Would An Investor Have To Assume An Option To Purchase Clause On Existing Lease After A Purchase At A Trustee's Sale?
Posted by: Kenny Tan
September 17, 2011
Topic: Foreclosure
The Protecting Tenants After Foreclosure Act of 2009 has been around for a couple of years. Its purpose is to protect innocent tenants who pay their rent to landlords who had their properties foreclosed on while they the tenants are still occupying the premises.
Before this law was passed, many tenants were evicted by the new owners as a result of the foreclosure of the properties they're renting.
However, until the Protecting Tenants After Foreclosure Act sunsets, there's presently some - but not absolute - protection from eviction for the innocent tenants.
Assuming the tenancy is "bona fide", the new owner would have to honor it with two exceptions, i.e. he's planning to occupy the property as his primary residence or he has found a bona fide buyer to buy the property. If either exception applies, the tenants can be evicted with a 90-day prior notice.
But to what extent must the new successor owner honor the existing lease? I don't think the Act covers this issue very well. Granted it was the result of an emergency bill to address an urgent situation. So it was probably not well thought through.
Some residential leases provide for right of first refusal or option to purchase. What happens to these provisions after the property has been foreclosed on?
Stating the Act in paraphrase, it basically says the successor owner shall assume any bona fide lease until the remaining term of the lease. So the successor owner literally must honor the entire lease. What if you're an investor who's stuck with this property because either you're not occupying the property as your primary residence or you can't find a bona fide buyer for the price you want, and the lease provides for an option to the tenant to purchase it at the fair market rent less an agreed-upon discount which is more than your profit margin. Suddenly the tenant gives you notice to exercise the option, then what do you do?
Would a right of first refusal clause hamper your ability to sell the property to a bona fide buyer? It could and here's why.
Most right of first refusal clause requires the landlords to give the first priority to the tenants to buy the property on whatever terms the lease provides. Sometimes it gives the tenants the right to have a discount off of the fair market price. In a declining market, or for that matter any market, this means a reduction in the profit margin for the investor.
Having a right of first refusal clause may also mean that you can't even utilize the second exception, i.e. you've entered into a purchase contract with a bona fide buyer, because you're not supposed to do that until the tenant has chosen not to exercise his right of first refusal.
When that happens, you might as well forget about flipping the property and use the proceeds for the next investment. You might be stuck with this lease for a long time especially if it also contains successive options to renew. However, being a landlord in this market may not be too bad unless you're stuck with a lease that fixes the rent for a long period of time. This rent may be the fair market rent at the time the lease was entered but it may be below as the rental market has been hot the last several years due to a higher demand from the people who have been dislodged from their homes due to foreclosure.
About The Author: Kenny Tan is a real estate attorney practicing in the State of Caifornia with offices in both Northern and Southern California. He follows new development in foreclosure closely and regularly write blogs on interesting and seemingly unresolved issues in foreclosure
