Year-End Lease Housekeeping—Are You Ready?
Now is a good time to update your tenant lease for 2023
Many investors have their attorneys create a custom lease document for their property entity when they venture into real estate investing or when they purchase a new property. Your lease should always include cost-of-living adjustments as well as any new stipulations you’d like to include based on prior tenant actions or new property acquisitions.
A Limited Liability Company (LLC) is a commonly-used structure for “buy and hold” or longer-term investment strategies. S-Corps are more popular for short-term or “buy and sell” investors. A Limited Partnership is a less-popular structure due to the expense to set up, and depending on the state in which the LP is created, there can be intangible tax benefits. (An attorney is your best resource to learn more.)
Regardless of your investment entity, you will need a tenant lease if you plan on leasing your property to create cash flow. A properly-written lease allows you to set expectations for the tenants and identify house rules for the rental term. It also provides you legal leverage in the event your tenants step outside the agreed-upon terms, potentially saving you a lot of time and money. Each year, you should review your lease for each property to make sure it reflects the conditions and terms you and your attorney deem appropriate given the current economy and tenant behaviors.
Reviewing your lease(s)
Besides having the general foundational items—start/end term, amount of rent and payment date—review that your lease explicitly states all of the terms of occupancy. The list below are a few additional items that you can add when you do your annual review of your tenant lease (please work with your attorney on these items when reviewing your lease agreements):
Waiver of “Notice to Quit”: This language allows you to file for eviction without first having to give the tenant a written posted notice under the Landlord Tenant Act. It will save you time in a standard eviction proceeding. By adding a waiver of notice, the tenant agrees to immediate action by the landlord should the tenant breech any term of the lease.
Renewal Term: Include a clause stating what happens at the end of the lease period to protect your property and interests. A year-long lease, for example, might specify that when the lease expires, it automatically renews for one year or converts to a month-to-month lease. Have a clear, defined renewal term as well as a holdover clause.
Holdover Tenant: A holdover tenant is a renter who remains in a property after the expiration of the lease. If the landlord continues to accept rent payments, the holdover tenant can continue to legally occupy the property. State laws and court rulings determine the length of the holdover tenant’s new rental term. If the landlord does not accept further rent payments, the tenant is considered to be trespassing. If they do not promptly move out, an eviction may be necessary.
Utilities: Specify which utility bills are the tenant’s responsibility and which bills are the landlord’s responsibility.
Security deposit: Define the security deposit amount and the banking institution name and address where the deposit is held. In Pennsylvania, the security deposit amount cannot exceed two month’s rent for the first year or exceed one month’s rent beyond the first year of occupancy. Security deposits are legally the tenant’s money and are not to be used for personal or financial gain. Security deposits must be held in a separate account and not commingled with any other funds.
Pets: With more than 50% of the renter population having pets, you will need to define the allowances for pets in your lease. State any additional pet fees, if applicable. Some landlords charge a higher security deposit for tenants with pets or charge a separate pet fee. No matter what you label a deposit, security deposits still cannot exceed the amounts noted above. However, any deposit not used for damages will go back to the tenant once their tenancy has ended. If you charge a monthly pet fee instead, that fee goes directly into your pocket and increases your bottom line.
Renter’s Insurance Requirement: Require your tenants to carry renter’s insurance. Renter’s insurance covers the cost of replacing the tenant’s personal belongings in the event they are damaged, destroyed or stolen, which your owner’s policy does not cover. It also might cover the cost of temporary housing due to natural disasters or fires and may cover damages or injuries caused by pets to others’ property—mitigating the landlord’s risk. It provides additional liability and property damage coverage for your building due to tenant negligence.
Tenant-Caused Damages: Provide the tenant(s) a clear understanding of costs they may be responsible for regarding damages to the property. For example, if roaches and/or bed bugs are present, it is likely due to the tenant’s uncleanliness. Therefore, the costs of pest control is the tenant’s responsibility.
Snow Removal and Lawn Care: Specify the party responsible for snow removal/clearing and seasonal lawn care. If it is not stated as a tenant responsibility, it becomes the responsibility of the landlord. There are many clever ways to cut costs of snow and lawn care. Passing the responsibility onto the tenant is one option. You can also give your tenant a rent rebate to cut down on this cost versus hiring an outside vendor. Whatever the choice, consider your liability if someone falls on ice or snow because the tenant failed to clear a walkway—the small savings may not be worth the risk.
House Rules: Specify the do’s and don'ts of the property including any specific requirements you wish the tenant to abide by. An example of this would be: no hazardous or flammable materials may be kept in or around the building such as gasoline or other flammable liquids.
Lead-Based Paint: In Pennsylvania, if your property was built prior to 1978, you are required to provide a lead-based paint information pamphlet and a complete disclosure. If your property was tested for lead paint, you must disclose the results of the test. Even if your property has never been tested, you are still required to provide the tenant with information on how to protect their family from lead poisoning.
Occupants: List the names and ages of all occupants allowed to live at the property. Do not forget to include occupants under the age of 18 as well. This allows you to identify any “illegal occupancy” and keep the tenants from turning your property into a boarding house.
Sale of Property: State the landlord’s rights and responsibilities are if/when the property is sold during the term of the lease. Specify your right to terminate the lease with a 30-day notice in the event of a sale.
Automatic Renewal Increase: Prices on everything increase year over year as we’ve seen in rising inflation over the last year. Make sure your property is always competitive and in line with market values. A good practice is to build in an automatic 5% rent increase each year, but keep pace with inflation. You can choose not to increase the full 5% and negotiate this at each renewal term, but the discipline of having it be a part of your renewal terms is the first step.
Default Clause: State what happens if the tenant defaults on the lease or terminates early. You can allow tenants to terminate early, but be sure that it is only with landlord’s written permission and after they pay a discouraging fee. Additionally, they should have to pay their monthly rent until a new tenant is secured.
Final thoughts when refreshing your lease for 2023
Leases are the first step in a positive landlord-tenant relationship, legal security and overall peace of mind. Here are some additional tips to consider:
Work closely with your attorney, preferably one with experience in real estate law.
Research local and state laws. Make sure you know the law and how it affects your lease terms.
Remember that verbal agreements, month-to-month leases and expired leases are not leases that provide you protection. They do not hold nearly the same weight as written, signed, hard-copy leases with a specific term.
Thoroughly review any lease you obtain through an investment property purchase. If you bought a property while tenants are still living there, you have to honor their lease through the end date of that lease before making changes. Month-to-month leases can be changed upon new ownership with a 30-day written notice.
Remember to consider how you intend to respond or deal with a problem tenant. The most important steps to minimize problems are to act quickly, be consistent and clear on how to correct the problem when a lease violation happens. If you are not confident in your ability to deal with lease violations effectively, you should hire a property manager or consider retaining an attorney that specializes in Landlord/Tenant Laws in your state.
When you have a lease that reflects the current market conditions and specifies how you want your property occupied, you will be better prepared to deal with any tenant-related incident. Refresh and review your lease and legal documents annually.