This article examines the residential property rent skimming recoveries available to tenants, carryback sellers and lenders who incur money losses when a buyer engages in rent skimming activities in the first year of ownership.

Consider a first time investor seeking to acquire and operate residential income property as part of his estate building plans. He has sufficient cash available to make the customary down payment on property priced no more than $200,000 and still have reserves for six month’s carrying costs and emergencies.

The investor’s agent shows him a triplex valued at $400,000, fully-rented and not occupied by the seller.  The triplex rental income is enough to carry the property’s verifiable operating expenses and mortgage payments with a 10% annual vacancy factor.

On the recommendation of his agent, the investor enters into negotiations to purchase the property. However, downpayment and closing costs customary for acquiring a property in this price range will consume all the investor’s savings and liquid assets. He will be left with no cash reserves should the property experience more than the pro forma 10% vacancy at present rental rates.

Following negotiations to buy the property, the seller agrees to carryback a note to cover the gap between the down payment on the $400,000 price and the existing first trust deed which the buyer will assume.

On closing, the investor takes over the management of the property as the new landlord.

During the third month of the investor’s ownership, one of his tenants hands him a 30-day notice of intent to vacate.  After surveying the rental market, the investor discovers he will not likely be able to bring in the same amount of rent from a new tenant due to a developing recession and related job losses. Despite his findings (and due to rent control ordinances), the investor sets the asking rent at exactly what he was receiving from the vacating tenant. Due to his unrealistic expectations, he is unable to locate a prospective tenant.

During the fifth month of ownership, another tenant asks for a rent reduction, threatening to move to a less expensive rental property. The tenant’s work hours have been cut at his place of employment, and he can no longer afford the rent agreed to in the lease. The investor does not want another vacant unit, so he negotiates a rent reduction to current rental rates in exchange for a new one-year lease.

The investor has now suffered a 38% drop in the rents he collects. He is unable to make the first installment of property taxes.

In the seventh month of ownership the investor is also unable to make the lender’s mortgage payment. However, he keeps the seller current by paying the monthly installment on the carryback note.

The investor’s employer notifies its entire staff of impending layoffs. The investor decides not to make that month’s payment on either the lender’s or the seller’s notes until he receives word about his employment status. He is let go and makes no further payments. He attempts to resell the units, but receives no offers.

After two months of delinquent mortgage payments, a prospective tenant is located to fill the vacant unit. The investor offers the tenant a month-to-month tenancy agreement, but the prospective tenant insists on a one-year lease. In order to acquire the tenant, the investor agrees to the one-year lease.

After five months without making payments, the lender records a notice of default (NOD). Eventually the property sells at a foreclosure sale — seven months after the recording of the NOD, and after futile attempts at a pre-foreclosure workout with the lender. The investor collects rent from the tenants until the property is posted with the notice of a trustee’s sale (NOTS) and the tenants are advised of the foreclosure and their occupancy rights by the foreclosure trustee.

On completion of foreclosure on the first trust deed, the lender acquires ownership as the successful bidder. The tenants are given the minimum 60-day notice to vacate by the lender. The tenant with a lease vacates immediately on receipt of the notice to vacate and moves to a comparable but more expensive unit, incurring moving costs. The investor does not account for or refund the tenant’s security deposit. The other tenant, on a month-to-month rental agreement, vacates within the 60 days provided by the lender’s notice.

During his ownership, the investor does not use the rents for payment of his family’s health care. The rental units do not violate local ordinances requiring him to correct adverse habitability conditions on the property. The investor does not acquire more than four parcels containing residential rental units during any 24-month period.

Both of the tenants and the carryback seller make demands on the investor for their money losses, claiming he engaged in rent skimming activities. The investor claims he is not liable for the tenants’ and seller’s losses since he did not engage in malicious rent skimming but was merely an unfortunate victim in a concurrence of several adverse economic conditions.

Can the tenants and seller recover their losses from the investor based on the claim that he was engaged in rent skimming activities?

 

Yes! An income property investor buying fewer than five parcels each containing any number of residential rental units who fails within the first year of ownership to use a parcel’s rental income to make payments on that property’s mortgage liens (trust deeds) is liable as a single-act rent skimmer for money losses incurred by the tenants and the carryback seller due to a foreclosure and eviction notices, regardless of malicious intent or market conditions. [California Civil Code §§890(a)]

 

Rent skimming and the amounts recovered

Two classes of rent skimming exist:

• a single act of rent skimming; and
• multiple acts of rent skimming.

While a single act of rent skimming involves fewer than five parcels containing residential units, the investor who acquires more than five residential parcels during any two-year period and skims rents from each parcel during the first year of ownership is subject to one criminal count of multiple acts of rent skimming. [CC §890(b)]

A tenant of residential property may recover his money losses from a buyer who engages in a single act of rent skimming if:

• the property is sold at a foreclosure auction; and
• the tenant is required to move while rent skimming activities occurred. [CC §890(d)]

The tenant’s recovery when he relocates due to rent skimming and a foreclosure is limited to actual money loss incurred for:

• moving expenses;
• breach of a lease; and
• a failure to receive any refundable security deposit.

Breach of a lease includes lost rental value for the period remaining on a lease agreement. The lost rent is the gap between rent the tenant was paying the buyer and any higher rent he pays to rent or lease a comparable replacement residence.

The tenant’s recovery when he relocates due to rent skimming and a foreclosure also includes:

• attorney fees; and
• court costs.

A tenant who is given a notice to vacate after foreclosure and moves when the owner was involved in rent skimming activities is further entitled to receive a penalty amount of money, called punitive damages, at the sole discretion of a judge.

However, the tenant is to automatically receive a punitive sum of money from the rent skimming buyer of at least three times the tenant’s out-of-pocket money loss if payments on the underlying trust deed were at least two months delinquent at the time the tenant rented the property or the buyer was involved in multiple acts of rent skimming – whether or not the property was one of the multiple acts subject to a criminal action. [CC §891(d)]

The seller of a parcel of residential property who carries back a note (or land sales contract or lease-option agreement) and is wiped out in a foreclosure by a prior trust deed holder and whose buyer was involved in rent skimming activities on the property may recover his actual money losses, including amounts remaining unpaid on the carryback note, plus any attorney fees. [CC §891(a)]

Recovery on a carryback note when the seller’s security interest in the property – the trust deed securing the note – is wiped out when the property was the subject of rent skimming is not limited by California’s anti-deficiency law which bars the seller from recovering money by any means other than foreclosure on carryback debts, called purchase money obligations. [CC §891(g)]

As with the tenant’s recovery, a carryback seller may also receive an award for punitive sums of money, limited only by the discretion of a judge, unless the buyer was involved in multiple acts of rent skimming in which case a punitive money award of three times the seller’s actual losses is mandatory. [CC §891(a)]

Further, the carryback seller who himself forecloses and recovers ownership of the property must underbid at his trustee’s sale by the amount of his out-of-pocket money losses if he is to recover a money judgment for his buyer’s rent skimming activity on the property. Recoverable losses include:

• any lost value due to waste inflicted on the property by the buyer;
• any casualty loss suffered by the property;
• any deficiency in the property’s value to fully satisfy the carryback note at the time of foreclosure; and
• cash advances made as necessary to protect the carryback seller’s interest in the property, including payments on prior trust deed loans, property taxes and insurance premiums.

If the foreclosing carryback seller does not underbid, he has been fully satisfied due to his making a full credit bid and acquiring the property.

If the carryback seller accepts a deed-in-lieu of foreclosure from the buyer who was engaged in rent skimming on the property and later determines that judgment liens against the buyer are attached to title, the seller may request a court to clear title. On the seller’s request, a court will clear the title of all judgment liens against the buyer which encumber the property, except for mechanic’s liens and voluntary junior liens held by a lender who was unaware rent skimming activity was taking place when the (trust deed) lien was created. [first tuesday Form 406]

A court, however, will not clear tax liens, since tax liens are not judgment liens. [CC §891(b)]

Multiple acts of rent skimming

 

Consider a landlord who skims the rents off more than five parcels of residential real estate during his first year of ownership. All the properties are encumbered with loans and all were acquired by the landlord within a 24-month period.

The state files criminal charges against the landlord on:

• the initial act of multiple rent skimming; and
• additional single acts of rent skimming for each parcel beyond the five parcels which constitute the initial act of multiple rent skimming.

The state files the charges within the statute of limitations period of three years after the landlord’s acquisition of the last of the five parcels involved in the multiple acts of rent skimming. However, while the other parcels involved in the additional charges were acquired during the same two-year period covered by the initial multiple acts of rent skimming, the additional parcels were not acquired within the three-year statute of limitations period for each additional single act of rent skimming.

The landlord claims he is not criminally liable for the additional single acts of rent skimming since he acquired those additional parcels more than three years before the state brought the action, and thus he is protected by the statute of limitations.

The state claims the prosecution of each additional violation is proper since all the charges were brought within three years after the acquisition of the last of the five parcels included in the initial multiple acts of rent skimming, and the additional acquisitions occurred within the two-year period covered by the multiple acts of rent skimming.

Is the landlord subject to criminal charges for the additional single acts of rent skimming on properties acquired more than three years before charges were filed?

No! The state’s action on each additional single rent skimming violation after the first violation is time-barred by the three year statute of limitations. The date of acquisition for each additional parcel, the subject of additional single violations beyond the five chosen for the multiple acts of rent skimming, must occur within three years prior to filing the action to be a crime. [People v. Bell (1996) 45 CA4th 1030]

The crime of multiple acts of rent skimming

An owner who engages in multiple acts of rent skimming exposes himself to recovery from tenants, carryback sellers and lenders but more critically, engaging in multiple acts of rent skimming is a crime in California.

A buyer found guilty by a California court of five acts constituting a count of multiple acts of rent skimming is subject to:

• imprisonment for one year;
• a fine of no more than $10,000; or
• both imprisonment and the fine. [CC §892(a)]

For each additional act of rent skimming beyond the five properties that constitute the criminal count of multiple acts of rent skimming, the buyer is subject to:

• an additional one-year of imprisonment;
• $10,000 fine; or
• both imprisonment and the fine. [CC §892(a)]

If an owner is convicted of multiple acts of rent skimming, he will expose himself to further criminal liability if he continues to engage in rent skimming after his conviction. For each single act of rent skimming perpetrated after the conviction of multiple acts of rent skimming, a buyer will be subject to:

• one-year of imprisonment;
• a fine of no more than $10,000; or
• both imprisonment and the fine. [CC §892(b)]

 

Recovery for multiple acts of rent skimming

 

The tenant whose premises is sold at foreclosure auction and is required to move (by the way of a receipt of a 60-day notice to vacate by the lender or the highest bidder at the trustee’s sale) concurrently with a landlord’s multiple acts of rent skimming is entitled to an award for punitive sums of money which is mandated for at least three times the tenant’s out-of-pocket money loss. [CC §891(d)]

 

The carryback seller who sells a parcel of residential property and is wiped out in a foreclosure on a prior trust deed while the buyer is involved in multiple acts of rent skimming is entitled to a mandatory award of a punitive sum of money at least three times actual loss. [CC §891(a)]

 

Finally, a lender’s trust deed secured by a parcel of residential rental property which was one of the five parcels involved in multiple acts of rent skimming for which the buyer was found guilty in a criminal action may recover his actual money loss from the buyer. However, the lender’s recovery of actual money loss (delinquent payments) is limited to the rents collected on the property, whether the buyer originated or assumed the loan. This rents-only limitation does not apply to a carryback seller. [CC §891(c)]

A lender is not barred from recovering his losses by anti-deficiency law when the property owner was skimming rents from the secured property. [CC §891(g)]

However, the lender must underbid at the trustee’s sale by the amount of his actual money losses in order to recover based on the buyer skimming rents from the property. If the lender does not underbid, the lender has been fully satisfied due to his making a full credit bid and acquiring the property.

 

In addition, a lender may receive an award for punitive sums of money which is solely within the discretion of the court. [CC §891(c)]

 

The buyer’s defenses

Rent skimming buyers may avoid California rent skimming charges, both criminal and civil, if the rents collected during the first year are used to pay the buyer’s or his family’s medical expenses, or to pay licensed contractors or material suppliers to correct any building violations relating to the health and safety of the tenants, if:

• the payments of medical expenses or building violations are made within 30 days of receiving the rental revenue; and
• no other source of funds existed from which to pay for medical expenses or building violations. [CC §893]

Thus, for an owner to avoid rent skimming claims he must pay all rent he receives to the lender, limited to the amount of past and present payments owed and aside from payments for medical expenses or those relating to health and safety code correction.

The owner does not shield himself from rent skimming claims by obtaining an agreement from a tenant waiving the tenant’s rights against rent skimmers. Any waiver of rent skimming law is void as contrary to public policy. [CC §891(a)]

Similarly, an owner cannot shield himself from rent skimming law by purchasing his properties through a limited liability company (LLC), partnership or another other business arrangement. The person managing any business entity will still be held liable as a rent skimmer, since he is the individual in control of the rental properties and loan payments. [CC §890(c)]

For the same reason, a property manager will not be held liable for rent skimming. As an employee of the owner, the property manager is not in the position of control over the property — he works as an agent for the owner, the individual with the ultimate control over payments on the loans. [CC §890(c)]

Likewise, rent skimming law does not hold a tenant liable who sublets his unit, collects rental payments and fails to make rental payments to the owner of the property. [CC §890(2)]

 

Adverse possession

 

A individual who acts as a landlord and receives rents from residential tenants without the property owner’s consent, or anyone who receives rents claiming ownership of the residential property through a false claim of title, trespass or any other illicit means and does not use the rents to make payments on the loans encumbering the property, is considered to be engaged in rent skimming. [CC §890(a)(2)]

Consider an individual who, within a 24-month period, takes possession of five or more parcels of unoccupied residential property, calling himself an adverse possessor. Each parcel is encumbered by a trust deed lien. The adverse possessor then rents the properties to tenants who take possession under his claim of ownership.

The adverse possessor collects rents during the first year he claims possession. The rents (or other funds) collected are not applied toward payments due on trust deed notes encumbering the properties.

The state charges the adverse possessor with engaging in multiple acts of rent skimming since the rents he collected during the first year he held possession were not first applied toward the payments due on the trust deed notes, and he had no justification (such as maintaining the habitability of the property or correcting code violations) for not forwarding the rents to the lender, up to the amount of the delinquent and current month’s payments.

The adverse possessor claims he is not engaged in rent skimming since he rented the unoccupied properties as his initial step toward acquiring title.

Is the adverse possessor guilty of the crime of multiple acts of rent skimming?

Yes! The adverse possessor is criminally liable for multiple acts of rent skimming. However, the adverse possessor, like any buyer of property, is entitled to take the rents since he was in physical possession of the parcels. Thus, an adverse possessor does not commit the felony of grand theft since his taking of the rents themselves is not a crime, but instead is criminally liable for multiple acts of rent skimming. [People v. Lapcheske (1999) 73 CA4th 571]

 

The federal multiple rent skimming law

Buyers occasionally seek out desperate sellers in default on loans insured by the Federal Housing Administration (FHA) or Veterans Administration (VA). In FHA and VA mortgage rent skimming situations, the buyer acquires two or more one-to-four unit residential properties with little or no money down, and then rents the properties to tenants. A buyer who acquires two or more one-to-four unit residential properties encumbered by FHA or VA loans which are in default at the time of purchase, or intentionally defaults on the loans within one year after purchase (whether the buyer originated or assumed the loan) and instead uses the rental income for his own purposes is guilty of violating federal rent skimming law.

Consider an investor who acquires homes, taking title to two or more that are encumbered by FHA- and VA-insured loans. During his ownership, the investor rents the properties to tenants. After three months of ownership of each, the investor stops making loan payments while receiving rents, defaulting on the loans within one year of acquisition.

The investor is prosecuted for rent skimming by the federal government. The investor claims he cannot be prosecuted since he had no intent to defraud the government.

Is the investor guilty of violating federal rent skimming prohibitions?

Yes! An investor who acquires two or more one-to-four unit residential properties subject to FHA-insured or VA-insured loans which are in default at the time of purchase or defaults on the loans within one year after purchase and intentionally fails to make payments on the loan is guilty of violating federal rent skimming law. [12 United States Code §1709-2]

The investor is rent skimming regardless of whether or not he is personally obligated on the FHA or VA loan. Also, the investor does not need to be aware the properties are FHA-insured or VA-insured in order to be convicted of rent skimming. [United States v. Laykin (9th Cir. 1989) 886 F2d 1534]

However, the federal rent skimming statute does not apply to an owner who only skims rent on a single one-to-four unit property subject to an FHA or VA loan. The owner must be guilty of two or more acts of rent skimming on one-to-four unit residential properties subject to FHA or VA loans to be prosecuted by the federal government.

An investor found guilty of rent skimming will be subject to:

• a fine up to $250,000;
• imprisonment for no more than five years;
• or both imprisonment and the fine. [12 USC §1709-2]

Unlike California law, a buyer is not protected from a charge of federal rent skimming if he used rents as a last resort, having no other funds, to pay his own or his family’s medical expenses, or to pay licensed contractors or material suppliers to correct any building violations. [12 USC §1709-2]

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