Key Elements of Residential Real Estate Leases You Should Include
Having a rental property is a great way to create passive income. However, with most investments you are exposed to risk. Most people think the biggest risk is ‘market’ risk and how the price of your property is affected by market conditions. That is certainly a big risk, but one risk that is often overlooked is what I will call ‘tenant risk’. There are many risks associated with renting to tenants and it is important to have a good lease in place to protect you and your property.
Below are 5 essential clauses you should consider including in your lease agreement.
Use of Premises: This clause lets the landlord limit what the tenants use the property for. Most renters think they can use the property for anything they want. Ask yourself, do you want them throwing large parties? Do you want them renting it on AirBNB? Do you want your renters running a business out of your property? Wait…does that create a new type of liability for me?
It is important to have the use of the premise clearly outlined in a contract so that you are covered.
Subletting: This clause outlines whether the tenant is allowed to sublet the property, or parts of it. If a landlord is OK with tenants subletting, it should define under what circumstances. Most landlords do some form of screening to make sure they have good tenants they trust with their asset. If you do not address subletting, that screening may become moot if your tenants decide to sublet the property to new tenants you have not screened.
Lease Renewal: This clause will create transparency on what happens when the lease is up for renewal. Will you plan to increase rent? Will they move to month-to-month? Renters like predictability.
Some clauses may include a pre-defined escalator in rent, such as an automatic increase after the first year by a certain percentage. Anywhere between 2%-5% is pretty standard.
The clause may also include information about a ‘notice’ period, which would require renters to let the landlord know if they plan to renew. This helps as it will give you time to plan to find tenants so there are no gaps in rental income.
Severability: This clause basically means that if one part of the lease is deemed to be illegal for any reason, the rest of the contract is still legally binding. This is a very important clause that is often overlooked. You do not want to be in a situation where your lease is not compliant with local rules, thus, your entire lease becomes void and invalid.
Joint and Several Liability: This clause means that each party of the lease is jointly and individually responsible for fulfilling the terms of the lease agreement. This becomes important when you are renting to multiple tenants on the same lease. If one of them defaults on the lease, it says the other tenants are responsible for fulfilling all lease obligations.
Property managers and landlords are encouraged to have great leases that protect your asset and interests. As we always say, if you have any question or need advice on real estate leases, please speak to a real estate lawyer!