What buyers and sellers need to know about their responsibility for the condition of vacant units.
By Bruce Buckley (MultiHousingNews.com Article) — The rent-ready apartment provision is one of many focal points within a purchase and sale agreement for the inherent conflict between the interests, incentives and expectations of the buyer and the seller. While the purchase and sale agreement remains in effect, the seller expects to be able to take a “business as usual” approach to the management and leasing of the apartments and has little incentive to expend money to fix up vacant units for the direct benefit of only the buyer. As of the closing, the buyer expects to acquire apartment units that are in leasable condition, capable of producing the rental income. The expectations of both parties as to what condition vacant units are to be in when delivered at closing need to be addressed in the details of a rent-ready provision.
A typical rent-ready provision requires vacant apartment units to be in rent-ready condition as of the closing, defines what “rent-ready” means, and imposes some cost on the seller for units that are not rent-ready. The provision may also require that vacant units that are not rent-ready are to be identified several days before the closing and may allow that units that become vacant near the closing date are not required to be put in rent-ready condition and do not result in a charge to the seller.
Of course, a rent-ready apartment provision may not be appropriate in every situation. A lender selling a troubled project that has been foreclosed on may expect the issue to be addressed already in the overall price rather than on the basis of vacant units. A buyer who has let it be known that it will make major renovations or that it will tear down the apartments to make way for another use may have lost its bargaining position on the issue. A seller with a great rent roll and long-term residents may not be willing even to consider it. A seller may argue that the sale of an apartment property is much like the sale of an ongoing business and tenant turnover and refurbishing vacant units are just normal, periodic property management matters that a buyer needs to budget for and account for in the purchase price, so those risks should not be allocated to the seller.
If the parties agree that a rent-ready apartment provision would help address their concerns about the condition of vacant units, then it should include details to cover these aspects:
The buyer will want all vacant apartment units put into rent-ready condition. Exception should be made for units that have been converted to other uses, such as a maintenance shop or storage (and the rent roll ought to be clear about what units are actually in service as leasable units). Office and commercial spaces, the management office, laundry rooms, recreation rooms, garages, and other non-residential spaces should also be excluded. Units that have suffered casualty damage should be excluded if repair of those (or credit for insurance proceeds and deductibles) is being addressed under the casualty provisions of the purchase and sale agreement. The condition of vacant units that are subject to a specific repair obligation or escrow arrangement (for example, if one building has particular structural issues that are to be addressed) should be covered by the repair completion requirements of that special arrangement and not by, or in addition to, a set charge under the general rent-ready provision.
The seller might propose that only a certain number of vacant units have to be in rent-ready condition because the seller, in accordance with its normal business practice, keeps only a few of each type of unit (studio, two-bedroom, three-bedroom, for example) in rent-ready condition. As long as there in a reasonable inventory of vacant rent-ready units to show prospective tenants and to lease out on the spot, it would not be a good use of funds for the seller (or the buyer when it becomes the owner) to refurbish immediately every vacated unit only to gather dust while waiting to be leased. It is also likely that in any apartment project there are certain units that are less desirable, perhaps due to street noise, location, layout, etc., and those would always be the last to be leased, so it may not be reasonable to require the seller to put them in rent-ready condition.
Units that become vacant within a few days prior to the closing are sometimes excluded from having to be put into rent-ready condition and from any charge to the seller for their condition because there is not enough time for the seller to prepare those units, so the buyer would bear that risk and cost.
At a minimum, “rent-ready” should mean in compliance with applicable governmental requirements so as to be suitable for immediate occupancy. That meaning could also refer in general to some of the basics, such as: housing code compliance; working alarms, appliances, mechanical systems and utility systems; functioning doors, locks and windows; floor coverings, walls and ceilings free of damage; and in a condition and state of repair that is typically expected or required by tenants upon delivery of possession of similar newly rented apartments.
It is reasonable to provide that the quality level of a refurbished unit match that of the general overall quality of the occupied apartment units in the property, consistent with the standard set-up for the comparable apartment type and consistent with the seller’s normal practice for turning over vacated units. The buyer should not expect to get totally brand new interior with more luxurious finishes than other units, but if the seller typically re-floors and re-carpets its vacated units, then the seller may be expected to have to do the same for the vacant units being delivered to the buyer. Repainting might also be stated as a requirement. If a dishwasher, for example, is standard in other similar units it should be provided, even if it is not legally required to make it a leasable unit. An even more detailed provision might specify that the appliances and other finishes need to match or be compatible as to style, color and overall décor, to keep the seller from throwing together a complete but mismatched interior.
The vacant units should be required to be thoroughly cleaned, but consider whether a stain on the floor, carpet or counter may be as clean as can be but still be unsightly and unacceptable. Also consider whether “clean” should mean “dust free” in case a perfectly fine refurbished unit has been sitting vacant for a long time.
Although difficult to draft with precision, it may be advisable to say something about how much repairing (patching, gluing, caulking, etc.) will in good faith be tolerated before an item (wood trim, bathroom tiles, linoleum floor, microwave door handle, etc.) needs to be replaced entirely.
The dollar amount of the charge to the seller for each vacant unit that is not in rent-ready condition is usually stated as a per unit amount, like a liquidated damages provision that is applicable regardless of how far from rent-ready a particular vacant unit may be. The buyer should rely on its experience and on the information and general feeling for apartment project gathered from its preliminary visits to the property in negotiating the amount, and the seller should know the general status of its inventory. It should be enough to be some incentive to get the seller to do what is needed and enough to cover some fair portion of the buyer’s cost if the seller does not perform. Of course, that amount is influenced by the terms the parties have used to describe what rent-ready means (new versus cleaned carpets; working versus matching appliances, etc.).
The charge to the seller is usually a relatively minimal amount, which would make the resolution of a disagreement on the condition of a specific unit more of a nuisance rather than a big economic hit to either party. The rent-ready provision is not intended as a substitute for the inspection and repair provisions of the purchase and sale agreement. If the buyer finds serious condition issues during its due diligence, the buyer should look to contractual provisions or negotiations for a remedy, such as a credit for major repairs, a renegotiation of the price, the threat of contract termination and the like, but the buyer should not expect to be made economically whole through operation of the rent-ready apartment provision.
The parties can negotiate a full-blown inspection and contractor estimate approach to address the condition of the vacant units, but that is not typical. They might consider a refinement of the set charge approach by allowing that if the refurbishment cost of any unit materially exceeds the set amount, a contractor estimate for the actual cost could be substituted. An approaching closing date could force provisions for selecting a contractor and reviewing and approving the estimate into a tight time crunch, however.
The rent-ready apartment provision is used to establish the expectations of the buyer and the seller about responsibility for the condition of vacant apartment units. While the details of the provision help address ambiguities and over-broad interpretations about what is expected, the good faith and reasonable business judgment of the parties will still have a role in keeping it from becoming an impediment to negotiating a purchase and sale agreement and completing a successful sale of an apartment property.
Bruce Buckley is a real estate attorney based in Womble Carlyle’s Charlotte, N.C., office where he represents real estate developers, lenders, tenants and businesses in commercial real estate transactions and issues involving commercial real estate development projects.