A real estate investor recently asked me what an Estoppel Certificate was and why he should know about them. The old Real Estate Adage is: “You earn when you buy…and get paid when you sell.” Due Diligence research is how you make sure you are getting what you are paying for, and an Estoppel Certificate is an important component of that research.
When investors purchase multifamily or other revenue producing real estate investments they are counting on a certain level of on-going rents. An Estoppel Certificate (EC) is a form signed by the building Seller and his tenant stating how much the rent payment is, when it is due, the beginning and ending of the occupancy and a few more details such as the amount of security deposit.
WHY USE AN ESTOPPEL CERTIFICATE?
A QUARTER MILLION DOLLARS LESS CASH FLOW? Say you are an investor buying an office building as a 5-year hold that has 2 major tenants. If the Seller presents them both as having long term leases…when actually one of them is planning on moving in 60 days…you may pay well more than the property is worth. A fully executed Estoppel Certificate will give you complete information…so you can accurately evaluate the asset’s worth. If your tenant’s lease is years shorter than you thought, you will have lost revenue while trying to fill the space, Broker fees, and tenant improvement costs that weren’t included in your budget. In Portland if you have a 10,000 sf Class “B” building vacant for 9 months while finding a 5-year tenant you’ve lost a fortune. Factor in $112,500 in lost Revenue, add $50,000 for Brokerage Fees and $150,000 in tenant improvements and you’re out $312,500. The rule is: Insist on Estoppel Certificates if you can’t afford to lose the revenue.
SECURITY DEPOSITS: I helped a 1031 Exchange client buy a smaller owner-managed multifamily property to fulfill the second leg of his Exchange. When I compared the signed leases to the amounts shown on the rent rolls…I found that 40% of the units had the wrong Security Deposit on the Rent Roll. When those tenants give notice my client would have been liable for the amount on the lease. On a large property, the losses to the investor could have been considerable. To avoid that loss, an Estoppel Certificate or at least a careful examination of leases for Security Deposits and spreadsheet summarizing that research are a must for savvy investors.