Just When You Thought It Was Safe To Go Back Into The Real Estate Market: Congress Amends Obama Tenant Protection Law To Hurt Real Estate Investment

Remember the trumpeted financial reform bill that Congress passed in late July? You know the one, the new round of regulations that would abolish greed, protect us from Wall Street, the slap-on-the-wrist political payback for the bailouts, the kind of major legislation that results in hours of cable news face time for politicians standing in front of too many flags.

Not noticed among all of the pomp surrounding the law’s passage was a small provision within it pertaining to, oddly enough, state landlord-tenant law. Congress must have calculated that, while it was burdening even the most honest financial institutions with new regulations, it would be “germane” to take a shot at the real estate investor as well.

Whether the “financial reform” law delivers on all the windy promises or, more likely, is just another set of expensive regulatory and compliance headaches for law abiding firms that didn’t get bailout money, will have to await a future article. Tucked away inside the bill, however, and germane to this article, was an amendment to President Obama’s Protecting Tenants At Foreclosure Act.

If you read my June 15, 2010 post, I wrote about the Act at length. One of my criticisms was that the Act failed to define “Notice of Foreclosure”, a critical term for deciding whether a real estate investor at foreclosure purchased a tenant-occupied property subject to the tenant’s existing term lease. Prior to the Obama law, the answer was nearly always “no”, the new investor bought the property free and clear of all junior encumbrances, including leases, which were extinguished by the foreclosure sale.

Thus, the new investor knew when bidding that he could buy a tenant-occupied property and “flip” it, i.e. fix it up and offer a renovated and vacant property to the market in short order. Because “flippers” sell their properties at fire sale prices, the new family coming in could often times obtain the property with equity already in it. It is from this process of fresh investment and profitable transactions that the real estate market digs itself out of a recessionary hole with the resulting appreciation in values being a tide that lifts everyone’s boat.

Under pre-Obama law, the new investor had no reason to be concerned about tenant occupancy because he knew that the foreclosure sale wiped out the lease. Obama’s blow-hard Protecting Tenants At Foreclosure Act changed that. Now, a real estate investor buys at foreclosure subject to any existing term lease. (All other leases require a needlessly long 90-day notice to terminate).

Thus, if a tenant has a term lease with ten months remaining on it at the time of foreclosure, the tenant gets to stay for that ten months even if the lease came after the deed of trust foreclosed upon. In other words, the real estate investor is stuck. He has no way of knowing prior to the foreclosure sale whether the tenant has a month-to-month lease requiring a 90-day notice to terminate or a term lease with God knows how much time left on it.

The result is that investors will pass on tenant-occupied properties leaving the bank to credit bid and add to its glut of inventory of foreclosed properties or investors will lower their bids to take into account the investment uncertainty. Either way, the law’s result is the same, it slows recovery by either keeping fresh money out of the foreclosure process or it contributes to downward pressure on the real estate market because foreclosed properties will not realize their full bid potential. The law was completely unnecessary-and nothing more than political window dressing and pandering to the more numerous tenant voter-because existing state law already adequately protected the rights of tenants. 

Back to the language of the Obama law. Whether a term lease survived foreclosure depended upon whether it was entered into before “Notice of the Foreclosure”. However, Congress failed to define “Notice of Foreclosure” in the original text of the law. Congress fixed-for lack of a better word-that problem in the financial reform bill on July 21, 2010.

The term “Notice of Foreclosure” was critical to the law’s reach. If Congress defined “Notice of Foreclosure” to mean earlier in the foreclosure process, i.e. closer to the underlying default by the prior property owner, such definition would better serve the real estate investor since it would mean that fewer term leases would qualify and, as to those that did, less time would remain on them after foreclosure.

If, however, Congress defined “Notice of Foreclosure” further out, say closer to the actual foreclosure sale, such definition would be better for tenants because it would bring more term leases within the ambit of the law and such leases would likely have more time left on them after the foreclosure.

Would anyone like to guess which option Congress and the President chose? You guessed it. Congress chose the latter, determining in the fictional world of politics that the tenant does not get “Notice of Foreclosure” until the moment of the actual foreclosure sale.

In reality, the tenant knows about the foreclosure months before the sale. Also, the tenant doesn’t get notice of the foreclosure at the time of the property’s auction since the tenant isn’t present for it. Thus, Congress chose to define “Notice of Foreclosure” at the very instant in time where the tenant doesn’t get notice of the foreclosure. Since the law was political from its inception, however, it shouldn’t be surprising that logic and fact as considerations finished dead last in its wording. The effect of the Notice of Foreclosure definition is that any term lease entered into before the moment that the trustee bangs his gavel is enforceable against the new investor and the property is burdened with it.

Congress didn’t bother to clarify the more looming ambiguity in the law, namely, whether the tenant with a month-to-month lease must pay rent during the 90-day notice period required to terminate his tenancy. Since the law is a political sop for the tenant voter base, it follows that the law won’t even pretend to be fair to real estate investors. After all, Congress and the President instructing tenants to pay rent would ruin the political ambitions of the Obama law.

 

 

Tenancy After Foreclosure: Obama “Tenant Protection Law” Obscures Previously Clear California State Law And Gives Rise To Tenant Scams

Aaah, the good ‘ol days, back when in 2008.  Life was so much simpler then.  When an investor purchased real estate after foreclosure in California, the trustee conveyed clear title to the new owner.  All junior liens, including junior leases, were wiped out.  If the property had a tenant, no worries, the new owner need only give a 3-day notice if the tenant was the prior owner; a 30-day notice if the tenant was a third party. 

     Planning was easy; so was turning around a dead property and putting it back on-the-market, ready for a new family, occupied, useful and socially beneficial again, typically at a windfall savings to the new homeowner.   In July 2008, the California legislature, with our Governator’s consent, increased the 30-day tenant notice period to 60 days, not a great piece of news for the much-needed California real estate investor but at least the new law was clear and the investor could still plan. 

     And then came Barack.

     In a major federal intrusion into long-settled, clear, and fair California state law, Obama and the democratically-controlled Congress passed the beneficently-titled “Protecting Tenants At Foreclosure Act” signed into law by President Obama on May 20, 2009.  As with many of the grandiosely named federal laws, this one too has a truth in labeling problem. 

     The Act doesn’t “protect” tenants in California so much as it delays the rehabilitation of foreclosed properties and the offer of those properties to new families at discounted prices, increases the cost and uncertainty of real estate investment in tenant-occupied properties in California, and increases the amount of  deficiencies to be born by the lender in foreclosure since new investors price into their bids the inevitable delay and uncertainty that Obama’s law creates.  More troubling, the Obama law has given rise to tenant scams wherein tenants seek to extort huge sums of money from the new investor in exchange for leaving.     

     How has the Obama law created such uncertainty and havoc? 

     It’s very simple.  Recall that under pre-Obama state law, the junior lease held by the tenant was extinguished by the foreclosure sale.  In nearly all foreclosure cases, the tenant’s lease was junior to the foreclosed deed of trust because it either came after that deed of trust or because the lease contained a subordination clause.  Thus, the new investor bidding at foreclosure could do so knowing that he would receive absolutely clear title to the property and that any tenant residing there could be evicted on either a 3-day or 30-day notice (later increased to 60 days), depending upon whether the tenant was the prior owner. 

     The critical change to California legal prerogatives that Mr. Obama’s federal law made is that now new investors purchase at foreclosure “subject to” any existing term lease.  In other words, the tenant’s leasehold is no longer wiped out at the foreclosure sale.  If the lease is month-to-month, the new owner must give the tenant a 90-day notice, a period thirty days greater than what California state law currently provides.  

     From a policy standpoint, this hastily prepared law makes little sense.  The real estate market won’t recover until it first hits bottom.  It is the real estate investor, the “flipper”, who will determine the bottom of the real estate market.  For the benefit of all homeowners, the law should be making the process easy for flippers to turn these foreclosed properties around.  Instead, the federal government has chosen to make the process for investors less certain, more costly, and more time consuming.  Additionally, the Obama law was an unnecessary incursion into state law since California’s 60-day notice statute already adequately protected the rights of tenants.

     As if waiting 90 days-an eternity in real estate time-to terminate a tenancy weren’t bad enough, the law gets worse.  The Obama law also permits term-lease tenants to stay for the duration of their term, even where the remaining term exceeds 90 days.  The upshot?  A real estate investor in a tenant-occupied property in California has no idea going in how long it will take to offer to the market a vacant property. 

     But don’t worry investors, our president had your concerns in mind when he signed the law.   In a gesture of presidential even-handedness, Mr. Obama limited the scope of the law to only “bona fide tenancies” and “bona fide leases”.  Under the law, a bona fide tenant is one who a)  is not the prior owner or the child, spouse, or parent of the prior owner,  b) the lease was the result of an arms length transaction, and  c) the lease requires rent “not substantially less than fair market rent”.  The law fails to define “not substantially less than fair market rent.”      

     For the tenant to stay the duration of his term lease, the lease must also have been signed “before the notice of foreclosure”.  The Obama law does not define what is meant by “before the notice of foreclosure.”  Does that term mean before the tenant’s or the owner’s actual notice of . . .  what?  Default?  Notice of Sale?  What about the cases where the foreclosure sale was postponed?  Is the time of “notice” the date of the original sale or the postponed date?  Is the prior owner’s power to lease tied to his right of redemption?  Since the law doesn’t specify, it is virtually impossible for the new owner to know whether the tenant signed his term lease “before notice of the foreclosure” or afterwards. 

     In order for the new owner to learn whether the Obama law requires a 90-day notice or permits the tenant to stay for the balance of a term lease, the investor will have to sleuth out facts about the lease and tenancy, all of which will have to be voluntarily disclosed by the tenant.   For example, the new owner will have to learn who the tenant is and whether the tenant is related to the prior owner.  The new owner must obtain the tenant’s lease so that he can determine at what point during the foreclosure process the lease was entered into, whether the rent is “not substantially below fair market rent”, and, most importantly, what term remains on the lease.  The foregoing facts were irrelevant under state law but are now central issues due to the Obama federal law. 

     In practical terms, what is the problem?  Where President Obama and his fellow utopians saw an opportunity for reform, tenants saw an opportunity for profit.  Tenants and foreclosed property owners (particularly when the tenant and prior owner had a pre-existing personal relationship) have colluded to enter into long term leases near the time of foreclosure thus tying the property up for the new owner.  When the new owner comes on the scene, the tenant then demands an exorbitant amount of money in order to move. 

     The Obama law’s failure to define “before notice of the foreclosure” guarantees that the issue of whether the term lease is valid, i.e. whether it was entered into before or after “notice of the foreclosure”, will have to be litigated.  The Obama law makes this scam possible because it circumvents California state law that would have wiped out the junior lease at foreclosure.

     It didn’t take tenant lawyers long to get into the act.  Now, when a tenant-occupied property goes to foreclosure, the tenant is inundated with solicitations from lawyers promising the tenant months of free rent and financial windfall.  These solicitations advise the tenants not to cooperate with the new owner, not to identify themselves, not to give the new owner a copy of the lease, not to say how long they have lived there.  In short, the tenants are being told not to give any information to the new owner, regardless of the new owner’s legal right to the information.  The tenants are also advised against complying with the new owner’s statutory rights to enter the premises or cooperating in the new owner’s efforts to renovate and market the property.

     What are the solutions to the problems created by the Obama law?  First, try to work with the tenant.  Speak to the tenant and try to learn his name and the names of all people living at the property.  Try to obtain a copy of the lease.  Attempt to work out a cash-for-keys deal or, if your business model calls for the tenant to stay, try to close a new lease.  This process may take a lot of telephone calls and trips to the property. Second, make clear to the tenant that, if you have to hire a lawyer, all deals are off and the lawyer will do all that he must to safeguard the new owner’s rights.  Third, if you have a steadfastly uncooperative tenant, your only option is to obtain legal help. 

     I have a system in place to deal with uncooperative tenants that begins with telephone calls and correspondence and continues all the way through multiple lawsuits designed to give the tenant incentive to cooperate and to move-out, nearly always before the 90-day Obama period and commonly in as little as 30 days. 

     The costs and attorney’s fees associated with this system are often less than what you would pay the tenant to move, less than the monthly carrying charges on many properties, and a fraction of the discount that you factored into your bid to acquire the property because it was tenant-occupied.  If you would like to learn more, please contact me so that we can explore your options.  Please remember:  You do not have to tolerate an uncooperative or scamming tenant.