How to Buy a Commercial Property with Sitting Tenants02-02-2024 | Legal Issues
Investing in commercial property can be a lucrative venture, and acquiring a property with established occupants can offer immediate income and result in reduced vacancy risks. However, navigating this territory requires careful consideration and a clear understanding of the process involved. Here, we take a look at what buying a commercial property with sitting tenants encompasses.
What are sitting tenants?
Before delving into the purchase of a commercial property with sitting tenants, let’s explain exactly what sitting tenants are. Sitting tenants are individuals or businesses already occupying the property with a legal right to continue their tenancy even after the property changes ownership.
Their lease agreements or tenancy contracts remain valid, and the new owner inherits these arrangements upon acquisition of the property.
Conducting research and due diligence on commercial property with sitting tenants
Buying a commercial property with sitting tenants comes with its own set of risks, which is why conducting due diligence is imperative before any purchase takes place.
Conducting due diligence ensures that all legal regulations are understood and followed. Research also helps in understanding the financial aspects of the property, such as valuation, potential rental income, and operating costs. This is crucial for determining the property’s profitability and the return on investment that you would potentially gain.
It’s also important to understand the environmental factors that could potentially affect the property such as flood risks, contamination, or asbestos presence. Environmental hazards can have tremendous financial and legal implications.
Take the time to understand the local property market, including demand and supply dynamics, average rental yields, and future development plans in the area. Becoming familiar with all of this helps in making an informed investment decision.
As the property has sitting tenants, you need to understand the leasing agreement that has been drawn up, along with assessing the stability of the current tenants. Are they willing to stay in the property long-term? Or are they looking to end their tenancy agreement due to the change in ownership?
Equally, by verifying the legal title, you will ensure that the seller has the right to sell the property and that there are no outstanding disputes or encumbrances on the property. Understanding the tax implications, including stamp duty land tax and capital gains tax is vital for financial planning.
Buying a commercial property with sitting tenants is more complex than buying an empty one. Naturally, you wouldn’t have any say in the tenants that you inherit with the property and if tenants are unreliable with their payments this can be detrimental to the stability of your monthly income.
Buying a property with sitting tenants also means that you have no control over the condition of the property, and if any repairs need to be made, you would be liable. Equally, by taking on the property you would need to accept the leasing agreement as is, meaning that you accept any agreements around repairs, rent reviews and lease renewals.
Further to this, you may need to take on the responsibility of holding tenant deposits, which requires compliance with legal requirements for deposit protection. On the other hand, there is also always the possibility that tenants won’t renew their leases due to the new ownership of the property. As a result of this, you may find yourself in periods of tenant vacancy which will have an impact on your income.
Once you have taken the time to consider the risks involved with buying a commercial property with sitting tenants, you can start the process of actually purchasing your preferred property.
Identify potential properties
Start by identifying commercial properties with sitting tenants that match your investment criteria. Consider the property type, location, tenant stability, lease terms, and potential for rental growth.
Review lease agreements
Scrutinise existing lease contracts thoroughly. Understand the terms, including rental rates, lease duration, rights and responsibilities of both the tenants and a landlord, along with any clauses regarding rent reviews or lease extensions.
Assess tenant stability
Next, evaluate the tenant’s financial stability and business prospects. Understanding their industry, longevity, and stability can help assess the reliability of rental income.
Which legal and financial aspects should you consider?
Once you have conducted your research and have carried out your due diligence, you need to consider the legal and financial aspects.
- Rental income: evaluate the current rental income and how it currently aligns with market rates.
- Lease duration: take into account the current length of the existing lease and how this will affect your income stability.
- Maintenance and repairs: continue to assess the ongoing and potential future costs involved in maintenance and repairs.
- Tenant solvency: ensure that your tenants are financially stable enough to pay rent so that you have access to consistent rental income.
- Rental yield: conduct research on the rental yield of the property and compare it with other investment opportunities.
- Mortgage terms: make sure that you are fully aware of the terms and conditions put in place to finance the purchase of the property, including interest rates and loan durations.
- Tax implications: make sure that you are aware of how property taxes, stamp duty and potential capital gains tax work.
Commercial insurance costs: take the time to figure out the costs involved with commercial landlord insurance.
- Lease agreements: make sure that you review and understand the conditions of existing leases including rent review clauses, lease length, and termination rights.
- Tenant rights: understand the legal rights of tenants, especially regarding eviction and lease renewals.
- Compliance with regulations: ensure compliance with health and safety standards, building regulations, and other legal requirements.
- Title and ownership verification: verify that the property title is clear and the seller has the legal right to sell.
- Environmental assessments: conduct or review environmental assessments for issues like contamination or asbestos.
- Planning permissions: confirm that the property complies with local planning permissions and zoning laws.
- Dispute and litigation history: check for any past or ongoing disputes or litigations involving the property.
- Transfer of deposit responsibilities: understand the process and legalities of transferring tenant deposits.
How to negotiate before purchase
The third step in buying a commercial property with sitting tenants is to negotiate your terms and then proceed with the purchase once you are happy.
Once satisfied with your due diligence, you can begin negotiations with the seller. Discuss terms that accommodate the existing tenants, ensuring a smooth transition of ownership without disrupting their occupancy rights.
These terms can include lease duration, the rent amount and review clauses, options for the renewal of the lease for tenants, repair and maintenance obligations, termination clauses, and what the property will be used for. This is not an exhaustive list, however.
Taking on a property with sitting tenants needs to be a collaborative process. Tenants will be used to the previous owner’s terms, but you may want to change how you manage the property. This is normal as not everyone manages people in the same way.
However, maintaining a balance between the way these terms have been implemented versus how you want to implement them as the new owner is just as important. By being clear about your expectations as the new owner, but also taking into consideration what tenants have been used to previously, you will create a collaborative working relationship with your tenants.
Purchase agreement and completion
Draft a purchase agreement considering the transfer of existing leases and tenant rights. Ensure all legalities are covered before completing the transaction.
Managing your commercial property with sitting tenants
This is the final stage of buying your commercial property with sitting tenants, where most of the property management will start to take place. You may want to allow your tenants to voice any concerns they may have or ask you any questions regarding the new ownership.
Communicate with your tenants
It’s a good idea to introduce yourself to your tenants as their new landlord and clarify any changes, if any, in the management process. This will help you in the long run and will ease any concerns that the tenants may naturally have with the change of ownership.
Keeping communication open and transparent between yourself and your tenants is crucial in implementing a collaborative working relationship. Establish an open line of communication with your tenants. For example, you can give them a specific time at which they can call you for any urgent issues and an email address where they can contact you.
Further to this, give your tenants regular updates on anything that may be changing and listen to any concerns they may bring to your attention. Be clear and consistent in your communication with your tenants to ensure there is no confusion.
Maintaining the property
Keeping the property in good condition will help to ensure tenant satisfaction and in the long run, retention. For example, landlords are usually responsible for any structural repairs such as roof repairs, external walls, the foundation, and structural beams.
Additionally, landlords are usually responsible for any exterior maintenance such as gutters, exterior walls or windows. Common areas, such as hallways, parking lots and external lighting also fall under the responsibility of you as the landlord, as well as major systems such as the heating, ventilation and air conditioning.
Equally, however, some repairs may become the responsibility of the tenants. Any damages caused by tenants due to negligence or misuse will need to be fixed by them directly. Tenants are also equally responsible for internal repairs, such as plumbing and electrical repairs. Tenants are also responsible for business-specific installations, decorations and some utility repairs.
Buying commercial property with sitting tenants can be a strategic investment. However, it requires meticulous research, legal understanding, and financial planning. Engage with professionals, conduct thorough due diligence, and prioritise tenant relationships to navigate this investment avenue successfully.
As with any property investment, risks exist, and market conditions may fluctuate. But armed with knowledge and guidance, purchasing a commercial property with sitting tenants can be a rewarding and stable addition to your investment portfolio.
A part of managing your new commercial property is taking out commercial landlord insurance. More risks come with buying a commercial property and as such, things such as storms, floods, fire and property owners liability are covered.
Contact CIA Commercial today to speak to our experts about taking out commercial landlord insurance by contacting us on 01788 818 733
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