The listing says the property grosses 2,400 dollars a month and the seller has the deposits to prove it. You ask for the lease. The lease is for 1,650 dollars a month, signed two years ago, and it contains a clause permitting the tenant to sublet with written consent. The 2,400 is what the tenant collects from two people living there, or from a nightly booking calendar, or from a company that took the whole unit and re-rents it.
Your tenant is operating a business on top of your asset. The question is not whether that is allowed, because the lease you are about to inherit already answered that. The question is which number your lender will use, and the answer is usually the smaller one.
The lower-of rule does the damage before anything else does
Almost every investor program underwrites rent as the lower of the contract rent on the lease in place and the market rent supported by the appraiser. That is the whole mechanism, and it is the reason this situation is expensive.
Your contract is with the tenant. The tenant’s contract with the subtenant is not your contract and is not your income. You cannot collect it, you cannot enforce it, and if the tenant stops paying you, the subtenant’s payments do not reach you automatically. So the lender looks at 1,650 dollars, compares it to the appraiser’s market rent opinion, and uses the lower.
Work it. Purchase at 265,000 dollars with twenty percent down gives a loan of 212,000. At 7.25 percent over thirty years, principal and interest is about 1,446 a month. Taxes of 2,640 a year add 220, insurance of 1,320 adds 110. PITIA is 1,776.
At the 2,400 the listing advertised, the ratio would be 2,400 divided by 1,776, which is 1.35. A good deal.
At the appraiser’s market rent of, say, 1,900, it is 1.07.
At the actual contract rent of 1,650, it is 0.93. Below one. The property does not cover its own debt service on the number the lender is required to use, and you are now shopping for a program that tolerates a sub-one ratio at a materially worse rate and lower leverage.
Same house, same tenant, same cash actually changing hands on the street. Three different answers depending on which piece of paper governs. The formula underneath all of it is in how to calculate DSCR, and you should run your own version in the DSCR deal calculator using the lease number rather than the listing number before you write an offer.
This is the same trap as a long-tenured tenant paying under market, which is laid out in buying a rental with a below market tenant. The sublet version is worse, because the gap between what the property produces and what you are credited with is visible, documented, and right in front of you.
Read the sublet clause before you read anything else in the lease
Residential leases handle this three ways and the differences matter.
Silent. The lease says nothing. Default rules vary by state, and a surprising number of jurisdictions permit assignment or subletting unless the lease prohibits it. A silent lease is not a prohibition.
Consent required, not to be unreasonably withheld. The most common drafting. It sounds protective and it is weaker than it reads. You get a veto, but you have to be able to articulate a reason, and a creditworthy proposed subtenant is hard to refuse on a straight face.
Prohibited outright. Clean. If the tenant has been subletting anyway, you have a breach and a remedy, which is a different situation with different options.
Whichever one you find, read it as the agreement you are buying, because you are. You do not get to rewrite the lease at closing. You step into the landlord’s shoes on the terms already there, and in most states you are bound through the end of the current term.
Pull the actual signed document, all pages, with every addendum. Do not accept a summary and do not accept the listing agent’s description of it. If there is no written lease at all, you are in a different fact pattern entirely, which is covered in buying a rental with a month-to-month tenant. And if the lease is the only income document on the file, the lender’s requirements for it are in do you need a signed lease at closing.
The estoppel is where the truth lives
The single most useful document in this deal is a tenant estoppel certificate. It is a signed statement from the tenant confirming the rent, the term, the deposit held, whether there are side agreements, and whether anyone else occupies the unit. It is the only instrument that gets you the tenant’s version in writing before you own the problem, and the full case for it is in the tenant estoppel certificate on a rental purchase.
On a sublet property, add three specific questions to it. Who currently occupies the unit and under what arrangement. What does that occupant pay and to whom. Is there a written sublease, and will you provide a copy.
If the tenant refuses to sign an estoppel, that is information. If the tenant signs one that contradicts the seller’s rent roll, that is better information, and it is information you got during the inspection period instead of after closing.
Short-term subletting is its own category
When the subtenancy is a nightly rental operation run by your tenant, three additional things are true at once.
First, the local regulatory question applies to the property regardless of who is operating. If the municipality requires a permit for short-term occupancy and there is none, the violation attaches to the address, and in some jurisdictions to the owner. That regulatory landscape is the subject of short-term rentals in regulated markets.
Second, the lender will not treat nightly income as qualifying income here no matter how good the booking history looks, because it is not your income. If you intend to take over the operation yourself after the lease ends, that is a future-state business plan, and the rules for qualifying on nightly revenue when you are the operator are in how Airbnb income qualifies. Those rules do not help you on a file where a tenant is the host.
Third, and this is the one people miss: your insurance. A standard landlord policy contemplates a long-term tenant. Transient occupancy is a different exposure, and a carrier that learns about it after a claim has an argument. You want the carrier to know what is actually happening at the property before you bind, not after.
What the appraiser does, and does not, see
The appraiser forms a market rent opinion for a long-term unfurnished tenancy of that unit. Not the sublet revenue, not the nightly rate, and not the premium the tenant earns for running the operation. That opinion is what your lender compares the contract rent against, and how it is built is explained in how Form 1007 sets the number your ratio runs on.
On the value side, the appraiser is doing something separate again: adjusting recent sales to your subject. A property occupied by a sub-landlord does not appraise differently for that reason, and the arithmetic of how the comparison actually gets made is in the adjustment grid.
So do not expect either the value or the market rent to rescue a weak contract rent. They are independent of it.
The occupant nobody vetted
Your tenant screened the subtenant, or did not. Either way you inherit whoever is living there, and your lender has its own interest in who the occupant is. The four places an occupant actually shows up in a loan file are catalogued in does your lender screen your tenant.
Worth distinguishing clearly: a lawful subtenant under a permitted sublease is not the same as an unauthorized occupant with no legal right to be there. The second situation has a different and harder playbook, set out in buying a rental with a squatter or unauthorized occupant. If the lease prohibits subletting and the tenant did it anyway, you may be closer to that second situation than the first.
And if the master tenant is behind on rent to you while collecting from a subtenant, that is its own fact pattern with its own underwriting consequence, covered in buying a rental where the tenant is behind on rent.
When the current tenancy ends and you take the property over yourself, the screening standard you apply is entirely yours, and what actually predicts payment is the subject of how to screen a tenant.
Three ways to structure around it
Price to the lease, not the operation. The simplest answer. If the lender will credit 1,650, underwrite the purchase price at 1,650 and make the offer that works at that number. The sublet premium is upside you capture when the lease rolls, not value you pay for today.
Buy it delivered vacant. Negotiate for the lease to be terminated before closing at the seller’s cost and risk. Then the appraiser’s market rent becomes the governing number, which in the example above moves you from 0.93 to 1.07, and you control the next tenancy. The seller may not be able to deliver this, and if they cannot, that tells you something about the tenant.
Restructure the tenancy. If the subtenant is the better credit and wants to stay, a direct lease with the subtenant at the real market rent, replacing the master lease, fixes the file. This requires everybody to agree, which means it usually requires paying the master tenant something to step aside. That payment is frequently cheaper than the rate difference on a sub-one ratio loan.
One thing that does not work: counting the sublet revenue by adding it to the rent roll yourself. Ancillary and non-lease income gets scrutinized carefully even when it is genuinely yours, which is the whole point of whether a lender counts ancillary income. Income that belongs to your tenant is not a close call.
The bottom line
A sublet property shows you a gross number you cannot use and hands you a contract rent you are stuck with. The lower-of rule converts that gap directly into coverage ratio, and in the worked example it was the difference between 1.35 and 0.93 on an identical building.
Get the signed lease and every addendum. Get an estoppel with the occupancy questions added. Underwrite at the contract rent. Then decide whether you are buying the building at that number, negotiating for vacant delivery, or paying the master tenant to get out of the middle.
The documentation habits that make this easy are the same ones that make the rest of the file easy, including the ones in who actually holds your note and the frozen credit file. Read the paper early. Almost every expensive surprise in this business is a document somebody skimmed.
FMC Capital is a Pittsburgh-based mortgage brokerage. We place loans on rentals and flips across Pennsylvania and additional states. NMLS #1840537. Rates, terms and program parameters vary by lender and are subject to change, and nothing here is a commitment to lend or legal advice. Call 412-990-2941 or get in touch.