Although more common in commercial transactions, many residential transactions involve the sale of homes subject to existing leases and tenants. A potential buyer of a property in which a tenant currently resides should be aware of the legal status of such leases after closing, and be comfortable with rights and obligations imposed on them by the lease after closing.
For whatever reason, many folks believe that once a property sells, any existing lease automatically terminates, and the new buyer would have the right to immediate possession. This misunderstanding is obviously incorrect; an existing lease, whether written or oral, conveys a leasehold interest in the land that would be superior to any contractual rights that may arise thereafter. Therefore, anyone who goes under contract to buy the property, and ultimately closes on the purchase, would take title subject to the pre-existing lease. The new buyer would in effect step into the shoes of the seller as landlord until the term of the lease has expired. Yes, the new buyer would be entitled to future rent payments made under the lease, but would also be responsible for any obligations and promises the previous owner may have agreed to under the lease.
Because the new buyer will be saddled with the rights and obligations due under the lease, it is imperative that the buyer conduct sufficient due diligence to understand what they are taking on. What does the buyer need to know? For starters, what are the basic terms? Length, amount of rent, rights to renew or purchase, responsibility for repairs, maintenance, taxes, insurance, and the like, are all important. Are the tenants current on rent? Has the tenant pre-paid any rent? The last thing a new buyer wants to find out when he or she becomes the new landlord is that the tenant has prepaid rent for a year, will not be paying any future rent during that time, and oh, by the way, the landlord promised in writing to replace the roof the next month (true fact scenario!).
Most commercial sales contracts contain clauses that provide satisfactory treatment of these issues, but the TREC contract is fairly bare. Fortunately, TREC amended the base form last year to help a bit. Now, under Par. 10B., the seller must provide copies of existing leases within 7 days of the contract effective date. The Buyer will want a chance to review the lease and get comfortable with the terms, so it is important that an option period extend a minimum of 10 days. If the Buyer doesn’t like the lease terms, they would be able to terminate the contract during the option period. Par. 9B (5) provides that any security deposit will be transferred from seller to buyer at closing, and Par. 13 provides that rent will be prorated at closing.
But what important agreement does the TREC form lack? Most well-drafted commercial properties require the seller to obtain an “estoppel certificate” from the tenant, and provide it to the buyer during the option period. An estoppel certificate is a statement from the tenant themselves as to the tenant’s understanding of the lease terms, the amount of rent already paid, and any accrued obligations owed by the landlord. It is always best to confirm with the tenant that they are in agreement with the landlord’s characterization of the lease status. A buyer is well advised to add a provision in Par. 11 calling for an estoppel certificate.
Because lease and tenant-related issues expand the complexity of the transaction, the assistance of a competent attorney will be of great help in wording the contract and evaluating future rights and obligations. Armed with these protections, buyers of tenant-occupied property are in better position to protect themselves from post-closing lease surprises.
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Jeffrey A. Rattikin is an AV Pre-eminent rated attorney, Board -Certified in Residential Real Estate Law by the Texas Board of Legal Specialization. Mr. Rattikin has provided transactional legal services to clients across the State of Texas for over 28 years, emphasizing real estate, business and title law. Mr. Rattikin continues to define new legal frontiers through his incorporation of technology to enhance the attorney-client experience, as evidenced by his firm’s innovative websites www.rattikinlaw.com and www.texaslegaldocs.com.