Tenants in the House
One of the misconceptions we run into often is how tenants/renters are handled in the midst of a real estate closing. Many investors and agents are under the false impression that either (a) the new owner has the right to remove the tenant when they buy a piece of property or (b) the seller must vacate the property of tenants before they sell a piece of property.
While the above would make life much simpler for old landlords trying to sell their old property and new landlords trying to upfit or re-lease their new property, it would be unfair for a tenant to lose their lease rights just because their landlord decided to sell the property.
So, is the landlord just stuck with their property until the lease is up? Well, no—it would be similarly unfair for a landlord to be restricted in their ability to sell a piece of property, just because they had a tenant in the place.
Legally, landlord and tenant have a lease agreement, a contract, by which the landlord sells their right to occupy the property to the tenant for rent. When old landlord sells the property itself, that contract “inures” to the benefit (and detriment) of the new landlord. While this isn’t always the case with contracts, it is almost always the case with residential lease agreements. In legal jargon, the distinction is between “privity of contract” and “privity of estate”—while the new landlord and tenant do not have privity of contract (they didn’t agree with each other), they do have privity of estate (the tenant’s right to occupy the property is carved from the new landlord’s property ownership rights).
Short version? If there is a lease, that lease runs with the property. So long as the tenant has an active, unexpired lease, the new landlord has to comply with the terms and obligations of that lease. Old tenant stays on the terms agreed. Now comes the fun…real estate agents listen up…
A Case Study in Material Facts
What if you buy a piece of property and the tenant has a 30-year written lease? What if that 30-year lease says that the tenant only has to pay $150 a month to stay in the property? The new landlord has to honor that lease. So long as the tenant wants to stay, new landlord must accept $150 per month for the entirety of that thirty-year period, provided tenant doesn’t otherwise break/violate the lease agreement.
You can envision how this plays out.… Absent or uninvolved Seller decides they are going to sell a rental property because they aren’t making any money on it. A couple years prior, the Seller agreed to lease the property to the Tenant, but the Tenant was cash-strapped and needed a place to live. Tenant and Seller were old work buddies, and the place needed some upkeep, so Seller says, “fix it up a bit and we’ll call it even.” This fact pattern was very common during COVID. So, Seller and Tenant sign a lease on an old form Seller found from Google and, voila, privity of the estate established!
The Seller hires a listing agent to get the property off his hands. Seller figures that the lease will expire when he sells it, and he doesn’t even mention the old lease to the listing agent. Seller gives the listing agent the tenant’s phone number to arrange for walkthrough, etc. This is where you would see the divergence between what should happen and what often does happen…
What Should Happen
The listing agent, as soon as they hear the word tenant, asks the Seller for the lease agreement. As soon as they see the lease agreement (and the term/rental), they have a difficult discussion with the Seller about the actual value of the property with this lease. They lay out options to the Seller with respect to reducing the purchase price, making necessary concessions, or trying to renegotiate the lease with the Tenant.
The buyer’s agent, during the course of their material fact research, check the register of deeds to see if there is any relevant encumbrance or instrument affecting the Seller’s ownership of the property. As North Carolina law requires leases of more than three years to be recorded (NCGS § 47-18), our astute agent notices there is a Memorandum of Lease that runs for thirty years and starts asking questions as to what that lease says…
Or even better, the buyer’s agent recognizes that the Seller lives out of state and does not occupy the property. If your seller does not occupy the property, the very next question that should be asked is who occupies the property? If it is a tenant, and there is a lease, the terms of that lease affect the marketability/value of the property.
What Often Does Happen
Your listing agent does not have a strong awareness of how the lease survives the transfer of ownership between Seller and Buyer. Listing agent makes assumptions or otherwise doesn’t bother to ask—is the tenant vacating the property?
Your Buyer’s agent doesn’t know that the existence of leases on the property is a material fact. They don’t have a compliance checklist that includes existing leases on the property as something that needs to be requested from the selling side. Unfortunately, they don’t know how to search the Register of Deeds in the county—if they had, they would have found a recorded Memorandum of Lease that showed a 30-year tenancy on the subject property signed by the Seller for the benefit of the Tenant.
When the Buyer and the Buyer’s agent show up for their walkthrough, they notice that the property looks suspiciously occupied. As in, there is a tenant in the property who has made any preparations to leave. Buyer asks the Buyer’s agent… what do I have to do to replace the tenant? Now we are day of closing, and the Buyer is finding out for the first time from their attorney that the Tenant (a) cannot be removed and (b) is paying a pittance to live at the property for the next thirty years.
Systems Keep you Compliant!
It is insane to think about all of the possible material facts that can pop up prior to closing and obliterate an otherwise normal real estate transaction, and it is certainly difficult to keep up with all of the things that you have to research and keep information about in the course of a normal transaction. A similar variation on the fact pattern above caused a $250,000 purchase transaction to turn into a $130,000 purchase transaction, just by virtue of a little piece of paper that was signed years before.
As a real estate agent, you need to have a checklist that you run through for every transaction that helps walk you through material facts—the system itself will help you avoid circumstances where you don’t think of an angle. One of the things on that list would be to check the register of deeds for odd liens, encumbrances, or recordings (like a memorandum of lease) that can affect your seller’s ability to sell. This should happen on both listing and buying side of the transaction!
Every agent wants to build a book of business—as your business grows, it is critically important that you develop systems to scale with your business. If you are responsible, on every transaction, for remembering to check whether your property is in the airport noise cone, but also whether that property had septic permits pulled for the right number of bedrooms, you will get bogged down trying to handle the sheer scope of different problems that can be revealed in the material fact process. The only way to be able to consistently cover your bases is to have a great checklist and replicable system for reviewing material facts.
