Rental Property Acquisition "Subject to" Clauses You Should Consider
Any offer real estate investors submit to purchase a rental property becomes a legally binding contract once it is signed by the owner. And as a result, the investor will be expected to abide by its terms and conditions of the contract or possibly face legal action for defaulting.
Most realtors, investors and others who have ever purchased real estate, of course, understand this. That's why most offers to purchase typically include contingency clauses to protect the buyer. Such as "Subject to" loan qualification, property appraisal, various types of property inspections like pest and dry rot, condition of the roof, and so forth.
The buyer's objective, naturally, is to clearly state to the seller that he or she is willing to purchase the property according to the terms of the offer contingent upon certain conditions that meet with the buyer's satisfaction and approval.
But in addition to these types of contingencies, there are others common to commercial and residential income property that can protect the investor and should be included in the offer to purchase. These "subject to" clauses aren't quite as obvious to those less experienced with rental income property, so it seemed like a good idea to list my top four.
1. Interior Inspection of All Units
Rental property owners commonly do not allow buyers to enter the units until he or she has a signed, acceptable offer. Therefore, you will have to make your offer contingent upon your satisfaction and approval of the interiors of all units.
It's smart to make this interior inspection your first priority before time or money is expended doing other inspections just in case you don't like what you see and want to back out.
During one such interior inspection, for example, my "mom and pop" investors were appalled to discover that one of the tenants kept three stacks of tires and a pitched tent in the living room. It shouldn't have been a deal breaker, but it was enough to sour the buyers and they walked without shelling out a dime.
2. Approval of Rental Agreements, Books and Records
You must satisfy yourself that the income and expenses you were presented before you wrote your offer is credible. Ask to see all the rental agreements along with the income and expense statements for the property. Be sure the numbers add up to what you were expecting otherwise rethink your offer.
Upon examination of the income and expense statement associated with one particular offer, for instance, we discovered that the operating expenses only included the cost of materials. Namely because the owner was doing all the repairs himself. Since this wasn't an option for my buyer, we had to rerun the numbers based upon a higher cost for repairs and maintenance to include labor and wound up renegotiating the price.
3. Approval of the Seller's Schedule E Tax Form
Confirm what the seller has been reporting to the IRS regarding the rental property's income and expenses (say over the past three years). This allows you to validate that the numbers presented to the IRS line up with the numbers presented to you in the marketing package. Sellers, after all, have been known to skew numbers in their zeal to sell their property.
During one inspection, for example, we discovered that a recent boast in rents occurred just before the rental property was listed for sale. This, of course, created a "current" rental income that supported the seller's asking price, but the lack of rental history also caused my real estate investor to rethink his offer.
4. Seller Cooperation in a 1031 Tax Exchange
If the buyer is purchasing the rental property in order to complete an IRC 1031 Tax Deferred Exchange, start the paper trail in the offer. Make it clear that the rental property is being purchased as part of an IRC 1031 Tax Deferred Exchange and require the seller to acknowledge that he or she will cooperate.
You can obtain the correct verbiage from the buyer's 1031 accommodate just to be sure that it's worded correctly on the offer. You don't want to inadvertently mess up a buyer's exchange because of faulty or inadequate wording.