Managing a Vacation Rental Purchase Transaction

By Fred MorenoChief Deputy Legal Counsel

Have you acted as a broker in a transaction where the subject property was being leased? If so, you may have learned that North Carolina has two different sets of laws relating to rental property, one pertaining to long-term rentals (Chapter 42), and the other to “vacation” rentals (Chapter 42A). This article will discuss the implications that Chapter 42A may have on the transfer of vacation rental properties.

What makes a rental property a “vacation rental”? Chapter 42A, the Vacation Rental Act (“VRA”), defines a vacation rental as “The rental of residential property for vacation, leisure, or recreation purposes for fewer than 90 days by a person who has a place of permanent residence to which he or she intends to return.” The bulk of the VRA deals with the management of these properties, so anyone handling the management of vacation rentals should be familiar with this law.  But, what about brokers who only deal in sales?  Do they need to know about the VRA? Absolutely – they might be listing one for sale, or representing a buyer who is purchasing one.

There is a common misconception that the VRA only deals with properties located at the beach. In reality, however, rental properties that fall under the VRA are found on the coast, in the mountains, and everywhere in between. More residences in more locations are available now than ever before due to the emergence of the Internet and sites run by companies such as VRBO, Airbnb, and FlipKey, among others. These sites have made it much easier for property owners to rent their places out for a week, two weeks, a month, or even just a weekend get-a-way. The VRA may apply to these properties whether they are being managed by licensed brokers or by unlicensed property owners.

It is common practice for tenants in vacation rentals to submit their applications months or even a year in advance of the dates they intend to occupy the property. Typically, these tenants will also pay most, if not all, of the rental amounts well in advance of their secured dates. This should create two major questions for any buyer agent or listing agent when faced with binding vacation rental agreements during the sale of the property: (1) how are the future tenants going to be handled by the new buyer, and (2) how are the deposits being handled as a result of the sale?

What do we do with these tenants when a property is sold prior to their reserved dates?

NC law requires that a residential property purchaser takes title subject to any vacation rental agreements that are to end “no later than 180 days after the grantee’s interest in the property is recorded”. This means that the purchaser MUST honor those vacation rental agreements. Failure to do so subjects a buyer to a civil lawsuit. A purchaser is not required to honor vacation rental agreements that end more than 180 days after recording, but if they do not, then the tenant is entitled to a refund of the monies paid, minus any fees allowed by law.

The VRA also requires that the property owner disclose to the potential buyer the time periods of any vacation rental agreements currently in place, prior to entering into any contract for sale.  Existing reservations within the 180-day window are a material fact that any listing broker must disclose to prospective purchasers. The property owner is also required, within 10 days after the property transfer, to disclose the name and address for each tenant and to provide a copy of each vacation rental agreement. This task is often handled by the listing agent, working with the seller’s vacation rental manager, if any. A listing agent should ensure that required disclosure is being handled as part of the transaction.

The new purchaser also has duties under the law.  Within 20 days of recording, the purchaser must: (1) notify each tenant in writing of the property transfer, the new purchaser’s name and address, and the date the interest was recorded; (2) advise each tenant whether they have the right to occupy the property subject to the terms of their vacation rental agreement and the provisions of the law; and (3) advise each tenant of whether they have the right to receive a refund of any payments they made.

What do we do with their money?

In a purchase transaction, buyer agents and listing agents must know what is going to happen to the advanced rents, already paid by tenants. These could have been paid to the owner directly, or to a property management firm on behalf of the owner. Some of it may have already been disbursed to the property owner by the management firm prior to the tenant occupying the property. In any case, the law requires that the property owner, or their agent, transfer these funds minus any lawful deductions to the new owner.  The law requires this to occur within 30 days of the property transfer; typically, it is reflected on the Closing Disclosure statement and sent from the closing attorney’s trust account at closing.  This means the amount being held must be accounted for and transferred to the closing attorney prior to closing. It is important for both the listing agent and buyer agent to verify that the correct amount of funds are being transferred.

The law also requires the property owner to refund any advanced rents minus any lawful deductions, back to tenants whose vacation rental agreements end after 180 days of recording and whose agreements the new owner will not honor. This must also occur within 30 days of transfer.

What are “lawful deductions”?

Lawful deductions may include fees earned by a property management company who managed the property up until recording.  Management fees are owed by the prior owner, not the tenant. So, if they have already been deducted from the tenant’s deposit, the prior owner is responsible for either reimbursing the tenant or adding the deducted amount to the funds being transferred to the new owner as part of the deposit transfer.

In a Nutshell The sale of residential property that is or has been used as a vacation rental can harbor a number of potential issues that can come back to bite a broker who is not alert to the situation.  It is imperative that a listing agent talk with their seller client and gather all information prior to listing about current vacation rental agreements in place. It is also imperative that a buyer agent talk with their buyer client and discuss the implications of the VRA, including that the buyer would have to honor vacation rental agreements within that 180-day period. The listing agent should also reach out to the property manager, if there is one, and bring them into the loop regarding the sale.  The property manager could be a valuable asset for things such as providing copies of vacation rental agreements and documentation regarding repair issues, as well as providing an accounting of advanced rents that have already been collected or disbursed. Finally, if the proper steps are not followed under the VRA, such conduct may be found to constitute an unfair or deceptive act under N.C.G.S. §75-1.1, which can result in treble damages in a successful lawsuit.