You gathered a pile of applications for your rental property. You narrowed it to several finalists and, after screening a few backgrounds, you finally settled on the best candidate for your next tenant.
Now, that tenant is backing out of the lease at the very last minute. What should you do, besides tearing your hair out?
It depends on whether or not the tenant signed your lease agreement, and whether you obtained a Hold Deposit. Also, did your lease include an Early Termination clause?
Know the answers to these questions before reading further – they matter!
Unsigned lease with no hold deposit
If this is your situation then, briefly, you'd better start advertising for another tenant ASAP.
That's because a written lease is useless unless the tenant actually signs it – even if the tenant read through the lease and verbally agreed to sign it in the future. (A verbal lease, by the way, is never a good idea for many reasons, and it typically can only be enforced if the tenant moved in or paid the landlord.)
Landlords who share a draft of their lease for tenant feedback may find themselves especially disappointed when, after revising terms to incorporate a tenant's suggestions, they get word the tenant is not taking the unit after all. Just as frustrating is the tenant who demands upgrades before moving in, only to cancel at the last minute.
The lesson here is that lease concessions and rental unit improvements should happen on the landlord's timeline, not to meet the demands of potential tenants. Wait until the ink is dry on the lease before repainting, replacing flooring, or making other improvements that a potential tenant requested.
Unsigned lease with a paid hold deposit
The lease hasn't been signed but you have collected a hold deposit. Good for you! This money is not the same as a security deposit, although some landlords agree to transfer hold deposit money into a security deposit account AFTER the lease is signed.
A hold deposit is just like a reservation fee paid to guarantee a hotel room, cruise trip, or other high-ticket item. It is a refundable fee that either gets returned to the tenant after the lease is signed, or is applied as a security deposit or rent payment. The key here is to provide the tenant with a written receipt and a disclosure that describes the terms of the hold deposit.
If the tenant backs out, he or she forfeits the hold deposit. The exception is in cases where the rental property is Section 8, federally subsidized housing. In those situations, the landlord may be required to refund the hold deposit even if the tenant backs out.
Tenants who pay hold deposits are far more likely to carry out their plans to move in, which is why landlords collect the fee. Be sure to send a follow-up notice to the tenant who backed out, explaining that he or she has relinquished rights to the money.
The tenant who signed a lease then backed out must immediately pay a year's worth of rent, and the landlord can just leave the unit vacant and collect the money for the next 12 months, right?
It is true that the tenant is legally obligated to honor the contract but, in many states, the landlord must try to find another tenant to rent the property. Landlord mitigation laws spell out these different requirements.
Until a new tenant can take over the rental, the former tenant is on the hook for rent. In fact, in some states, the tenant who backs out may have to pay the landlord's cost to advertise the property. Yet, the landlord has responsibilities, too, and is expected to make reasonable efforts to find a new, qualified tenant.
It's in the landlord's best interest to move quickly through anger or disappointment and focus on finding a good replacement tenant. Don't let emotions get the best of you or dwell on what might have been. Indeed, a tenant who backs out at the last minute is probably an occupant the landlord would be better off without.
Early termination clause, security deposits, and how to move on
A strong lease includes provisions for all possible circumstances, including a tenant who wants to end the lease before it expires. These addenda lay out, in advance, what will happen if a tenant moves early.
Many landlords write early termination clauses into their leases; the clauses call for a one-time charge to the tenant. This means that, even if the landlord is able to find another occupant for the property, the tenant who's leaving must pay the early exit charge.
Security deposits are handled somewhat differently. Most leases define a security deposit as a refundable payment that can be partially or fully used to repair damages caused by a tenant. These are damages that go beyond simple wear and tear. Some states require the landlord to hold the money in an interest-bearing account, and to provide tenants with a statement showing the deposit and interest rate that will be earned. When the tenant moves out, the landlord must itemize any security deposit amount that won't be returned to the tenant and the reason for the deduction. The money must be returned quickly. In California, for instance, any deposit that is being returned must be given to the tenant within three weeks.
Landlords may be tempted to keep security deposits paid by a tenant who backs out of a lease at the last minute, but this could be illegal unless lease terms and laws for your state allow you to use security deposit money for unpaid rent. Since security deposits are set aside, in part, to cover property damages, you may be taking an unnecessary risk if you keep it when the tenant never moved in.
Property management, like any business, is filled with risks and disappointments and some are greater than others. Maybe you really liked the tenant who backed out. Or, perhaps, you were counting on rental deposits to begin and you'll have to scramble to make up the lost income.
However irritating this setback may be, it is not a landlord's job to “teach the tenant a lesson” but to minimize losses and get back to business. Your business is real estate investment and your profits come from keeping your properties rented, not spending time and money on court battles. If the tenant who backed out has a decent reason for doing so, it is probably in your best interests to let them go. Start sending out new applications, contact previous applicants to see if they're still looking, and schedule showings as soon as possible. On the plus side, at least you won't lose time prepping the rental unit since it's already ready to go.