The Lowdown on Pre-Occupancy Agreements: What You Must Know

What Is a Pre-Occupancy Agreement?

For our purposes, a pre-occupancy agreement is a residential real estate contract — a contract that is linked to the sale of a property, an agreement that permits a Buyer to take possession of a property prior to the completion of the sale and/or the registration of a Transfer of Title in the applicable Land Registry Office.
A pre-occupancy agreement is not an occupancy agreement, which is more typically used in leasing scenarios and is designed to govern the rental/lease of a property from an owner to a tenant for an ongoing term. The tenant pays rent to the owner .
The pre-occupancy period can be a useful tool when dealing with certain sales transactions in order to allow a Buyer to take possession of a property early. A related advantage of such an early possession might be to permit the Buyer to facilitate renovations prior to closing, or even prior to the completion of the underlying sale.
Although in many circumstances an occupancy permit is not required for a home and a home can be ready to occupy, the occupancy permit can be required for certain properties based on municipal bylaw guidelines.

Basics of Pre-Occupancy Agreements

Pre-occupancy agreements typically contain the following elements:

• The Memory Builder Co. and Purchaser agree that the Purchaser can occupy the property under construction ("the Property"), at the Purchaser’s own risk, on or after "X" day of month "Y" in year "Z". The date set out above, or any subsequent date agreed to between the parties in writing, is referred to as the "Occupancy Date."
• After giving reasonable notice to the Vendor, the Purchaser shall be permitted to enter on the site and supervised access will be provided to the Property.
• Purchaser acknowledges and agrees that the Purchaser shall not be permitted to occupy the property until:

A. The walls, partitions and ceilings are constructed and finished;
B. Exterior doors and windows are installed and secured; and
C. Electrical, HVAC & plumbing rough-ins are installed and are in reasonable working order.

• The Purchaser shall at no time be permitted to accommodate any subcontractors, friends or family members on the Property.
• The Purchaser shall not use the Property for any purpose except as may be necessary to view the Property (or the interior of the Property) and save and except for the installation of Purchaser’s furniture, furnishings and appliances.
• It is a condition precedent to Purchaser being permitted to occupy the Property that Purchaser’s deed transfer monies have been provided to the Vendor’s solicitor and that a Statement of Adjustments in respect of the Property has been delivered to the Purchaser by the Vendor’s solicitor.
• Sole relief required of the Purchaser from giving satisfactory evidence to the Municipality respecting all statutory requirements (including final occupancy and final building inspection approvals) and as a condition of the Vendor closing the purchase of the Property with the Purchaser, is evidence to the Municipality that the Purchaser has taken possession of the Property and from the Municipality’s perspective may occupy the Property.
• Purchaser shall keep the Property locked and in a secure manner at all times and shall remove the Purchaser’s contents from the Property at the Purchaser’s sole cost and expense, at the time that the Purchaser takes ownership (i.e. the closing of the Property).
• These Pre-occupancy Acknowledgement and Agreement supersedes all existing agreements respecting occupancy and is part of the Agreement of Purchase and Sale signed by the Purchaser.

Benefits of Pre-Occupancy Agreements

With all of the above, pre-occupancy agreements are not without positive benefit. Pre-occupancy agreements can be good for buyers if the timing of the possession date is important (for example, the holidays) and also for buyers to start bringing some of their personal items to the property before they take possession.
On the seller’s side, the ability to lease-back the property to the seller (or some other party) may drive a sale that otherwise would not happen. Moreover, it may be a way for the seller to make a little more money rather than have to pay his or her own expenses (real estate taxes, hydro, condo fees, etc.) on the old and new properties.
Buyers should start out from a position of caution with pre-occupancy agreements. That said, where the parties are comfortable with the arrangement, and where the real estate sales price can be driven up for the seller’s benefit, buyers may also find a pre-occupancy agreement to be a win-win situation.

Possible Dangers and How to Avoid Them

Aside from the stated down payment, potential risks associated with the use of pre-occupancy agreements include:

• Late closing
• Missing Indemnity
• Equity Position
• Loan to Value Ratios
• Existence of Second Mortgage
• Judgments
• Judgements against the Purchaser
• Construction or Delays
• Commitments by developer as to improvements
• Risk to Developer’s Security Arrangements
• Deficiencies in Title
• Other potential liabilities

Risk associated with a late closing can be ameliorated by a letter from the vendor which stipulates that the purchaser is prepared to close at any time given one to two days notice. A short, simple, written statement signed by the vendor should do the trick. This written letter will help mitigate any mismatch in the seller’s and buyer’s assessment of the closing date; it may be that neither has any binding expectation on the other’s internal closing date. The only other option would be making sure each party has completely informed the other of their internal closing dates, which is not something that may be done as a practical matter.
Missing indemnities may not pose a significant problem unless the matter at hand is related to "known" issues, such as an addition made to the subject Suite without proper authorization. In this case, the vendor remains liable to the purchaser for any losses sustained through the stated party’s waiting period. However, the actual impact on the transaction will depend on the scope of any construction or demolition that may abut the property.
In terms of equity position, a pre-occupancy agreement may be extremely risky if you are an owner who lacks sufficient equity in a property that is already subdivided. Owners also run the risk of being unfairly taxed on a gain they have not yet realized: the sale price on a pre-occupancy agreement is based on its current state but the tax liability (if there are any) will reflect the final sale price rather than the current one. Consider perhaps eliminating pre-occupancy agreements altogether or charging a premium to reflect the increased risk of liability to the owner.
With car loans, mortgages and second mortgages, it should come as no surprise that a property could undergo a decrease in value if substantial debts are attached to it. Since pre-occupancy agreements may bring problems that do not lend themselves to adequate disclosures, a serious buyer should secure a loan with a sufficiently large loan-to-value ratio. This will afford them the ability to enter any equity situation.
The existence of any outstanding or second mortgages could introduce significant liability to the vendor and put them at risk for subsequent transfer fees or other liabilities associated with the early payout of their loan. A vendor who is a periodic (in this case, a quarterly) borrower is less apt to be subjected to any significant risk than if they were a significant annual borrower. In the latter case, the lender may regard the sale as a payment of a loan and treat the income. Again, a simple letter from the lender could eliminate this risk.
Judgments against the vendor, whether made local or otherwise, could lower the value of a property and affect the pre-occupancy agreement. Inter-jurisdictional judgments may be registered immediately. A comprehensive title search should mitigate this risk.
Any judgments against the purchaser could similarly lower the value of the property and potentially affect the pre-occupancy agreement. Again, a full title search should mitigate this risk.
Construction and delays may not pose any real danger to vacant land parcels. However, if there are associated risks, it is important to verify that all construction has been approved through the proper channels and that buildings are in compliance with the development agreement.
In regards to deficiencies in title, even small agreements should contain representations and warranties that protect the purchaser. A seller should have provisions in place to correct any defects. Otherwise, pre-occupancy agreements may require the developer to take on what could be significant liabilities.

Legal Implications and Compliance

When drafting and entering into a pre-occupancy agreement, associations must ensure that they are complying with state laws and local ordinances. For example, in New Jersey, in order to obtain the benefit of the new owner’s diligence for taxes and water and sewer charges, a Condominium must first file a "notice of settlement" in the land records. Under Pennsylvania law, municipalities with more than ten thousand residents, as well as those municipalities subject to a home rule charter, have the ability to enforce requirements under the Uniform Condominium and Planned Community Acts requiring pre-occupancy agreements and certain notice provisions .
Sometimes governing documents require the association to register a lien against the former owner’s property to perfect the association’s lien for outstanding assessments (this requirement is uncommon). More often, pre-occupancy agreements require that the former owner assign his or her right to collect outstanding payments owed by the new owner, including assessments, charging delinquency fees and/or legal fees, to the association. It is important to note, however, that even if the association must accept payments from the new owner, this does not automatically mean that the association must accept that owner as a member of the association. The laws in most states are clear on this point.

Pre-Occupancy vs. Rent-Back Agreements

Pre-Occupancy Agreements versus Rent-Back Agreements
There are two key ways to structure a Pre-Occupancy Agreement: (1) in the Agreement itself; or (2) in a separate addendum. Either way, the seller (and the buyer) will want to agree upon the rent amount (if any), when that rent is due, and where that rent is to be sent. The seller will also need to agree on how long it will have access to the property and to move out. These Rental or Rent-Back addenda, which can also be used without a formal Pre-Occupancy Agreement, are common, and it is in the seller’s best interest to make sure the rental amounts are affordable because the seller will be paying that rent each month before it vacates. It is important, however, to clarify that the buyer does not want to be considered a landlord by virtue of collecting rent, so it is advisable that rent be considered as "post-occupancy" fees or "contribution toward taxes and insurance" rather than rent.
What if the Seller Needs More Time?
If the seller needs additional time to close or to move out of the property, the buyer can agree to extend the closing date and provide more time for the seller to vacate. However, that delay usually extends the loan period and the buyer may also need to pay higher interest on the lender’s loan. A good alternative is to offer the renting seller the use of the property under a Rent-Back Agreement signed after the closing. At that point, the seller will already have earned the equity interest in the property that the buyer would have charged him or her in a Pre-Occupancy Agreement.
Loan and Appraisal Issues
If the buyer is financing the purchase of the property (rather than buying it for cash), the lender may refuse to approve the loan if the Pre-occupancy Agreement is signed before the loan is funded. It may also be unavailable for the seller to sign an Addendum to the Agreement or a Post-occupancy Agreement after the buyer has already taken title to the property, and then to agree on a rental arrangement with post-dated checks before the closing. In that case, the buyer cannot sign a Pre-occupancy Agreement before the closing, even to a cash buyer. However, after the closing, he or she can sell the property back to the seller under a Rent-Back Agreement. Alternatively, the closing can simply be delayed until the seller is ready for the settlement.

How to Draft a Solid Pre-Occupancy Agreement

A pre-occupancy agreement is strongly recommended due to the potential liability and risks involved in an owner of residential property renting their premises to tenants. In the case of an owner of a residential property who rents a home or a condo to tenants, the owner must ensure that the formalities associated with renting his/her home are finalized prior to the tenant taking possession. The owner should draft a strong yet simple pre-occupancy agreement which would provide details about any matters that the tenants will be responsible for prior to the execution of the rental agreement. These details may include but are not limited to: moving dates, installation of services, payment of deposits and costs to take possession. Depending on the circumstances, the owner should consider the following items, guidelines and recommendations in order to produce a strong pre-occupancy agreement:

• Deadline for Agreement: The parties should consider setting a date whereby both parties will consider the agreement to have been executed unless either party has given notice that such party is no longer prepared to conclude such agreement. This provides clarity and certainty to both parties.
• Deposit of Funds/Service Level Guarantees: Consideration should be given to having an amount set aside to cover any damages arising out of the tenancy or the damage of contents. While negotiating the agreement , consideration should be given to the services to be offered by both parties and incentives that may be required. It should be noted however, that the tenant should not be under any obligation to obtain service warranties or guarantees that exceeds those provided by the manufacturer of the goods and/or materials.
• Cancellation or Default: The parties should have clearly stated provisions regarding what will happen in the event that either Party either cancels the pre-occupancy agreement or fails to execute the final lease agreement. Issues of course remain as to who should be cancelling the agreement, whether the agreement is void or voidable and what types of damages would be required to remedy the situation. It may be prudent that the party at fault indemnify the other for any losses incurred.
• Consultation with Legal Professionals: Due to the strict nature of real estate law and the potential for liability between litigating parties, it is strongly recommended that both parties retain independent legal counsel to assist them in drafting the pre-occupancy agreement. Often it is the investment of both time and money that will ultimately lead to a successful owner/tenant relationship.