Owning a rental property can be a lucrative investment, generating a steady income from rent payments and property value growth. But in a strained economy with an uncertain future like what we’re seeing in 2020, many property owners are deciding to get out of the landlord gig and offload their rental homes amid falling rent prices in many major cities.
And even when the market is thriving, there are plenty of other logical reasons to sell, such as a relocation, a better investment opportunity, or a lack of time to manage the property.
Selling any type of home comes with complexities and considerations, but even more so when it’s a rental property where tenants are currently living. If you’ve been thinking about selling your occupied rental home, you probably have a lot of questions. First and foremost: Do you have to wait until their lease runs out and have them vacate the property before you sell — or can you list it while they are still living there?
We talked to some experienced property investors and a top real estate agent to help you gather all the information you need to proceed.
Types of rental situations
Erik Jacobs, a real estate investor with Cicero, France & Alexander, P.C., works on many sales of rental properties. He estimates that 90% to 95% of the commercial transactions he handles involve tenants staying with the property.
The most important factor is the type of rental agreement you entered into with your tenants. Brian Phan, a full-time property investor in Atlanta, Georgia and owner of the direct cash house-buying company Sure Closing, identifies two main types:
If your tenant is renting on a month-to-month basis, it won’t be a problem to sell the home while it’s occupied, as long as you give them proper notice.
“Proper notice involves mailing or delivering a letter to your tenant 30 days before you’d like them to be out, usually in respect to the rent due date,” says Phan. “You don’t need a reason to terminate a month-to-month agreement, which is why it’s called a ‘no cause’ termination. It’s one of the main benefits of having a month-to-month agreement.”
Different states have different requirements for the notice period, so be sure to check the rules in your area.
If your tenants have signed a fixed-term lease, your options get a little more complicated. “Selling an occupied rental property with a fixed-term lease requires more processes, and doesn’t easily terminate just because of a change in ownership of the property,” Phan explains.
Options for handling tenants with a fixed-term lease
While a longer-term lease will be more difficult to get out of, it is still possible to sell your rental. The key is understanding your options. Phan, who has purchased over 75 properties himself and more than 500 properties collectively with his company’s partners, breaks them down for us:
1. Wait until the lease expires.
The easiest method for a fixed-term lease is to just respect the contract by waiting until the lease expires and your tenant has to move out, Plan explains. “However, if your tenant has violated any lease terms, you can terminate the lease more quickly with proper notice,” he adds.
Valid reasons for a lease termination include, but are not limited to:
- Failing to pay rent
- Engaging in illegal activities on the property
- Violating a no-pet clause
- Subleasing, if prohibited
- Causing serious property damage
- Being a nuisance to others
- Falsifying information on the rental application
There are a couple of key benefits to waiting until the tenants have moved out to list a rental property. First, the current rental income will dictate what the house is worth, says top-selling Huntington Beach, California real estate agent Cheryl Coleman. If the tenants move out, you can increase the rent, which will in turn raise the value of the property.
Another reason to sell a vacant property is that you’ll have the opportunity to make any renovations, repairs, or upgrades without disturbing the tenants, and it will also be easier to prep, stage, and show the home, Coleman notes.
“Even if we lose two to three months of rent payments this way, we usually end up selling for up to 20% more than we would if we’d sold with the tenants still living there,” she says.
2. Sell the property to an investor with an active lease.
A fixed-term lease doesn’t automatically terminate when a property is sold or by mere transfer of ownership, Phan notes. “In almost every state, the law dictates that the lease and security deposit must be transferred with the property, and the new owner becomes the new landlord,” he explains.
For this reason, selling an occupied rental property with a fixed-term lease limits your prospects, because you would need to sell to someone who accepts and understands that a tenant is living in the property.
“In this case, selling to an investor would be the best option, as it is important that the new owner lets the tenant live in the property until the lease is up,” Phan says.
In fact, with commercial leases, an existing tenant can actually be a major selling point, according to Jacobs. “Investors are more apt to look at the rate of return that they are receiving on their investment than other buyers might be,” he explains. “They are concerned with net operating income (NOI). Good, solid tenants are gold to an investor. In residential settings, most would love to have a tenant who’s been renting for 10+ years.”
3. Offer ‘cash for keys’
If you have a qualified buyer who is ready to make a deal, and you really need the property to be empty, you might consider negotiating a settlement to get the tenant to vacate the home before the lease has expired. Commonly known as “cash for keys,” this strategy can be effective, but also expensive.
If you decide to try this route, Phan offers these tips to determine how much to offer:
- Make up the difference: “Look to see what comparable properties are renting for in the area. If rent elsewhere is more than what you’ve been charging, offer to pay the difference between what your tenant will likely have to pay and what they have been paying you, times the amount of months left on the lease,” says Phan.
- Cover moving costs: To make up for the inconvenience of an early relocation, you might want to offer some money to help cover the expense of moving.
- Pay the security deposit: Phan suggests offering half of what your tenant would need to move into a new place, which is usually the first month’s rent and a security deposit.
- Offer whatever you can afford: Ultimately, the amount you offer will come down to weighing your available financial resources and what you stand to gain by getting your tenant out early.
“Keep in mind that the tenant is under no obligation to accept your offer or agree to your terms,” notes Phan. “In that case, you’ll be back to square one, which entails waiting until the end of the lease to sell the property.”
4. Sell the property to your tenant.
Another easy way to sell an occupied rental property is to offer it up to your current tenant, who is already familiar with what the home has to offer. One way to sweeten the deal is to offer a seller financing arrangement, which is a type of transaction where you step into the role of lender and your tenant makes payments to you (on a short-term basis) toward the purchase of the property.
“Seller financing is only especially attractive to long-term tenants in good standing,” Phan notes. “Also, keep in mind that you typically need to own the property free and clear or get approval from your mortgage lender to conduct a seller-financing deal.”
If seller financing isn’t a viable option, you could always just allow the tenant to obtain their own financing to complete the purchase.
5. Execute an early termination clause in the lease.
Phan explains that some leases contain a “safety net” for the landlords known as an “early termination clause,” which can be used to handle a variety of situations.
There is a case where tenants, even those in good standing, don’t get to live out the entire lease. Some leases have an early termination clause to handle a variety of situations.
“These clauses usually say that the lease terminates in 30, 60, or 90 days, for example, after closing on the sale of the property,” says Phan. “The ‘trigger’ for the termination can be anything you want, as long as it is reasonable and both parties agree to it in the lease.”
The keys to a smooth sale with tenants
When selling a property with tenants, keep the lines of communication open so they know what to expect. Phan offers these tips for keeping them informed and preventing any unpleasant surprises:
Know the laws.
Each state may have different laws when it comes to tenants’ rights, so it would benefit you to work with a proficient property manager, attorney, and/or real estate agent who is familiar with the local regulations.
Be upfront about selling.
Meet with your tenants and be fully transparent about your efforts to sell the house and any possible impact it could have on them.
“Explain the process you will use to show the home, but demonstrate that you understand it could inconvenience them and that you’ll do what you can to mitigate disruption,” Phan says. “Showing this kind of care and concern can help tenants trust you more easily, which will make the transaction smoother.”
Schedule showings as conveniently as possible.
Ask your tenants for their preferred days and times for showings and try to adhere to that as much as possible. It’s best to give residents at least 24 hours’ notice when scheduling showings, which sends the message that you respect their time and space.
“It is not acceptable for a real estate agent to just show up and enter the property unannounced,” Phan notes. “They must provide advance notice according to your state laws for entering the property.”
Don’t put signage in the yard alerting neighbors and the general public.
Phan warns that this could be seen as an opportunity for passersby to knock on the door and request a showing. “Let your tenants know that if someone shows up, they should never let them in,” he says. “They should always refer back directly to the agent for safety and best practices.”
Communicate after the sale.
After closing on a property, Jacobs usually drafts a letter signed by the seller informing the tenant of the sale of the property and directing them to send their next rent payment to the new landlord.
“In many cases, the seller takes the buyer to the home and introduces him or her to the tenant,” says Jacobs. “I think this more personal approach is the most effective.”
With other sales he has overseen, the real estate agent is also the property manager. In that case, the agent stays on in that role and there is simply a new owner behind the scenes.
“Those tenants usually don’t notice any difference, as they pay the same management company after closing,” says Jacobs.
Partner with professionals, period
The sale of a rental property can get complicated, which is why you should work with professionals who have experience with these types of transactions.
“An investor-friendly agent will know more about the buying criteria of investors, how much they could pay, and the investor market itself,” notes Phan. “The agent could also help connect you to investors looking to buy properties like yours.
“That would likely make for a smoother sale because you wouldn’t have to conduct numerous showings, and there would be a greater chance that investors will allow the tenants to stay with a fixed-term lease.”
Jacobs says the real estate agent will run comps on the property, analyze your current lease income, and come up with an appropriate listing price. In addition, the agent will have you fill out any disclosure forms that are required in your state.
It also might be beneficial to speak with a real estate attorney, who can look at your lease agreement to help you understand your rights, the tenants’ rights, and any legal consequences.
“A lease agreement is a contract, and sometimes clauses can be misunderstood,” says Phan. “Seeking legal opinions is always better than assuming what the clause means.”
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