Leases are at the heart of value for investment real estate. Well-crafted lease agreements can create value for both landlords and tenants, and poorly designed agreements can do just the opposite. Be as careful and thorough as possible when negotiating this real estate contract or else you could find yourself saying, “Oops, I should have put that in the lease!”
A recent episode of the “Commercial Real Estate Show” provided an enlightening look at a few of the common trouble spots in leases and provided some tips for crafting good leases.
Get good help
The requirements for commercial leases can vary widely from state to state so obtaining the guidance and advice of local experts is essential, said John Wiles, a managing partner of the Wiles & Wiles law firm in Atlanta. “We regularly negotiate leases with out-of-town lawyers,” Wiles said. “It’s always fun because they think what’s going on in New York is the law all around the country, and we sometimes clean up on them just because they don’t know the local law.”
Laws requiring commercial landlords to make disclosures about their properties are relatively few, Wiles said. Therefore, it is imperative for tenants to ask questions during lease negotiations. “If you’re a tenant or a tenant’s lawyer and you’re concerned about security, flooding or any other thing, you need to ask, because there is a duty [on the part of the landlord] to be truthful,” he said.
Know who you’re dealing with
Too often, tenants are not as diligent as they need to be in determining exactly who their landlords are, guests noted. “I’m amazed at how few people really understand who their landlords are,” said David Tennery, the principal of Regent Partners’ Office Properties and Development Group in Atlanta. “That is critical and before you really begin to negotiate that document, run a title report and make sure early on you understand exactly who that landlord is.”
On the flip side, landlords should run background checks on prospective tenants to get a firm handle on the financial strength or potential shortcomings of the prospective tenant, Wiles advised.
It’s also important for a landlord that the tenant entity is actually who you think it is. If you need to enforce collections and you find the national tenant used a similarly named entity as a holding company for signing leases, you could be saying, “Oops, I should have covered that in the lease.”
Clauses for concern
As a landlord you want to be aware of how lease clauses will affect value and your ability to sell or finance the property. Landlords should be hesitant to grant tenants early termination rights in leases, Tennery added. Property owners were fairly willing to give tenants the rights during the recession, when space was hard to fill, but the clauses “are value killers for a number of reasons,” Tennery said.
As landlords, “we want long-term, stable net-operating income, and anything that interrupts that, in the middle [of the lease] or earlier, affects everything we’ve done, the capital we’ve put out on the front end,” Tennery said.
On the other hand, a tenant should consider the merits of pursuing a non-disturbance agreement, which guarantees that the tenant can stay in the property under the terms of its lease in the event that a property is foreclosed on, Tennery advised. In an environment of climbing rental rates, a new landlord is likely to be anxious to remove existing tenants in favor of higher-paying ones, according to Tennery.
In multi-tenant facilities, landlords must also keep track of the exclusive-use rights, expansion rights and co-tenancy clauses they have granted to tenants. This would seem to be the no-brainer of no-brainers, but my guests and I discussed how sloppy reviews of existing leases prior to signing new ones are surprisingly common.
Wiles recalled a story from his young associate days that highlighted the expensive problems landlords can create for themselves when they fall asleep at the switch. A fellow associate of Wiles “had to read every single lease in an office building that was being sold, and on one floor they had four different tenants that had rights to expand into the same space,” Wiles said. “You know what the solution was? The buyer went to the seller and said, ‘Get out your checkbook. Go buy out three of those four expansion rights.’”
A different animal
Leases for residential properties feature more disclosure requirements – such as the federal requirement that owners disclose any information they have about the existence of lead-based paint or other lead hazards,said Robert Hein, an attorney with Fowler, Hein, Cheatwood & Williams in Atlanta.
Additionally, “in a residential lease, you cannot shift the duty of repair from the landlord over to the tenant,” Hein said. “Even if that provision is in there, it’s not going to be enforceable.”
Michael Bull, CCIM, is founder of Bull Realty Inc., a U.S. commercial real estate sales and advisory firm headquartered in Atlanta, and the host of the nationally syndicated "Commercial Real Estate Show."