Authored By: Ryan A. Featherstone, Esq. rfeatherstone@dunlapmoran.com
In this current crazy market a very hot topic is leaseback agreements where sellers lease back their properties from their buyers after closing. This appears to be happening mostly because sellers are, understandably, rushing to sell at the height of the market, but are doing so in many cases without any real relocation plan. They are finding the purchase market or rental market is very competitive, leaving them with a serious challenge as to where to go after closing.
A short-term solution for this coming up on a regular basis is the leaseback. But these deals can be fraught with problems. The following presents some of the more commonly overlooked pitfalls that can arise in a leaseback situation.
1) The Post-Closing Occupancy Rider: this is the document typically used when this topic arises while negotiating the contract. We often find that the parties to the transaction believe that this itself is the leaseback agreement. In fact, this document is only a contingency, providing that a further agreement must be drafted and mutually agreed to by the parties no less than 10 days prior to closing, otherwise either party can cancel the transaction by written notice. Therefore, this can actually be dangerous if the leaseback agreement isn’t timely drafted and agreed to, as it could result in a cancelled closing. Furthermore, this document only provides for two of the terms of the leaseback agreement, its length, and the rental amount. That’s it. It doesn’t provide for any of the other essential terms, which will be addressed in the next section.
2) The Leaseback Agreement: the rider discussed above only provides for the length of the leaseback and the rental amount, and that’s if those sections are even filled in, and we often find that these are left blank. A leaseback agreement is a short term lease, and as such, should contain all material terms of a standard lease. Namely, length, rental amount, security deposit, utilities responsibility, maintenance and repair responsibility, services responsibility (e.g. pool, lawn, pest), HOA or condo dues responsibility, rental insurance, pet restrictions, risk of loss, extension options, and hold harmless indemnification, among other topics. Most times, none of these items have been discussed or even considered for discussion, which can lead to disagreements later.
3) Lender Restrictions: this particular issue is coming up more and more often and lending underwriters are getting ever more strict on this topic due to the prevalence of leasebacks in this current market. Any primary residence loans that need to meet Fannie Mae, Freddie Mac or FHA underwriting guidelines will mandate that the buyer occupy/possess the property within 60 days of closing. Thus any leaseback term cannot exceed this timeframe, including any extensions. This is a hard-and-fast rule, however it must be noted that some lenders have “overlays” that might limit the term further, to as little as 45 or 30 days. It’s is very important to determine the buyer’s chosen lender’s leaseback term restrictions before going under contract. A note about second homes: while the concept of extending beyond 60 days may not itself violate a rule, from a practical perspective, any leaseback longer than that will likely involve a rent payment obligation and this will violate underwriting rules as that will result in the leaseback making the property into an “income-producing” property which won’t be allowed by underwriting. We have had many deals lately involving leaseback periods of 90 days or longer, which has been very problematic as the sellers in such situations absolutely could not get out within 60 days. This has caused disputes amongst the parties or expensive consequences, like delaying closing for a period of time to allow the 60 day restriction to be met, resulting in costly mortgage rate lock extensions and attorney’s fees for resolving the disputes.
4) Sales Tax: Florida law provides that any lease period of less than 6 months is subject to sales tax and “tourist development tax” based off the rental amount. This is at the state level (6% sales tax) and the local level [depends on county (Sarasota and Manatee County = 1% sales tax)] plus the tourist development tax [also depends on the county (Sarasota and Manatee = 5%)]. Taken together this is 12% or higher! Additionally, this must be remitted appropriately to both the state and county and the paperwork to register as a taxpayer and remit is fairly complicated.
5) Landlord-Tenant Law and Covid-19: regardless of what you call the arrangement or title the agreement itself, it is a lease, and will be subject to Florida landlord-tenant law. Thus, any rules that apply, like eviction legal procedures, will apply to the leaseback. If the seller refuses to vacate at the end of the leaseback term, the only remedy available to the buyer is eviction. Evictions can be costly and time consuming and can be directly impacted by federal, state or local Covid related moratoriums.
Leasebacks can be a good solution in this current climate, but as often occurs, the “simple” solution ends up being much more complicated than anyone expected. It is essential you keep these issues in mind when negotiating a contract that is to be subject to a leaseback. Any time you are involved in a transaction where the parties are negotiating a leaseback agreement, be sure to contact a Florida licensed real estate attorney to assist.
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