The most common use of estoppel certificates is in commercial real estate. In general terms, it’s a form that owners or banks will use to confirm a tenant’s acknowledgment of specific lease details..
Estoppel Definition
By definition, an estoppel certificate is a “signed statement by a party certifying for another’s benefit that certain facts are correct, as that a lease exists, that there are no defaults, and that rent is paid to a certain date. A party’s delivery of this statement estops that party from later claiming a different set of facts.” – Black’s Law Dictionary, 7th Edition.
Estoppel is a tricky concept, so let’s look at a quick example of how these are used in residential real estate.
Estoppel in Residential Real Estate
Estoppel certificates are relatively uncommon in residential real estate because the stakes are low – it’s not like you’re dealing with a 50,000 square foot tenant that anchors a retail complex. For instance, if a grocery store anchor goes out of business or fails to pay the rent, the owner could easily default on their loan. Losing an anchor tenant is much different from having someone move out of an apartment. Residential landlords can usually absorb the loss of a single resident better than owners of large commercial spaces.
That said, just because estoppel certificates aren’t commonly used in residential real estate doesn’t mean they shouldn’t be used more often. Here are a few hypothetical examples of when an estoppel agreement makes (or would have made!) much sense.
Example 1
Arthur recently sold his 10-unit apartment building and, per both his lease agreements and his insurance policy, residents were not allowed to have pets of any kind. After Arthur sells the property to John, John sees two dogs playing in the backyard. When John approaches the tenants and reminds them that they cannot have pets on the premises, they tell him that Arthur has always allowed pets. Had John realized Arthur was running a pet-friendly building, he would have factored that into the purchase price. Pet-friendly properties sustain more wear and tear and are typically more costly to insure. John could try to evict all tenants with pets, but this would be an expensive endeavor for the sake of uprooting otherwise good, long-term residents. John now knows the folly in not asking for estoppel before purchase.
Example 2
Sally recently purchased a two-family home just outside of Atlanta. A family was living in the first-floor unit, and she planned to occupy the second-floor unit, which was vacant at the time of closing. It came as a surprise to Sally a week after she moved into the property: the driveway she expected to park in was already full of three tandem-parked vehicles. She assumed the tenants parked here in error, perhaps taking advantage of their new unsuspecting landlord.
Well, as it turns out, the previous owner never indicated that the first-floor residents had previously negotiated sole use of the driveway (which at the time, worked out with no issue because the second-floor tenants did not have a vehicle). When Sally tried to tell the residents that this was not going to work (she and her husband both intended to park in the driveway), the first-floor residents threatened to withhold $150 in rent per month, per vehicle – the cost they’d pay for off-street parking elsewhere. This was a challenging way to start the landlord-tenant relationship and a situation that could have been avoided entirely with an estoppel certificate.
Example 3
Michael recently listed his 30-unit apartment building for sale. In the offering package, he noted that rents ranged from $900 to $1200 per month, which resulted in compelling returns for prospective investors. In the meantime, he asked his property management company to start compiling documents, including copies of the rent roll and estoppel certificates signed by residents. When he started collecting the estoppel certificates, he realized that he had understated rental rates. Unbeknownst to Michael, the management company had raised rents by $100 per unit and was skimming the difference off the top! This series of events caused Michael to sue the management company after his sale of the property.
The Laundry List
Although estoppel certificates are not often used in residential real estate, there’s certainly a case to be made for doing so – particularly if you’re planning to purchase a new investment property. Here are some of the statements you may consider including in your requests for estoppel:
· That the lease is in full force and effect;
· That the lease is unmodified (either orally or in writing);
· The commencement and termination date(s) of the lease;
· Whether there are any remaining options to extend the lease;
· Whether the tenant does, or has the option to, lease/use other space in the building;
· Whether there are any options to purchase the leased premises;
· Whether either the landlord or resident is in default under the lease;
· The base rent or minimum rent payable under the lease;
· That the resident has made no agreements regarding free rent;
· The amount of the security deposit posted with the landlord (if any);
· Whether any rent has been prepaid;
· The date through which rents have been paid;
· That the property manager has completed all improvements required to be made to the leased premises;
· That the property manager has performed all maintenance obligations under the lease;
· That the resident is not in bankruptcy or party to any litigation regarding the premises; and
· That the resident will not modify the lease without the new owner’s prior written consent.
The Bottom Line
Resident estoppel certificates are a tool that investors should consider using as part of their due diligence process. Estoppel certificates are a powerful way to confirm the facts about existing lease terms, thereby providing a full picture of the deal before entering any formal purchase and sale agreement.