We received a call recently from somebody who had recently purchased a rental property in the area, and they said that they are thinking about hiring us to manage the property for them.
He said, “Hey, I just bought a rental property, and I think I want you guys to manage it for me. The rents are substantially below market value.”
This buyer wasn’t concerned because he figured that being the new owner he could bring the rent up to market value.
Well, hold on a second… rents are certainly going up in this area… but if you buy a property, can you increase the rent once you take ownership?
Remember, the key to our client’s scenario is that he bought an occupied property.
So, what can you do? There are two rules you’ll need to make sure you follow…
Rule #1: All sales of any real estate are subject to lease agreements.
All sales of residential real estate are subject to pre-existing lease agreements. That means that the lease agreement supercedes the sale agreement. When you buy a property that is currently occupied by a tenant, you are also buying the tenant's lease.
Specifically, that means you must consider four things...
- You must honor all terms of the current lease agreement… Even if the agreement has some unusual clauses buried in the middle of it. So, make sure you familiarize yourself with the lease agreement BEFORE you purchase the property. For example, they could be a rent rebate of the tenant pay their rent on time every month… you would have to honor that. You had better be aware of the terms of the lease agreement going into the purchase.
- If the tenant is on a fixed lease (meaning, a lease for a period of time) then you cannot increase the rent for the term of that lease, unless there is a clause of some kind written into the lease allowing you to do so. You have to wait until the term of the lease is up before you can increase the tenants rent.
- It also means you can't terminate the lease without cause. You have the tenant in place until their lease matures.
- If you bought a property with a tenant in place, and planned on making this home your family home, thereby taking it off the rental market… you’re still required to wait out the terms of the tenant’s lease. If the tenant, for example, is six months into a 12 month lease, you’ll have to allow that tenant to stay in the home until their lease has matured in six months’ time.
Rule #2: Is the property subject to the Tenant Protections Act (AB-1482)?
If your property is subject to the so-called tenant protections act, then you will have further restrictions to deal with. If you're not sure if your property qualifies under AB-1482, feel free to give us a call.
Put simply, for the most part the TPA only applies to multiple residence properties; that could be duplexes, triplexes, apartment buildings, and even a family home with an ADU. Anytime there are two or more residences on the property that cannot be sold separately, then you are subject to the multifamily tenant protections act. There are also certain business entities that fall under the TPA as well
A few things to consider if your new property is subject to the TPA...
- You will be restricted as to the amount of any rent increase. The TPA limits rent increases to 5% per year plus the cost of living increase, and you can only increase the rent once per year. At the time of the writing of this article, that capture your rent increases to about 8%. "Well," you say, "that isn't so bad... I don't usually increase the rent that much anyway." Before buying the property, you need to be aware of how much rent is currently being paid per the terms of the lease. If the rent for the home that you purchased is well below market value, you won't to be able to catch up with current rents without having the tenant vacate first. There is a duplex in my town that is struggling to sell because the rents are far below market value - investors don't want to purchase it because they can't get the property up to reasonable rent standards so the numbers don't pencil out.
- There's one exception to that rule, and that's if you take the home off the rental market for an extended period of time. However, if you're taking the home off the market just so that you can increase the rent, you're going to get into trouble. You have to have good cause to take the home off the market… for example, you're moving into yourself yourself it for an extended period of time, or you need to do major renovations that typically require permits to be pulled. So, not minor renovations such as painting… but major stuff like replacing an HVAC unit, significant construction, etc. It needs to be something that you couldn't do if the tenant remained in place.
- If the tenants have been in the home for more than 12 consecutive months, no matter if they're on a fixed lease or a month month agreement, you must have what the Department of Real Estate calls “cause” to remove them from the home. You can’t just say, “well, their rent is way below market value, so I’m going to get rid of them and bring in a new tenant at a higher rate.” Usually “cause” means they’re not paying their rent or they’re causing damage to the property or are otherwise in violation of their lease or rental agreement.
The duplex in my town still hasn't sold (at the time of this writing) because the owners of the property felt like they were doing the tenants a favor by keeping their rent low. And since they were, but they weren't doing themselves any favors because the property has become a significant challenge for them.
If you have any questions, I would love to answer them. Let me know if there's anything we can do to help you with finding, or managing your rental property. Placerville Realty and Big Oak Property Management specializes in single-family residences and multifamily dwellings in the greater El Dorado County area.
Side note: AB-1482 was promoted by California's Governer Newsom as a means to protect tenants. However, in practice, the law hurts tenants and homeowners alike.
