Breaking down a lease

Own some land and going to rent it out? Before you hand over the keys, make sure your tenants sign a lease. No matter how good a tenant looks, things can always go wrong.

"But how do I make a lease?", you ask. "This is why real estate is so much more complicated than stocks and why I'll never get into it. I'm not a lawyer you know!"

Not so fast my friend. While legal forms, such as a lease, can be intimidating, in the end they're just a list of things you agree to do and a list of things your tenant agrees to do. Usually that's wrapped up in a bunch of legal-ese, but it doesn't have to be. You can very easily make your own lease, or even get one from the web (google the phrase "residential lease" and you'll get tons of templates to use).

Now even if you pull a template off of the web, you need to review it carefully to make sure it covers everything that's important to you. Let's look at the anatomy of a lease and specifically cover the areas that are absolutely necessary to have included in your lease.

A lease consists of 4 basic parts. The first part dictates the specifics of the lease, the rent and dates and so on. The second part explains your rules for living in your house. The third part deals with how you and the tenant will interact, and the last part just deals with the document itself. Sometimes these parts are a bit jumbled up, but they are usually grouped together.

So the first part of the lease deals with the specifics. This is the part of the lease that you have to change every time you get a new tenant. In this part you have to explain:

• The length of the lease (also referred to as the Term)
• When the lease begins, when does it end?
• The rent owed. Most leases will give a total of the amount owed over the life of the lease, and then specify how it's to be paid (i.e. $X on the first of each month)
• Any money that is due up front, i.e. a security deposit or first and last month's rent. You should clearly state how and when they can get their deposit back (such as "after all deductions for damage have been taken out, the balance will be returned to the Tenant within 45 days of the end of the lease").
  

I want to take a quick second here to talk about security deposits. Virginia actually has an entire section of law just about how security deposits are to be handled. Every state is different, but I believe most states have similar laws in place, though the specifics may vary. In Virginia, for example, the maximum amount you can ask for a security deposit is equal to two months rent. And if a landlord holds a security deposit for more than 13 months, they have to pay interest on it when they return it. Please take a look through your state laws, or just try to find a FAQ that can answer those types of questions in your state.

Now that we've dealt with the specifics of when the lease takes place and how much the other person owes, it's time to talk about the most important part, protecting your assets. The next section of the lease should dictate the rules that you want to set down for your property, and while those rules can vary from investor to investor, a few rules should be in every lease.

• How many people can live in the house? This should be filled out before the lease is signed. How do you differentiate between a tenant and a guest? Trust me, you don't want the Cletus's moving in and then having their extended family move in with them.
• Subletting rules. Subletting is when a tenant decides to rent their lease to someone else. This can often happen in college towns when students will sublet their apartments over the summer. Do you allow it? Do you require approval before it's allowed?
• Can the tenants alter the house? Put up some new paint? Replace ceiling fans? Unless you chose a tenant because you want them to improve the property, it's probably best to prohibit alterations to the house.
• How are utilities to be treated? Will you cover them and wrap them into the rent? OR is the tenant supposed to take care of them (including setting them up)?
• What about pets? Allowed? Not allowed? Are hamsters ok, but a fish tank forbidden?
  

In addition to this you need to think through all the other rules as well. If there is a yard, who's responsibility is it to keep it clean? If there's a Home Owners Association, they need to be made aware of the rules. Any rules you can think of for how you want your property treated should be covered here.

In the next section we talk about the relationship between you and your tenant, and what happens if things go wrong. Hopefully nothing bad will happen (the worst Biff and I have put up with is our first tenant hanging animal heads on the walls), but if something goes south you will be extremely glad you wrote this part of the lease. Things to cover in here include:

• The property is in good condition before the tenants move in. This is important to state and have the tenant sign, in case they wreck the place they can't tell the judge "it was like that when I got here". This, by the way, should be accompanied by an inspection form that you fill out when you let the tenant into the property for the first time.
  
• Your access rights. As the owner of the property you have the right to inspect your investment. The tenant should do anything to bar you from areas of the property (such as changing locks).
• What if someone gets hurt on your property? You need to have a clause in there saying you are not liable (called "indemnification"). Of course if someone is injured due to your negligence (you never got around to fixing those old stairs until the collapsed) the judge will throw this clause out, but if someone trips and falls down the stairs by their own stupidity, this will assist your defense.
• If the rent is late, what next? Do you impose a late charge?
• What if either you or the tenant want to break the lease (maybe you have a buyer who is very interested)? How is that situation to be handled?
• Let's say the lease ends and the tenants moves out, what happens to thing the tenant leaves behind? Include a clause that explains that you have the right to treat such things as "abandoned" and can dispose of them as you wish (even in auction).
• When the lease is over, then what? Does it continue on in a month-to-month fashion? You definitely need a clause that states you expect the property to be in as good of shape as when the lease began (excluding wear and tear, of course).
  

A few more things to note in this section. I also have a clause in my lease that says the tenants must leave notice to us if they will be away from more than 7 days, so Biff can keep an eye on the property. As for early termination, if you believe the military will make a reasonable portion of your tenants you should be aware of a federal law that allows soldiers to break a lease penalty-free if they are being shipped out or reassigned. They have to provide you with a copy of the written orders to do so.

Finally the last section of the lease is simply the rules about how the lease itself should be treated. Weird, huh? Yet every lease should mention:

• The fact that this is a binding document. You might get away without having it, but it certainly can't hurt and helps diffuse any possible "ignorance" defenses.
• That the lease cannot be modified by either party without all parties signing the new amendment.
• Severability. This is a fancy legal word that means if some part of this lease is invalid for some reason (like a judge throwing out you no-liability clause) the rest of the document is still considered valid, instead of the entire document just getting thrown out.

Congratulations. You've just written a lease. Now at the bottom make sure you have room for both you and the tenants to sign and date the document. With this document in hand, you are ready to protect both your property and yourself.