There are pros and cons to almost every situation in the world of real estate. Something you may be all-in for a fellow investor may be staunchly opposed to. It is this varying opinion and strategy that helps make real estate such a unique business. One of the more often debated topics is whether to pursue a rental property with a tenant already in place. There will be times when the only way to close is to inherit a tenant. On the surface you may feel strongly for or against, but like everything else in real estate there are two sides to every situation. Before you dive all in or avoid a property at all costs you need to weigh the pros and cons and see what makes the most sense for you and your current situation. Here are some pros and cons with buying a rental with a tenant in place.
- Loan approval. One of the core items for loan approval is something called debt to income ratio. The lender will weigh your minimum monthly payments into your gross monthly income. If that number falls above a certain threshold your loan will not be approved, regardless of how strong it may be in other areas. When buying a rental property most lenders need to see a current tenant in place in order to use the income. That income can often make the difference in a strong debt to income ratio and one that is too high and will not qualify.
- Ready made cash flow. The most obvious reason you would a tenant already in place is for the ready-made cash flow. Instead of having to go through the process of marketing the property, setting up showings, screening tenants and ultimately agreeing on a tenant you have one right from the day you close. This allows you to maximize cash from as soon as you take ownership. Without a tenant in place it would take weeks, sometimes months, to find the right tenant and start collecting rent checks.
- Rental security. As hot as most rental markets are, there is no guarantee you will quickly find a tenant. Depending on when you close you may have a difficult time filling your vacancy. Most tenants do not want to move in after October and before the holidays. This doesn’t mean you can’t find one, but it would take a unique circumstance. Having a tenant in place means you know that you are locked into the rent until the end of the lease. This provides you with some financial security and assurances that rent checks will be there on the first of every month.
- No screening. The biggest issue with inheriting a tenant with the property is a lack of screening. Simply put, you do not know what you are getting. The tenant may have had a great relationship with the current landlord and paid on time every month, but it doesn’t mean it will carry over to you. Even if you have a chance to speak with them before the closing and assure them that everything will be the same there may be some animosity. People inherently don’t like change and may feel resentful towards a new owner. Most tenants don’t mind turnover if everything remains status quo, but you truly never know until you take ownership.
- Fixed rent. Your projected rent can be much different than the current rent amount. There are various reasons why, and how, a landlord comes up with what they charge for rent. It is not uncommon for a landlord to reduce their rent for an existing tenant or because they are struggling to fill the vacancy. When you take ownership, you inherit the agreed upon amount. This certainly isn’t the worst thing in the world but depending on the length of time remaining in the lease your numbers are forced to be adjusted until you can make the changes you want.
- Security/lease issues. Ending a lease with an inherited tenant can be a tricky situation at times. When you take ownership you also inherit whatever lease is currently in place. Something you may never had agreed to can be on the lease. Most leases do protect the landlord, but you never know what you will find. At the end of the lease you have to worry about security deposit and move out issues. Without pictures in place prior to moving in, it can be difficult disputing what damage was done by the tenant. They may expect the full security and you may want to dispute some damage in the property. Usually your attorney will review the lease prior to the closing but this can get sticky if a disagreement pops up.
It is essential that you take every property on a case by case basis. A lease with a few months remaining is much different that a lease with over a year left. You also need to consider the long-term plan with the property. Taking a suspect tenant for a few months shouldn’t deter you from years of profitable ownership. Like anything else in real estate, always weigh the pros and cons prior to making a decision.