Landlord: Keys to Successful Rental Income

Raymundo LarraĆ­n Nesbitt, January, 31. 2008

Article copyrighted © 2008. Plagiarism will be criminally prosecuted.

By Raymundo Larrain Nesbitt
31st of January 2008

 

Over the last decade we have witnessed an explosive growth in the rental market in Spain. Coastal areas are awash with properties to let by expat landlords. However, many landlords are unaware of the different mechanisms in place to secure such rental income and therefore often fail to implement them in their rental agreements, which leaves them unprotected if the tenant decides to stop paying the rent. Mechanisms such as bank guarantees and rental income insurance enable them to rent out their property safely. In this article we strive to deliver some legal insight by identifying and employing such mechanisms in your own advantage.


The problem with defaulting tenants in Spain

Dafaulting tenants have become a real nuisance for landlords who rent out their Spanish property. The number of tenants who default on their monthly payments is increasing at alarming rates, to such an extent that it is considered the main reason as to why landlords don’t let their properties.

If your tenants stops paying the rent, it is advisable to start an eviction process as soon as possible. An eviction process can take anything ranging from 10 to 18 months. The loss of rental income during this period of time can leave the landlord in bad financial shape, and things may turn uglier if the rental income is partly being used to pay off a mortgage: if the monthly payments are not met, the bank could repossess the property. A horror story that many a landlord can be faced with.

Tips on how you can secure your rental income in Spain

There are different options you can implement either to reduce the risk of not being paid your monthly rental income, or completely eliminating it. The cost varies depending upon the level of protection each option offers, which ranges from ‘free’ for the most simple tenant credit checks, to the most expensive rental income insurance options (which can be up to one month’s rent fee for a one year insurance rental policy)

These options are the following:

  1. Know your tenant. A good starting point is to know well your prospective tenant. This is something which is done in the UK although not in Spain, safe in large cities such as Madrid and Barcelona. It would be most advisable to request from your prospective tenant a copy of their last payslips much like in Britain is done. If he has a labour contract (indefinido) he is –generally- more financially reliable than a self-employed (autónomo). Additionally, requesting a letter from their bank manager as to ascertain their financial ability might be a good idea.

    These easy steps help to weed out professional squatters who move around the country only paying the first month’s rental or two and then stop paying all together. Unfortunately Spain’s laws are biassed to protect the tenant, not the landlord, and some unscrupulous people take advantage on this fact.
    By law you are entitled to request a month’s rental as a deposit following art. 36 of the Rental law for dwellings which the rental agency normally withholds.

  2. Agree to setting up an Arbitrage mechanism.- May be included in the contract’s clause as an alternative option in lieu of litigation. The ruling by the abitror compels both parties and cannot be appealed. This option is available mainly in large Spanish cities and saves considerable time.

  3. Implement a rental Bank guarantee. Our advice for landlords is to require from a prospective tenant a rental bank guarantee or “aval bancario”. This would ensure the landlord against the tenant defaulting. The landlord may execute said guarantee and the bank would be obliged to pay them immediately as it is an executive title in Spanish law. The bank in turn would claim this amount on the tenant. This bank guarantee should ideally be made to secure the following 5 years even if the tenancy agreement is for short term (eleven months).

    However there is a catch, claiming on this rental bank guarantee is no substitution for an eviction procedure, rather a compliment to it. For example, the tenant may default on the second month, the landlord after having sent to the tenant letters claiming the owed rental to no avail, executes the bank guarantee (which secures for example 6 months rental). In despite of this, the tenant will still be living in the property. The landlord would then have to wait until the six months are over to initiate an eviction proceeding at the court.

    Ideally rental bank guarantees should be exercised after the eviction ruling, not before. It is common place that tenants on Spanish coastal areas have, naturally, no assets of their own so after an eviction process the landlord is still owed the lost rental income. The bank guarantee could then be claimed on to offset this rental loss. The tenancy contract would also have to be terminated of course for breach of contract according to art. 1124 of the Civil Code. We advise you to hire a lawyer on doing this.

    In the current economical context in which -specially in coastal areas- tenants are defaulting increasingly this bank guarantee would act as a safety net for landlords ensuring payment once the eviction process is over helping to take off stress.

    Is a rental bank guarantee suitable in all cases?

    No it isn’t. It is suitable for long term tenancy’s (eleven months renewable) not for short periods such as summer lets (one month or a couple of weeks).

    A bank guarantee is expensive and requires the tenant to deposit lump sum an amount of money at their own bank, typically 12 months rental, which is left in custody. On top of this, banks normally charge 1% of the amount, notary fees, opening interest and a quarterly interest. Not all tenants find themselves in a comfortable financial position to provide this bank guarantee either because they simply do not have the money or, even if they do, are unwilling to have it tied-up until the guarantee elapses which could be as long as 5 years.

    Does the bank guarantee ensure the tenant’s financial ability?

    No. The bank at no time carries out a due diligence on the tenant’s assets and financial ability. It only guarantees that the tenant deposited an amount of funds equivalent to say twelve months rental which you can claim on default. The tenant cannot dispose of said funds until the bank guarantee elapses. Notwithstanding banks include clauses that might hinder the execution of the guarantee which is why we recommend you to hire a lawyer to help arrange these guarantees and avoid abusive clauses which render the guarantee virtually unclaimable.

    At what stage is this bank guarantee handed over to the landlord?

    This guarantee is handed over by the tenant at the time of signing the rental agreement, never after. The landlord will hold it and deliver it back once the tenancy is terminated satisfactorily with no pending amounts owed.


  4. Arrange a Rental Insurance. In Spain there are companies that offer relatively inexpensive tenancy insurance charging only a one-time annual fee equivalent to 60%-100% of a monthly rental. This insures the landlord against the tenant defaulting, and covers lawyers’ fees during the eviction process (up to around 2,100 €). They also insure different scenarios such as the tenant destroying furniture during the eviction process up to a pre-agreed capped amount (normally 3.000 €).

    These insurance companies do evaluate the credit risk of the prospective tenant unlike banks with rental bank guarantees.

    i.e. A typical monthly rental of 900 € would mean you would have to pay one annual payment of 900 €.


Duration of Spanish Rental Contracts

In Spain short term lets (typically 11 months) have been devised to waive the Rental Act (LAU). The LAU stipulates that any tenant staying longer than a year in a property without the landlord’s opposition is entitled legally to stay in it for the next 4 years making a total of 5 years (long term let). That is why a bank guarantee should last ideally 5 years even if the tenancy is for a short term let (eleven months).

Having signed a short term let is no guarantee as in case of default it might transform itself into a long term let if the landlord doesn’t act fast enough. That is why an eviction process becomes a necessity in case of unpaid rental. Landlords in general cannot afford to have someone occupying their property for the next five years. This is where a lawyer is needed.

 

Conclusion

Finding a tenant to let your property is no major feat albeit evicting one takes its toll both in time and money.
That is why it is most advisable to hire the services of a lawyer from the on start, before you even begin searching for a tenant. A good independent lawyer will draft a rental contract covering diverse issues such as bank guarantees and rental insurance protecting your interests even if the tenant defaults.

Besides, there is also a cost of opportunity in which your property will be occupied by the tenant during the eviction procedure for the next 10-18 months in which you will be both losing rental income and still be obliged to face mortgage repayments.

Hiring a lawyer may well mean the difference in saving yourself thousands of pounds in legal fees and expenses as well as removing all the associated stress of a defaulting tenant.

 

Are you Renting out your property?

We advise you to hire the services of a lawyer to ensure you are fully protected if your tenant should stop paying the rent. Lawbird Legal Services offers the Drawing up of a Rental Contract service, which includes options such as implementing rental bank guarantees or setting up rental income insurance policies. If you are interested in this service, please contact us.

 

Larraín Nesbitt Lawyers, small on fees, big on service.

Larraín Nesbitt Lawyers is a law firm specialized in litigation, conveyancing, taxation, and inheritance. We will be very pleased to discuss your matter with you. You can contact us by e-mail at info@larrainnesbitt.com, by telephone on (+34) 952 19 22 88 or by completing our contact form.

 

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