We diligently search advertisements, work with property bird dogs, and do extensive research trying to locate that excellent rental property investment. For multi-family properties, we want all the normal things, like reasonable condition, good location, a below-market purchase price, and stable market leases. It’s the leases that bear really close scrutiny. We have honed our skills at condition, remodel/repair estimating, and valuation, but we must be very careful when it comes to leases. We know that WYSIWYG in computer talk means “What You See is What You Get.” Unfortunately, we can’t count on that with leases.
The first, and most obvious, thing to check is the duration of the current leases. Are most of them rolling over in the next six months or less? What is the anticipation of renewals by the current tenants? If they are at market levels, you’ll really want to get new leases without having to get new tenants. If the lease terms are out a year or more, examine them to make sure that they don’t have loopholes or easy escape clauses. There’s no fun in having a number of tenants bale on you unexpectedly a couple of months after you buy the property.
Are the rents at current market levels? If they are below market, you really want to see shorter terms before expiration, giving you the ability to raise rents sooner. If they are at market level, are they really paying what it says in the lease. This is one area in which buyers have been very upset after purchase. Just because a lease says that Tenant Smith pays $900 per month, it doesn’t mean that the really do. Check lease rental terms against actual rental deposits. You don’t want to buy and then find out that several tenants are trading out services for rent.
Dean Graziosi, in instructing his real estate investment clients, is very clear with tips about getting the real information behind leases. Do the tenants have options to renew? Do these options allow rent increases, or can they renew at their current rate? This could be a very important factor in your purchase decision. Are there automatic rent increase escalator clauses? With long leases, you want to be sure that the increases negotiated will cover inflation.
When you think you’ve found that perfect multi-family investment, pay extra attention to the leases currently in place.