One of the most basic and yet often overlooked aspects of rental property management is the real estate lease agreement. Those of us who rent property to tenants should strive toward understanding leases. Not just simple real estate lease basics, but a comprehensive understanding of the full residential lease agreement. In this story, Mashvisor will endeavor to offer those who are starting in this business an understanding of the rental lease agreement.
What Is a Residential Lease Agreement?
A real estate lease agreement is a legal contract between a landlord and a tenant. You already know that. But how does a lease agreement help a landlord, and what protections does it afford to a tenant? The simple answers are: “Mot much to a landlord,” and “An amazing array of protections to a tenant.”
One of the most basic benefits of a lease to a landlord is the hope of a predictable rental term. By signing a lease with a tenant, the landlord hopes to know that the tenant has committed to remain in the unit and pay the rent for a set period of time. A lease can also outline options for lease renewal. This matters for your small business because it allows you to plan ahead. However, there are some other benefits.
One additional benefit is that a residential lease agreement can help you when you finance your property or refinance it. Banks look for many things before offering you a loan. Included in that list are rent roll and a lease that they can see. It provides the bank with some certainty that you will have the income to pay the mortgage. Don’t be surprised if your insurance company also asks if your units have leases when you apply or renew.
Who Do Leases Benefit?
There was a time in many parts of America when a real estate lease agreement protected a landlord legally. Those days have mostly come and gone in the US housing market. Without a possibility of eviction, a lease is almost worthless to a landlord, and eviction moratoriums are now the norm across the country. If you cannot enforce a legal agreement in court, the value is almost nill.
However, there are still honest people in the US who are tenants with only good intentions. An official real estate lease agreement still has some value with such honest tenants. It helps to create an objective understanding between the landlord and the tenant about what is expected from both parties. As the saying goes, “Locks keep honest people honest.” Leases, in a way, keep honest renters honest.
Elements of Real Estate Lease Agreements
Most state real estate rental groups will offer standard lease agreement templates or formats that work in that given municipality. However, these real estate forms all have common elements. Let’s focus on the most important aspects. Here are what the most common sections of a residential lease covers:
Name, Rank, And Serial Number
At the start, the rental property is described, and the information of the landlord and the tenant is listed. If you have an LLC or a corporation, ensure that it is the LLC or Corp. that is named as the landlord, not you personally. If you don’t use an LLC and instead are doing business under your own name, this is a perfect opportunity to step back and reconsider that mistake. You are exposing yourself to unnecessary liability.
The Signature Section and How To Use It
The end of the lease is the signature page. Here’s a tip: If you don’t sign your lease in person, always give your tenant an unsigned pair of leases and ask him/her to sign both and return them to you. Then, sign one and send it to him/her. Never send a signed lease to a tenant until he/she has signed first. Otherwise, you risk a situation where the renter holds a lease and you do not.
Duration, Renewal, and Termination
Just under the introduction, you will find the rent payment amount and the manner that rent is to be paid in. Also, the duration of the lease is listed. If your municipality has enacted rent control measures, this section may be expanded to include wording around the mandates surrounding the way you are able to renew the lease, notify the tenant of non-renewal, and your restrictions on selling the unit. Be certain you understand how these can impact your options for your investment property. Once you sign the lease, you no longer control these things.
Security Deposit and Last Month’s Rent
Scan down the real estate lease from the top, and you will find that it defines the security deposit held in escrow by the landlord as well as the last month’s rent. This is a great opportunity to ensure that the way you manage these two financial transactions complies with local laws. That usually includes paying annual interest to the tenant.
Related: 3 Ways You Can Help Renters Pay Rent During the COVID-19 Pandemic
Utilities and Who Pays for Them
Farther down, you will find that the real estate lease defines how the municipal water, hot water, heat, and utilities are paid and by whom. Most states regulate your options here. Be certain you know what you can and cannot delegate to the tenant. For example, in almost all cases, if the unit is a multifamily home with only one heating source and a common supply, you must include heat. If the standard lease form does not match what you are planning, you should edit it.
Pets and Usage
Real estate leases include standard wording as to the restrictions that the landlord enforces. For example, rules regarding pets, use of the unit, damages, etc. You should carefully define the unit and its uses either in the main body of the lease or within an appendix. For example, if an unfinished storage area in a basement or utility room is strictly for such use, you should make clear that it is not to be used as a living space.
Occupancy Limitations
All real estate leases also define who is to live in the unit and how many occupants will be permitted. Of course, you cannot preclude family members or tenants’ significant others from living in the unit, but you can certainly define before the lease is signed how many people will live in the unit. This can be important. If your tenant has a family of five and later wishes to move in more occupants, you have an agreement that precludes that unless you change the agreement.
Common language used to restrict occupancy may look like this: “Tenant shall not allow any other person, other than Tenant’s immediate family or transient relatives and friends who are guests of Tenant, to use or occupy the Premises without first obtaining Landlord’s written consent to such use.” This can help keep your two-bedroom unit from becoming a ten-person rooming house.
Subletting
Subletting is always mentioned in a proper lease. A sublet agreement is when a tenant then moves out and turns the unit over to another party or adds more tenants. You need to ensure that is not allowed unless you agree in advance.
Late Charges
Every real estate lease agreement has a section for late charges. These are fees that a landlord can impose if rent is not paid according to schedule. In the real world, it’s worth a try to impose late fees. However, you need to go to court to enforce them, and the time commitment will offset any actual gains. This is a scare tactic intended to impress upon tenants that the date rent is due matters.
Default
The default section is the long-format description of what will happen if a tenant stops paying rent. This is a section in a real estate lease designed to give some structure to how a landlord would remove a tenant if he/she failed to pay rent. In the age of COVID-19, it is no longer applicable in the real world. If your tenant stops paying rent, you should contact an attorney or consider a “cash for keys” approach.
Surrender of Premises
This real estate lease section simply states that the tenant will return the unit in the same condition in which it was initially rented. It never happens. Normal wear and tear and mistreatment are common. You can try to use the security deposit to recoup blatant damage, but be aware that you may end up in conflict with your municipality’s laws. This is a good reminder to take images of your unit and have the renter initial them before you sign the lease.
Indemnification
This real estate lease section says that you can’t be held liable for any harm that comes to anyone on the property while the tenant is under contract (lease). It is not a substitute for a liability policy.
Inspection Clause
The inspection clause is important. It defines your rights as the property owner to inspect the unit periodically and to enter it when needed for repairs or maintenance. It also helps you to set the expectation that you can advertise the unit for rent prior to the end of the lease. In my own business, I usually explain to the tenant before we sign a lease how I expect to manage these things so that there is no misunderstanding.
Maintenance, Repair, and Rules
These sections simply explain common sense things that need to be in writing. In my own rental business, I often augment them with an appendix that goes into specific detail. For example, “The shed is for tenant use to store items of no significant value, and shall not be locked at any time.” Or, “Parking on the side of the building is prohibited because it creates an unsafe condition in the event of a fire.” If the unit is a condo with its own rules, be sure you read and include them.
Trash
If your real estate lease does not have a section on trash management, create an appendix. Explain the expectations for weekly trash removal, who pays for the pick up of trash (usually the landlord), and what expectations are for trash stored on sight in terms of type, volume, and length of time.
Hazardous Materials
The hazardous materials section is pretty straightforward. In my own business, I expand it. I list many items such as barbeque lighter fluid, oil-based paints, solvents, and vehicle fluids as prohibited.
Smoking
Smoking can still be prohibited in a real estate lease in almost all parts of America, but you should check your local laws. In my rental business, I avoid the word “tobacco” and use “smoking materials.” That expands the scope to non-tobacco smoking materials. The most costly type of damage I have had to remediate in my units was smoke residue. My realtor screens tenants, and we expand the scope of the no-smoking clause to the entire property, not just the interior of the building.
Month to Month or Tenancy At Will vs. a Lease
A 12-month real estate lease is not the only option afforded to landlords. There are other acceptable rental real estate agreement types that may add some flexibility to your management of the property. In my own business, I generally shift to a Tenancy At Will agreement. This is sometimes called a month-to-month rental agreement. The general idea is that a month-to-month agreement affords the landlord more flexibility, and it eliminates the need to lock in a tenant for 12 full months.
If you have difficulty understanding how a lease works consult with a local real estate attorney. Realtors can also be helpful in many cases but are not legal experts and their advice is only that, not a legal opinion.
If you are interested in learning more about the basics of the real estate rental property business, Mashvisor has the knowledge you seek. Joining is easy, and once you have the leasing basics down, you will find Mashvisor’s real estate investment tools are helpful time-savers. Particularly our Rental Property Investment Calculator. To get started with Mashvisor with a 15% discount right now, click here.