Leasing out your home to a renter during the short sale negotiation process is fraught with risks for the homeowner, lender and renter. The homeowner and renter risk the lease agreement being declared void by a judge. The lender risks the lease agreement being declared valid by a judge. It is a way, however, that the homeowner can earn a monthly payment from the home, a much needed benefit, since his home will ultimatley cost him dearly.
THE HOMEOWNER SHOULD DISCLOSE HER INTENTIONS TO THE LENDER
If the homeowner decides to lease out the home during short sale negotiations, all documents related to the lease should be disclosed before, during and after the execution of the lease. Once the lender becomes aware of the homeowner’s intent, the lender must choose between a) accepting the short sale and waiving the deficiency judgment, or b) rejecting the short sale, foreclosing and geting stuck honoring a long-term lease.
If the lender rejects the short sale and chooses foreclosure, it will get stuck with a tenant, or at least having to be the landlord to a valid lease. TITLE VII–PROTECTING TENANTS AT FORECLOSURE ACT SENATE BILL 896 requires the new owner (bank) to honor the existing lease, unless the new owner will live in the home. If the new owner will live in the home, the new owner must provide a 90 day notice.
THE LEASE MUST BE PROVEN TO BE BONAFIED
After the lender forecloses and takes title to the house, it must then chooose between a) honoring the lease pursuant to federal law, b) challenging the lease in court as invalid, or c) paying off the renter to get out of the lease.
A lease will be considered bonafide, and valid if it was executed before the “foreclosure notice” and:
(1) the mortgagor or the child, spouse, or parent of the mortgagor under the contract is not the tenant;
(2) the lease or tenancy was the result of an arms-length transaction; and
(3) the lease or tenancy requires the receipt of rent that is not substantially less than fair market rent for the property or the unit’s rent is reduced or subsidized due to a Federal, State, or local subsidy.
The lender will try to get out of the lease by arguing that the lease was entered into after the foreclosure notice; the homeowner and renter were in collusion; and the monthly rental rate is below market.
PROVING THE LEASE RESULTED FROM AN ARMS LENGTH TRANSACTION REQUIRES PROVING THE PARTIES WERE NOT IN COLLUSION
The arm’s length principle (ALP) is used specifically in contract law to arrange an equitable agreement that will stand up to legal scrutiny, even though the parties may have shared interests (e.g., employer-employee) or are too closely related to be seen as completely independent (e.g., the parties have familial ties).
A simple example is the sale of real property from parents to children. The parents might wish to sell the property to their children at a price below market value, but such a transaction might later be classified by a court as a gift rather than a bonafide sale, which could have tax and other legal consequences.
To avoid such a classification, the parties need to show that the transaction was conducted no differently than it would have been for an arbitrary third party. This can be done, for example, by hiring a disinterested third party such as an appraiser or broker, who can offer a professional opinion that the sale price is appropriate and reflects the true value of the property.
EXPERT TESTIMONY CAN BE USED TO PROVE THE RENT IS AT MARKET RATE
The lender’s defense that the rent is below market rate can readily be defeated through testimony from a seasoned Las Vegas real estate appraiser stating that the market rate for renting a home that is in default is 10% (or whatever deep discount) of renting the same house out prior to default. Who wants to enter into a long-term lease if the house is on the verge of a foreclosure sale? As long as the lease agreement specifically calls for “market rate” or even a few hundred dollars a month, it should easily defeat the not at market rate defense.
PROVING THE LEASE WAS EXECUTED BEFORE FORECLOSURE REQUIRES ESTABLISHING THE DATE FORECLOSURE BEGAN
The defense that the lease is invalid because it was entered into “after foreclosure” is up for debate. Technically speaking the homeowner will argue, foreclosure begins after title is transferred, not after the Notice of Default was mailed, which is what the lender will argue. The date when foreclosure actually begins has not been adjudicated in Nevada as it applies to the law here. Like most cases, the judge will have to make a ruling after hearing from both sides. This issue has not been settled by the courts.
SOME STATES HAVE EXISTING LAWS THAT CAN BE USED AS GUIDELINES TO DETERMINE IF A LEASE IS BONAFIED
There are several elements which are used in other state jurisdictions as considerations to validate a lease document and demonstrate the parties’ intent. These elements may or may not be considered by Nevada judges. Those elements include:
1) the length of the lease, including the beginning and ending date;
2) a statement giving the lessor the complete and exclusive use of the property for the entire duration of the lease;
3) execution in good faith, without deceit or fraud;
4) a sufficient description of the leased property;
5) a statement that the lease contains the complete and sole agreement;
6) a provision that the lessee will pay an agreed amount of rent; and
7) a statement containing the due date, frequency and address for payment of the rent.
If the judge validates the lease, the renter can live in the house for the term of the lease. If the judge invalidates the lease, the renter moves out and having learned a lesson, tries it again, under different terms, with hope that the judge will approve the lease next time.