Recently, the following question was posed on the LinkedIn discussion board for the upcoming Real Estate Connect conference: "Should a seller let a buyer move in prior to the closing?"
This question garnered more than 250 responses. Based upon the litigation I saw adjudicated when I was executive director of training for Prudential Jon Douglas Co., my answer to this question is, "Absolutely not!"
If you have been in the real estate business for any length of time, you probably have an array of horror stories about what could go wrong with a transaction. One of the worst examples I’ve heard happened to two brokers from my office.
The listing in question was vacant. The buyers and the sellers met and hit it off well. The buyers asked permission to paint the house prior to closing. Because the house was vacant, the sellers agreed.
The painters covered the hardwood floors with drop cloths to keep them clean. What no one noticed was that one of the drop cloths was sitting on a floor furnace. The furnace came on during the night, ignited the drop cloth, and the house burned down.
In another equally messy situation, the sellers agreed to have the buyers take possession prior to closing provided the buyers released part of their deposit to the sellers. Once the buyers were in possession of the property, they refused to close the deal. The sellers filed a lawsuit.
At the preliminary hearing, the judge ruled that because the sellers had taken part of the buyers’ deposit, the buyers now had a financial interest in the property. Because there were so many lawsuits on file in Los Angeles, it would take five years before the case could come to trial. In the meantime, the seller was stuck with no recourse.
In my personal opinion, if the buyers need a place to live until their property closes, put them up at your house, in a hotel, send them on a vacation, but whatever you do, avoid allowing them to take possession of the property prior to closing. If a problem arises, resolving who is responsible can result in expensive and lengthy litigation.
If there is absolutely no other option but to let the buyer move into the property prior to closing, here are the steps to take to protect all parties involved.
1. Don’t let the buyer take possession without a separate lease agreement plus a security deposit.
It’s absolutely imperative that you draw up a separate lease agreement. Until the transaction closes, the buyer is a tenant. This means that you collect a separate security deposit (in addition to whatever amount the buyers put down as an earnest money deposit).
We typically collected two or three months’ rent as a deposit. This provision alone was normally enough to discourage most buyers from attempting to occupy the property prior to closing.
2. Tenants can be evicted.
The most important distinction between a buyer in possession and a tenant in possession is that evicting a tenant is relatively easy. In contrast, getting rid of a buyer in possession often requires a lawsuit.
3. This is not a "do-it-yourself" project.
It’s important to use a lease agreement that is either generated by an attorney, your local board of Realtors or your state association of Realtors. Do not attempt to write out a lease agreement that addresses the rules for eviction, how the deposit will be handled, or the liabilities for damage to the property during the rental period. To do so is practicing law without a license.
4. Make sure the appropriate insurance is in place.
Many sellers mistakenly believe that their homeowners insurance provides adequate coverage for a buyer who moves into their property. This might be the case if the sellers were still living on the premises and the buyer was their guest.
The best way to handle this is to notify your insurance company. Find out what is required in terms of handling a short-term rental and have the sellers pay the extra insurance fees. It’s more than worth it if there is a claim as in the case above.
Also be sure to advise the buyers that the lessor’s (seller’s) insurance does not cover their belongings. Furthermore, it normally doesn’t provide liability coverage for the buyers or their guests. The best way to protect buyers’ interests is to purchase a renters’ insurance policy. (Be sure to put this in writing.)
To provide extra protection, insist that a home warranty policy is in place on the property. That way, if there is an issue with a major system on the property, there won’t be a conflict about who is going to pay for the repair.
5. Document the condition of the property.
The condition of the property is often a major source of contention if the buyer fails to close. Take extensive photos (and shoot a video if you can) prior to the time that the buyer/lessee takes possession. If there is a dispute, you have concrete proof about the condition of the property.
The bottom line is this: Do whatever you can to avoid having a buyer move into a property prior to closing. If there is no other alternative but to have the buyer take possession early, make sure that you have taken the necessary steps to protect all parties involved. Otherwise, it might be your career that is going up in flames.