangement.
While this can be an effective strategy to addressing good properties with underperforming tenants, retaining a good lawyer to draft the right provisions is essential to achieve your objectives and properly protect you.
2. Cash for Keys After Closing
Another strategy to address tenants in default or paying below market rent is to offer them a sum of money to vacate the unit so that you can find better tenants that will pay rents more consistent with market rents. However, investors can only use this strategy after closing, so there is a risk that after you close you may not be successful in negotiating a deal where the tenants vacate. You may be stuck with defaulting or underperforming tenants for the near future if you cannot negotiate this deal. This is a consideration in closing and using this strategy.
3. Increase Rents After Closing
Another strategy is to simply raise the rents after you close. However, there are several considerations. First, this may not be legally feasible if the tenants are on written leases. As the new owner, you must honor the term of the existing lease (until it expires). If the tenants are month-to-month, the tenants may still refuse to pay higher rent. Then you have to decide whether to evict, or keep them. Last, before implementing this strategy, you should check whether the town or city has rent control rules which may impose limitations on how much you can raise rent. While raising rents is a common strategy for improving the cash flow of these properties, these are considerations to think about before moving forward.
4. Negotiate a Lower Contract Price
A good strategy that hedges the risk of underperforming tenants is simply to negotiate a lower purchase price. There is a valid argument that an investor should be entitled to a lower price because they may face strong objections when they try to evict a defaulting tenant or raise the rent on an underperforming tenant. This may be a good negotiation point to lower the purchase price.