The tenants are important

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“When you’re buying a rent controlled building,” I said to the buyer during an inspection yesterday, “the tenants are at least as important as the physical condition of the building.”

This is kind of counter-intuitive, right? After all, tenants come and go, but you plan to own the building for a long time.

But, under rent control, tenants don’t necessarily come and go. Instead, they often stay for long periods of time. And, if you’ve inherited them, you probably also inherited the terrible leases they are operating under. Here are some examples of terrible legacy tenancies I’ve run across recently:

  • One tenant in a 9 unit complex has in his lease that he can pay rent on the 15th, not the 1st like everyone else, so we have to make two trips, every month, to that one building to get the rents;
  • Many leases contain an attorney’s fees clause saying that, if the tenant doesn’t pay and the landlord evicts and wins, tenant has to pay landlord’s legal expenses. Sounds good, right? Except that judges in CA have interpreted those clauses as bi-directional, meaning that, if the landlord sues for eviction and loses, landlord has to pay tenant’s legal bills. Tenant advocacy lawyers love that one, because they opt for a jury trial and you’re potentially stuck paying them tens of thousands of dollars if you lose;
  • No security deposits. If you have a tenant with no security deposit who doesn’t care about his credit / eviction record, the tenant has zero incentive not to stiff you on the rent/destroy the place. What’s the worst that happens? He sticks around rent free for 2-3 months and then moves out when the sheriff arrives;
  • A landlord who intentionally scratched out the pet provisions in his lease, and thereby allowed a tenant to move in four extremely aggressive pitbulls;
  • Resident managers working with no employment agreements and without leases, leaving the landlord open to failure-to-pay minimum wage litigation and (possibly) a tenant in an apartment at zero or close to zero rent.

There are a million more of these kind of problems. All are avoidable / manageable with the right leases and the right tenant screening process. (In fact, I’ve never had to evict a tenant from one of our renovated buildings… knock on wood!). But, if you buy something with old leases / badly screened tenants, watch out.

What does this mean for buyers?

  1. Value those new tenancies more highly. If the leases are good and the tenants are screened and have security deposits, you will definitely have an easier time managing the property; and
  2. You need to carefully review the leases during the diligence process. If you (or your broker) know what to look for, you can mitigate some of the problems. But you definitely can’t if you don’t know what you’re looking for.

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