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Rental Property in Foreclosure - Now What?

The Rental Property is in Foreclosure. The Tenants Know. What is a Landlord or Property Manager to Do?

By John Nuzzolese

In today's turbulent economy with foreclosures nationwide, more landlords and property managers are sharing a once uncommon experience: Foreclosures. Today, foreclosures are everywhere you look. Many of the properties in trouble happen to be rentals, some under property management contracts. Let's take a look at the situations faced by private landlords and property managers hired as an agent of the owner.

Private Landlords

Picture this: The tenant is home thinking about making his next rent payment early. A knock on the door interrupts his thoughts only to be told by a bank representative that "the house in in foreclosure. Your landlord is not making his payments. You'd better start paying us directly or we will EVICT YOU!" Unfortunately many banks say even worse things to the tenants to scare them. This creates havoc for the landlord who is very likely trying desperately to find a way out of foreclosure.

How do you handle the tenant when he finds out the home he is renting is in foreclosure? If possible, nip the problem in the bud, before the tenant decides this is an opportunity to stop paying rent.

When you buy bread, do you ask the supermarket if they paid their bread bill?
Why then, does the tenant think he is entitled to FREE RENT when the landlord is behind with the bank?

Nipping the problem in the bud: If you know up to 3 months or more before the tenant that you can not make your mortgage payments, the best thing for you to do is prepare the tenant to be your ally. Get the tenant on your side. You can let him know you are "in the process of renegotiating the terms of your mortgage", (which you should be doing) and that there is a "slight possibility that the bank may try to "play hardball" and start foreclosure proceedings". Most banks will not negotiate terms with you UNLESS you are already in foreclosure! Imagine that! You try to talk to your bank and work things out BEFORE your account becomes delinquent - and they won't discuss it until you are in foreclosure! What's with these banks? Does it take a total collapse of the economy to make them start working with people???
Tell the tenant, "If you are visited by a bank representative, please let me know right away. Don't let them try to scare you with any of their unethical tactics. They should be talking to ME, NOT YOU." The cooperation of your tenant in this situation is extremely important!

They figure, "if the landlord's not paying the mortgage, why should I pay the rent?"

When it is too late to nip it in the bud: The tenant already found out you are in foreclosure! Many tenants see this as an opportunity to not pay rent. In this case, it is very important to take the bull by the horns and still try to "nip it in the bud." Explain that you are working with the bank and this is "standard bank procedure" for when mortgage payments are withheld. Let the tenant know you are trying to resolve the matter. You can be honest and tell them the worst case scenario actually could be foreclosure, but if that becomes the case, these proceedings take time and you will still be able to honor the term your lease agreement. If the tenant is difficult, warn him that it would be a shame if he stops paying the rent and has to be evicted.

Property Managers

I've been asked by property managers, what recourse there is against their client in the event an owner of a property falls into foreclosure. There's not a lot you can do besides sue the owner for breach of contract, if in fact they do lose the property, and your contract provides terms prohibiting the owner from losing the property. Most managers know it's probably a dead end and a waste of time to pursue, especially if the owner is also going bankrupt. Also, keep in mind that your management contract may not have been violated until the owner actually loses the property. You still get to collect your management fee as long as your client owns the property. Foreclosures can sometimes take a long time. It's very possible that your management contract could expire before the foreclosure comes to a conclusion.

"It's Not Over Till It's Over." - Owner's redemption rights
The management contract can forbid the owner from falling into foreclosure, but if he's going to fall behind on his payments, the manager may have to choose between two options:

keep doing his job until the last month the owner owns the house, collect rent and management fees and hope the owner will save the property, or

terminate the breached contract and involvement with the tenants and stop collecting rent and management fees.

Private Landlords and Property Managers

The tenants are contractually required to honor the lease and pay the rent for every month they are there. Even if the owner defaults on his mortgage with the bank,
a) he still retains the right to to redeem himself all the way up until after the foreclosure sale itself.
b) he still retains the right to evict the tenants if they fail to pay rent up until the property is transferred in the foreclosure.

As the LPA Lease says,

WITHHOLDING RENT Under no circumstances may any rent be withheld in full or in part, regardless of any expenses incurred by Tenant, regardless of the financial status of the premises, or the legality of the premises. Rent must be paid to Owner or Owner's agent only. Non-payment or payment to any other party is a violation of this Lease Agreement and cause for immediate eviction.

Existing tenants need to be aware of this fact and should not be allowed to see the owner's financial status as an opportunity for Free Rent. It is a good way for them to ruin their credit and be evicted. The banks also can take quite a while to evict an existing tenant after a foreclosure. In many cases they'd prefer the tenants to stay until the home is sold. During all or part of that time, the tenant has the opportunity to benefit from low or no rent, which will make up financially for the inconvenience of the foreclosure.

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