Prorating Rent for the Real Estate Investor
Do some simple math to calculate the exact amounts due at closing
Selling rental property involves a few more wrinkles than selling other real estate. Any rents that are paid to the seller prior to the date of closing must be prorated at the closing table in a real estate rental property transaction. This means that the seller owes the buyer any rent amounts that represent the period of time from closing through the end of the rental period—usually a month.
Rent prorations are normally done through the date of closing and they don't include security deposits, which can be turned over to the buyer by the seller to be held as they were before the sale. The buyer would then be responsible for the deposits and their eventual disposition based on the terms of the new rental agreement.
A Proration Calculation Example
Three calculations determine the amount of a rent proration:
- Determine the number of days' rent the seller owes to the buyer
- Arrive at the rental amount per day
- Multiply the rental/day amount times the number of days
Assume that a duplex with both units rented is being sold. The rentals are $500 a month for Unit A and $700 a month for Unit B. The rent was paid for both units on September 1 and we're closing on September 12.
- 30 days in September minus the 12 days through closing equals 18 days to prorate
- Rents total $1200/month so divide by 30 days for a daily rental amount of $40
- $40 per day rental amount times 18 days equals $720
This amount would show as a "credit" to the buyer and a "debit" to the seller on the closing statement.
Obviously, rental properties are purchased for their cash flow and overall ROI with appreciation and tax advantages, whether they're single-family dwellings or apartments. The proration of rents at closing is only one important consideration.
Buyers should determine whether the reported rents are correct. Make sure that the rents in spreadsheets and income documents are factual. A prospective buyer of a rental property should get bank statements to verify that those are the actual rents being paid. If one apartment's rent is supposed to be $750 a month, confirm that this is indeed the amount being deposited each month.
For example, the landlord might have been letting the tenant trade services for some or all of his rent payment. Perhaps the tenant was providing cleaning and maintenance services, or maybe the tenant received an off-the-books rent reduction due to a personal relationship with the landlord. For whatever reason, the numbers will balance only when all rents included in tenant leases are actually deposited.
A prospective buyer might also inquire as to whether the seller is charging current market rates. Confirm whether tenants are paying below, at, or above what other landlords in the area are charging for similar properties. There can be real value in this area for the buyer. Some landlords are either lazy or just don't like interviewing and placing new tenants so they'll avoid increasing rents for long periods of time in order to keep the same tenants in place.
The rents being paid can be significantly below current market rates as a result. Rents can be increased immediately upon lease expiration to change the ROI and cash flow for the benefit of the new owner.