A foreclosure protection strategy?
Rent it Right
November 05, 2009
By Janet Portman
Inman News®
Q: My landlord, who's been a great guy, told me that he thinks he's probably going to lose the property to foreclosure. My lease runs out in a couple of months, and I was hoping to stay here for at least another year. The landlord offered to renew the lease now, for as long as I want, because he says there's a new law that makes foreclosing banks honor existing leases. If we do this, will it work? --Paul L.
A: Your landlord is correct about the new law. Signed by President Obama in May 2009, the Protecting Tenants at Foreclosure Act of 2009 requires foreclosing banks who become the owner upon foreclosure to honor existing leases.
If someone buys the home at a foreclosure sale intending to occupy it, however, the new owner can terminate the lease with 90 days' notice. (Incidentally, for month-to-month tenants, both the bank and any new occupying buyer have the right to terminate the rental agreement, but must give tenants 90 days' notice.)
Your landlord's idea would give you the long-term protection you need as long as the bank buys the property rather than a buyer who plans to live there. Even if the bank turns around and sells to someone else, that new buyer will have to honor the lease.
However, even if the bank becomes your landlord upon foreclosure, you might face some problems if the bank learns of your last-minute lease-signing. Reasoning that an empty home will be easier to sell than an occupied one, and realizing that any subsequent buyer will be shackled with you as a tenant for the length of your new lease, the bank may decide to challenge the validity of your last-minute lease.
Undoubtedly, the bank would start by offering you some money to move fast and quietly (known as "cash for keys"). If you don't go for it, they'd proceed by terminating your tenancy. If you refused to move, the bank would file an eviction lawsuit.
You could argue that the bank must honor your new lease, but the bank would likely contend that the lease was an effort to defraud the bank and shouldn't be enforced. Ultimately, the judge would be asked to decide whether the new lease is valid.
Your landlord's plan is clever, but that doesn't necessarily mean that it's legal. You and the landlord are taking advantage of a legal right (signing a new lease) knowing that it will tie the hands of the bank later. Is this fraud?
Lots of maneuvers that businesspeople engage in do just this -- cleverly use the law to their own advantage, and perhaps at the expense of others down the road. These ploys become illegal when, for example, the actors owe some duty of care or loyalty to the person who ends up disadvantaged by their act.
But does the landlord's relationship with his lender make him duty-bound to make life easier for the bank when the landlord defaults on his loan? Perhaps. When two people are parties to a contract, they owe each other a duty of "fair dealing," which generally means that they must not act in a way that will harm the interests of the other.
Your landlord and his lender were under contract -- but does extending your lease and making the property less salable constitute active harm? If the landlord were dealing with the neighborhood bank, maybe ... but these days, the lender could be one of many subsequent owners of this mortgage, which might have been chopped and bundled and sold repeatedly to unknown buyers.
The new federal legislation you're relying on may itself supply the answer. Section 702(b) specifies that the new duty to honor your lease applies only when you're a "bona fide" tenant.
According to the law, tenants must not be the spouse, parent or child of the owner; tenants are paying rent that's not "substantially less" than fair market rent; and the lease transaction must have been conducted at "arm's length." This last requirement probably doesn't describe the plan hatched by you and your landlord, which might doom your chances of staying.
Q: Like many properties in town, my apartment complex is not fully occupied, and I'm having trouble filling vacancies. My wife suggests that we take advantage of the lull to renovate. I'm hesitant, given these hard times. What do you think? --Matt S.
A: I think your wife has a very valid point, and it's one that hasn't been lost on your commercial landlord counterparts. There are several good reasons to renovate now, rather than waiting until full occupancy returns and the economy recovers:
1. Renovating now positions you nicely once the economy improves. Things are bound to improve (that's why real estate cycles are called "cycles"). If you've upgraded your property, you'll be ready to attract the best tenants and charge them an increased rent for your spiffed-up units. But if you wait, you'll either have to rent for less or keep apartments off the market while you do the work, losing you even more rental income.
2. Renovating now helps keep current tenants. As you've noted, vacancies are up, which means that your remaining tenants have plenty of choices about where to live. If they see that you're actively improving the property, they're less likely to jump ship, even if they could rent for less.
3. Renovating now is convenient. You already have some vacant units -- you may as well take advantage of that to do the work. If you wait, you'll have to either take them off the market when you could be renting them or try to do the work with tenants in place. Even if that's feasible, most tenants will expect some compensation (relocation or diminished rent) in exchange for the disruption.
4. Renovating now may allow you to take advantage of discounted goods and services. Take a look at the price of appliances at big box stores -- there are bargains galore. You may also find contractors willing to work for less than they'd charge in a booming economy, when there's a higher demand for their services.
If you decide to go ahead, start by figuring out which improvements will set you apart from the competition. Learn what your market -- tenants who earn enough to afford your rent -- really want in a rental. Is it granite countertops? An on-site gym? How about "green" improvements? Talk to other landlords and brokers to find out -- the last thing you want is to spend money on remodels that don't appeal to your target market.
Finally, be sure that after you do all this work and spend the money, you choose qualified and creditworthy tenants. Your entire strategy is based on spending money now so you can collect more money (in the form of higher rent) later. That plan depends on finding solid tenants who pay on time and don't have to be evicted.
Having to evict means more expense, and rent-less months while you look for a replacement -- all of which will cut into your income stream.
Wives have such excellent ideas, don't you agree?
Janet Portman is an attorney and managing editor at Nolo. She specializes in landlord/tenant law and is co-author of "Every Landlord's Legal Guide" and "Every Tenant's Legal Guide." She can be reached at janet@inman.com.
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