How to Negotiate the Purchase of an Occupied Multifamily Rental Property

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Buying an occupied multifamily rental home is not like a traditional single family, owner-occupied house sale, but it’s a great way to add to your real estate portfolio.

Real estate purchases can be complicated matters, but some transactions are more complex than others, particularly when the rental home you’re looking to purchase already has tenants living in it.

The average number of properties our members own is 30, but half of us still own six units or fewer. At some point, most of us have likely considered adding to our real estate portfolios by buying properties.

In this article, we will go over our top tips for making an offer to purchase an occupied rental property, and what you’ll need to execute a purchase and sales agreement that will get you to closing.

Property Buying 101: A Quick Review

If this is your first multifamily investment property, you should know that purchasing an occupied property is more complicated than a traditional real estate transaction, but the basic steps are the same. If this is your first real estate purchase ever, you may want to review these steps more closely.

The buying process typically has four steps. 1) You identify a property you’d like to purchase. Maybe your realtor showed it to you, you saw it on Zillow, or you just drove by and saw the “For Sale” sign. However you found it, you think this is a property you want to own. 2) You make an offer to purchase the property, negotiating things like price and other terms of sale. This is where your contingencies go (more on that shortly). When you and the seller reach an agreement, the property is said to be “under agreement.” 3) You sign a purchase and sale agreement, which is a binding agreement to purchase the property (and a binding agreement for the seller to sell you the property). 4) You close on the property.

Step 1: Do Your Real Estate Due Diligence

You may know you want to purchase a multifamily property as a real estate investment, but not all properties are created equal. Before you get into making offers and issuing contingencies, you need to know that the property will suit your needs.

First, get a good real estate attorney on board, one who is familiar with landlord–tenant law. Your real estate agent may be dynamite at finding properties, but not as strong with the nuances of rental property. And the attorneys your real estate agent might otherwise recommend may only handle single-family, owner-occupied closings. It’s important that you have a knowledgeable attorney on your team.

You also want to make sure the property is suited for the rental business you have. If you love renting to students and professionals, it probably doesn’t make sense to buy a multifamily that isn’t located near any colleges or on a commuter rail. If you are hoping to target families, check out what amenities are nearby. A good school district will practically rent your property for you.

When you are buying a single-family, owner-occupied home, usually you’d take a tour or attend an open house before making an offer. When you are considering multifamily properties, selection can be more difficult, as some renters may deny access to their unit. Have a very honest conversation with yourself: Does the property seem so perfect that you’d be willing to gamble and purchase it with a portion of it unseen? The answer is, “probably not,” especially if you are new to rental real estate.

Step 2: Contingencies are Part of Every Offer

When you make your offer to purchase, you can ask for all kinds of things, called contingencies. Commonly, most buyers will say their offer is “contingent upon” something, such as a property passing inspection. But you can ask for other things as well, such as updates to the kitchen, or replacement of an old roof.

When you’re looking at occupied multifamily properties, you will (should) have conditions surrounding things like rental agreements, whether the property is occupied or vacant at purchase, and lead certificates.

What you offer depends on the kind of market you’re buying in.

How your offer is received will largely depend on the type of market that you’re buying in. That is, does the market favor buyers (high inventory, good interest rates) or sellers (low inventory, higher interest rates)? In the buyer’s market of the 1980s, for instance, sellers were finding all kinds of ways to make their properties more attractive to buyers, even reportedly offering cars and trucks with multifamily homes. In 2021, when there were more buyers than sellers, sellers were getting well above asking price for their homes as buyers competed to have their offers accepted.

So, in a market that favors sellers, you are going to have less negotiating power than you would in a buyer’s market.

Once you make your offer, the owner can accept it as-is (this would be a wonderful thing), reject it entirely (back to the drawing board!) or, most likely, return with a counter offer. Negotiations will go between the buyer’s and seller’s agents until the parties come to an agreement.

As with any real estate transaction, be careful with electronic discussions, whether that’s over email, text message or other chat platform. You may be held to whatever you say, so watch your words and only offer what you’re willing to compromise on.

One of the Biggest Contingencies: Delivered Vacant, or Occupied?

If the property you’re interested in has tenants living in it, you have two options: You can request the seller deliver the property to you vacant, or you can purchase it occupied at the time of sale.

When does it make sense to request a property be delivered vacant?

There are situations where you may want the property sold without anyone living in it. If you need to renovate, you may request that the entire building, or the units that need renovation, be delivered vacant.

If you are looking to owner-occupy one of the units, you can request that that unit be delivered vacant as well. This is especially important if you are looking for an FHA loan, which requires the buyer to live in the property to qualify for the program. You only have 60 days to occupy it after purchase, so getting involved in an eviction process after the fact could ruin your plans.

If you are the type of landlord who excels at good tenant screening but falls short at being able to effectively evict renters, then getting a vacant house may make sense for you. It removes the potential for inherited headaches if some of the tenants are reluctant to follow the rules or pay rent.

When does it make sense to allow the property to be delivered occupied?

Buying a property with the current tenants in place has its advantages. It’s almost certainly going to be more attractive to the seller, since they won’t have to handle terminating rental agreements ahead of the sale. It could also mean you get the property at a discount, because the renter is difficult and the seller knows it would take a lot of work to get them to move out.

Buying a property with good tenants in residence means that you can start collecting rent right away. It also means the property itself is potentially much more valuable: If the current owner has been keeping the place up to code and updated, you could be getting a turn-key building with paying tenants. It doesn’t get much better than that. Any past rental agreements will transfer over to you with your purchase, giving you time to figure out what you want to do regarding leases.

In a seller’s market, you are likely going to have less room to negotiate here. You can make your offer contingent on the current owner delivering the property vacant, but if another seller is willing to take the property with renters in place, you may have to adjust your expectations.

Make Your Offer Contingent on Having Copies of Available Rental Agreements

If you purchase the property occupied, then the rental agreements the tenants have in place at the time of purchase will transfer to you. This includes active leases as well as any that may have lapsed into month-to-month tenancies. You will be bound by those agreements until they expire, so make sure you know what you’re getting into.

Seller’s market: contingent on receiving any copies of paperwork that exist.

In a seller’s market, you aren’t going to be able to be too choosy about the conditions that exist in the rental agreements. Instead, you can make your offer contingent on receiving any paperwork that exists (or have the seller warrant that no such copies exist).

This is something any seller should be able to do, and therefore, should be considered the bare minimum for rental agreements even in the toughest market for buyers. If the seller cannot furnish these, it should dissuade you from moving forward.

Buyer’s market: contingent on satisfactory appraisal of rental agreements.

If you’re operating in a buyer’s market, you have a lot more room to assess whether this property is as perfect for you as you initially thought, and you can (and should) make your offer contingent on what you find in the rental agreements.

First, find out who is on the lease (i.e., who’s supposed to be living in the unit) versus who’s actually living in the unit.

Next, look at the conditions in the lease. Who is responsible for the utilities? Are pets allowed? What about smoking? Is parking available, and is there a fee for it?

And finally, make sure you note how long the agreement is for. Some leases may be expiring in a couple of months, others may be newly renewed for a year. Some may have lapsed into a month-to-month tenancy at will, others may be signed for five years. Even if the original agreement has expired, it’s the agreement that should be followed until you take possession and have your renter sign a new one.

Make Your Offer Contingent on Having Copies of Available Security Deposit and Lead Certificate Documentation

Another contingency surrounds security deposits. When the rental agreements transfer over, make sure the security deposits transfer to you as well. Ensure the security deposits come with the original conditions statements, as well as all account information (where the accounts are, who the money belongs to, and what units those renters live in). You will have 45 days after you close to set up the security deposits in appropriate accounts for your tenants.

Even in a seller’s market, you should ask for copies of security deposit paperwork. If none exists, have the seller warrant that they did not collect security deposits.

Next, there’s the issue of lead. If the seller is saying they have “no knowledge of lead” in the property, check that against the state’s database for lead-safe homes. If there are any children under age 6 on the property, there cannot be lead, known or unknown. Ask the seller for deleading documentation, if any. If there is lead on the property, you have 90 days to achieve deleading compliance or start interim control measures. There may be lead abatement funds you can access, but this is a situation you need to be walking into fully informed. In a seller’s market, you’re probably stuck dealing with the lead issues yourself or walking away from the deal, but you may have room to negotiate some remediation in a buyer’s market.

Don’t Forget Estoppels and Rent Rolls

There’s a term you may have heard used in the real estate world, and that’s estoppels. What’s an estoppel? Essentially, it’s a standard form that the buyer’s attorney will correspond with the tenants to obtain. Estoppels are where the tenant (not the seller) acknowledges the general terms of their lease. The estoppel can verify how much rent is being paid, whether a security deposit and/or last month’s rent was taken at signing, and any other terms or conditions that are specific to the rental agreement (for instance, if the tenant is responsible for trash removal). It can also state if there is rent owed.

Since you should get these statements from each of their tenants, it’s something you should make part of your offer. Don’t count on the seller thinking of it or offering it themselves, or assume you can request one later at closing. Make it part of your initial offer so everyone is on the same page. If you were to purchase a property without estoppels, it’s not the end of the world, but you would be less well protected against renter claims going forward.

Tread Lightly with Tenant Screening

In a buyer’s market, you can make your offer contingent on your satisfactory appraisal of what you see. If you want to screen the renters who live in the property, you can do so with little worry that the seller will walk away from the deal. Take applications from all renters, and accept those who you think will be a good fit by screening the renters.

In a seller’s market, screening occupants is likely to lose you the deal. In that case, you’d ask to see the required documents (for example, rental agreements) and make your offer contingent on those documents being delivered to you, but not subject to your analysis of the documents.

In either case, be careful with tenant screening. Even in a buyer’s market, you’re essentially forcing the seller to offer cash for keys to remove the renters you don’t want to keep in place, and that could cost you the deal. It can also make you unpopular with the tenants before you even close on the property.

Step 3: The Purchase and Sale Agreement

Once the negotiations are done and your offer has been accepted, it’s time to sign the purchase and sale agreement. One of the reasons you want to complete your due diligence before you sign a purchase and sale agreement is that it makes this step a lot smoother, as you are less likely to encounter “surprises” in this step.

The purchase and sale – or P&S – agreement will include the purchase price and closing date, but should also have the seller warrant the house is up to code, properly permitted, and have the buyer warrant that due diligence has been done on leases and Section 8 agreements. This is also when you’ll have the seller warrant submetering is set up appropriately.

Is the house up to code? Check with the local board of health or department of inspectional services. Are there any major or minor code violations in place? In a buyer’s market, see what you can get the seller to fix before closing. In a seller’s market, make a list and be prepared to fix the issues soon after closing.

If there are major code violations, look at the deal you’re about to close very carefully. Are you sure these issues are ones you want to handle? If the seller has been submetering the utilities, have the seller warrant that they have been properly set up.

Along with this, call your local building department and make sure that any improvements, since the seller purchased the property, have been properly permitted. Make sure that any open permits are closed before you sign the final papers on the property.

Check to make sure the leases are in order (you will have reviewed them during the offer phase, but double check them now). If there are Section 8 tenants, make sure all applicable paperwork from the housing authority is complete, and signed.

This is a lot of paperwork, but it protects you and your investment, so once again, consult with your attorney and make sure everything is in order before you get to closing. You’re almost there! We tackle what happens at closing, as well as what you should do in your first weeks as a landlord, in a companion article.

Conclusion

Buying occupied property is not the same as a traditional house purchase. There are a lot of extra steps to go through, but the payoff can be well worth it if you end up with a code-compliant property that has happy renters. 

Source: MassLandlords.net