Commercial Real Estate- The Key Factors About Lease Provisions That Become Detrimental To The Value Of An Investment Property

Date Post: March 11, 2020

March 6, 2020, in Commercial Real Estate

In commercial real estate, it’s important for investors to understand the structure of a lease and provisions included. Lease structure greatly impacts property value whether you are selling or purchasing a commercial real estate.

On the other hand, tenant or lessee can negotiate the best lease terms in lieu of long term commitment backed by the corporate or personal guaranty. Such a lease allows the tenant to do future business planning, run cost effecting operation and build a loyal customer base.

The key factors that you need to consider a lease structure:

Base terms and option
Rent bumps and income growth
Lease Structures & Landlord responsibilities
Lease Guarantor- corporate, franchisee, or personal
Rigorous assignment
Indemnification language

Base terms and option

Longer the base terms, the higher the property value. When structuring options, whether for 25 years, 15 years, 10 years, or 5 years, breaking down option into reasonable periods is more attractive than one long term, or too many short term options. For example, ‘2 five-year options’ is more desirable than ‘10 one-year options’ or ‘one 10 year option’. Make sure to look at both the base terms as well as the options structure.

Rent bumps and income growth

A fixed rent structure is preferred over rent bumps that are tied to CPI or market value. You can choose from some common terms like 10% increase every five years, 7.5% increase every five years, or even 2% increase annually.

Lease Structures and Landlord Responsibilities

There are different lease types such as single net lease (N), double net lease (NN), triple net leases (NNN), full service gross, and modified gross lease (modified net lease). It’s important to understand the pros and cons of each so you can choose which one is best for you.

As an investor, NNN or absolute NNN lease means minimal landlord responsibilities. This works great for a busy professional who is looking for passive investment. Single-tenant properties would normally have such a lease in place.

Guarantor being a corporate, franchisee, or personal

Look at who is behind the lease. National Credit Tenants, are tenants that carry investment-grade rating based on the size of the company and financial strength. Such a tenant provides great security to investors. It is preferred that the guarantor is corporate. If not, it should be a franchisee or a personal guarantor.

Rigorous assignment

If possible, the lease should not be assignable. However, if it is assignable, you want to make sure that you have a rigorous assignment term. Put some limitations, whether it is in the units or net worth in terms of dollars. This is to give you the best long-term security.

Indemnification language

Ask your attorney about the indemnification language, you want to have indemnification against environmental issues to give you more security over the long term. If possible, the tenant should have full indemnification against any long term environmental issues.

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