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Choosing Between Short And Long Term Tenancy Agreements
Wouldn’t it be great that you can sign up a tenant for the next 10 years? You effectively secure a consistent cash inflow for the next 120 months which in some cases can fully repay your mortgage. However, even though that can seem like a very attractive proposal for any investor, you wouldn’t know the mess you have got into until you run into a situation like that.
The basic buy and rent model of real estate investing have been around for centuries. And it has withstood the test of time precisely because it works. But the small matter of going for long or short term tenants is still something that is debated today. To avoid confusion any tenancy agreement of 2 years or more is considered long term. While anything that is less than 12 months is a short term one. The contracts that are in between are those that reside in the grey area we affectionately label “neither here nor there” leases.
Although most landlords would probably celebrate with a bottle of champagne when a long term tenant signs on the dotted line, there is still no guarantee that your income is secured over the course of the contract. Tenants can still move out whenever they want. You could take action against them for a breach of contract.
But is that how you really run a business? Where your income is based on the black and white on a piece of paper forcing people to contribute to your profits? Instead of getting off your butt and do your job of generating an income from willing customers who find value in what you offer? The basic goal you should try to achieve is that you are such a great landlord and providing such great value that prospects are lining up in a long queue just to be your new tenants. You could argue that the capitalist world is all about contracts and enforcement. But the most successful companies with an obscene amount of goodwill are those that do not force people to pay them. Can you imagine your favourite departmental store without their “no questions asked” refund policy? I cannot.
Other than the possibility of a breach of contract causing you to sweat over future income to cover the expenses you have already factored in, there are 2 other big disadvantages with long term lease agreements.
The first is that you will not be able to sell the property during the term of the agreement. This mean that if a crazy buyer who wants to use the property comes along and offers a price 10 times what your it is worth, you can’t take up the offer. Because the existing tenant has the legal right to use the property. A new owner cannot just kick them out because he wants to use the premises himself. How’s that for a demoralising dealbreaker?
The second is that you might not be able to raise rentals in relation to market rates in future as the tenant has already “locked in” the rental for the whole lease period. In this case, instead of making a profit, you could be making a huge opportunity loss on your asset. Have you spared a thought about that when you happily downloaded the lease template and gave your tenant to endorse? Are you sure you know what you are doing?
As you might know, the shortcomings of short term rentals are pretty straight forward. Tenants who are on these types of contracts can pack and leave with little fuss. And if you are on a month-to-month rolling contract, you will have the luxury of revising the terms each time a contract expires. This can work for or against you. But as nobody can predict the future, you can never know whether future market conditions will hurt you or not. If for example, the market is suddenly deprived of tenants, you could have a huge challenge in your hands to retain your existing tenant or finding a new one. You will be eating out of the tenant’s hands as he will hold the cards to either stay with you provided you lower your rent or move on to somewhere else in a better amenity-rich location with better value.
You might think that these problems have quick fixes that can solve the potential problems. You could go for “grey area” contracts and insert rental escalation clauses into your agreements to protect yourself. But that might not be as straight-forward as you would wish. Because tenants are not stupid and they are sure to have their own objectives to achieve. And they surely are not going to be push overs when there is another landlord waiting in the wings to offer them another house. It is too easy to say that you will insert this clause and that one into the contract and make people agree to certain terms. Easier said than done actually. Many times, the fear of going a prolonged period without rental income can force the landlord’s hand in agreeing to take in a tenant on compromised terms.
With these key points in mind, do a quick review of your plans before deciding on a short or long term tenancy agreement to draft out. Even though your financial goals are the most important, don’t forget that other parties have their own goals that they are striving for as well. Long term contract agreements are no doubt the preferred choice of investors, but keep in mind the potential drawbacks and take appropriate action to plan for contingencies.