This Article examines residential property rent skimming recoveries available to tenants, carryback sellers and lenders who incur money losses when an investor defaults on mortgage payments during their first year of ownership.
Rent skimming during the first year of ownership
Rent skimming occurs when, during their first year of ownership of residential real estate, an investor:
§ receives rents from tenants; and
§ fails to apply the rents towards the mortgages encumbering the property, causing a mortgage delinquency and eventual foreclosure. [Calif. Civil Code §890(a)]
Thus, a property must go to foreclosure as a result of the failure to pay the mortgage for the action to be considered rent skimming. However, it is the date of the delinquency of at least one month’s payment on the mortgage during the first year of ownership that triggers application of the rent skimming penalties, not the date of the foreclosure sale.
For example, an investor skips a mortgage payment during the first year of ownership and in the months following, the investor makes some mortgage payments but does not cure the delinquent payment, known as a rolling late payment. After owning the property for more than 12 months, the investor stops making payments and the property goes into default, and eventually foreclosure. Here, the investor is engaged in rent skimming activities due to the initial delinquent payment occurring within the first year of ownership, triggering the eventual foreclosure sale.
If the delinquencies on mortgage payments occurring within the first year of ownership are cured, later delinquencies in payments occurring after the first year of ownership do not constitute rent-skimming activities. [CC §890(a)(1)]
Rent skimming rules apply to residential real estate, defined as one or more residential units located within the boundaries of land with a single legal description.
Investors expose themselves to civil and criminal penalties depending on the level of misconduct set out in two categories of rent skimming:
§ Single acts of rent skimming subject the perpetrating investor to civil penalties for their conduct, not criminal prosecution.
§ However, engaging in "multiple acts of rent skimming" the investor is subject to civil and criminal penalties.
An investor purchases a rental property where the seller carryback a second mortgage
The property’s rental income is enough to carry its verifiable operating expenses and mortgage payments with a 10% annual vacancy factor.
The investor’s savings and liquid assets are entirely consumed by the down payment and closing costs. The investor is left with no cash reserves to cover operating expenses if the property experiences more than the pro forma 10% vacancy at present rental rates.
Soon after acquisition, the investor experiences a substantial drop in rental income due to the loss of a tenant. Worse, the investor is unable to locate a new tenant willing to pay the rent amount the prior tenant paid.
Shortly thereafter, the investor is laid off by their employer. Starved for cash, the investor makes no further payments on the mortgages and immediately attempts to resell the units. The investor receives no offers.
After two months of delinquencies, the investor locates a tenant at a lower rental rate and enters into a one-year lease. The investor collects rents and uses the monies to cover living expenses, not mortgage payments.
The property eventually sells at a foreclosure sale on the first trust deed, wiping out the carryback seller’s second trust deed lien.
At the foreclosure sale, the lender acquires ownership and the property becomes a real estate owned property (REO). The lender requests the property be vacated and gives the tenants the required 90-day Notice to Quit Due to Foreclosure.
The tenant on a one-year lease with several months remaining vacates immediately on receipt of the notice to vacate. The tenant relocates to a comparable residential unit incurring moving costs and an increase in monthly rent.
The tenants and the carryback seller now make demands on the investor for their money losses, claiming the investor engaged in rent skimming activities. The investor claims they did not maliciously engage in rent skimming and are not liable for the tenants’ and seller’s losses due to the concurrence of several adverse economic conditions.
Can the tenants and seller recover their losses from the investor based on the claim the investor was engaged in the act of rent skimming?
Yes! The tenants and the seller have separate, enforceable claims against the investor. Each can collect their money losses caused by the investor’s collecting rent and failing to apply the rent toward mortgage payments during the investor’s first year of ownership, called rent skimming. [CC §§890(a), 891(a), (d)]
Rent skimming during the first year of ownership
Rent skimming occurs when, during their first year of ownership of residential real estate, an investor:
§ receives rents from tenants; and
§ fails to apply the rents towards the mortgages encumbering the property, causing a mortgage delinquency and eventual foreclosure. [Calif. Civil Code §890(a)]
Thus, a property must go to foreclosure as a result of the failure to pay the mortgage for the action to be considered rent skimming. However, it is the date of the delinquency of at least one month’s payment on the mortgage during the first year of ownership that triggers application of the rent skimming penalties, not the date of the foreclosure sale.
For example, an investor skips a mortgage payment during the first year of ownership and in the months following, the investor makes some mortgage payments but does not cure the delinquent payment, known as a rolling late payment. After owning the property for more than 12 months, the investor stops making payments and the property goes into default, and eventually foreclosure. Here, the investor is engaged in rent skimming activities due to the initial delinquent payment occurring within the first year of ownership, triggering the eventual foreclosure sale.
If the delinquencies on mortgage payments occurring within the first year of ownership are cured, later delinquencies in payments occurring after the first year of ownership do not constitute rent-skimming activities. [CC §890(a)(1)]
Rent skimming rules apply to residential real estate, defined as one or more residential units located within the boundaries of land with a single legal description.
Investors expose themselves to civil and criminal penalties depending on the level of misconduct set out in two categories of rent skimming:
§ Single acts of rent skimming subject the perpetrating investor to civil penalties for their conduct, not criminal prosecution.
§ However, engaging in "multiple acts of rent skimming" the investor is subject to civil and criminal penalties.
An investor purchases a rental property where the seller carryback a second mortgage
The property’s rental income is enough to carry its verifiable operating expenses and mortgage payments with a 10% annual vacancy factor.
The investor’s savings and liquid assets are entirely consumed by the down payment and closing costs. The investor is left with no cash reserves to cover operating expenses if the property experiences more than the pro forma 10% vacancy at present rental rates.
Soon after acquisition, the investor experiences a substantial drop in rental income due to the loss of a tenant. Worse, the investor is unable to locate a new tenant willing to pay the rent amount the prior tenant paid.
Shortly thereafter, the investor is laid off by their employer. Starved for cash, the investor makes no further payments on the mortgages and immediately attempts to resell the units. The investor receives no offers.
After two months of delinquencies, the investor locates a tenant at a lower rental rate and enters into a one-year lease. The investor collects rents and uses the monies to cover living expenses, not mortgage payments.
The property eventually sells at a foreclosure sale on the first trust deed, wiping out the carryback seller’s second trust deed lien.
At the foreclosure sale, the lender acquires ownership and the property becomes a real estate owned property (REO). The lender requests the property be vacated and gives the tenants the required 90-day Notice to Quit Due to Foreclosure.
The tenant on a one-year lease with several months remaining vacates immediately on receipt of the notice to vacate. The tenant relocates to a comparable residential unit incurring moving costs and an increase in monthly rent.
The tenants and the carryback seller now make demands on the investor for their money losses, claiming the investor engaged in rent skimming activities. The investor claims they did not maliciously engage in rent skimming and are not liable for the tenants’ and seller’s losses due to the concurrence of several adverse economic conditions.
Can the tenants and seller recover their losses from the investor based on the claim the investor was engaged in the act of rent skimming?
Yes! The tenants and the seller have separate, enforceable claims against the investor. Each can collect their money losses caused by the investor’s collecting rent and failing to apply the rent toward mortgage payments during the investor’s first year of ownership, called rent skimming. [CC §§890(a), 891(a), (d)]
