Commercial real estate lease is a contract that creates and defines the legal relationship between the landlord or lessor and the tenant or lessee. In exchange for payment of rent and other considerations, the landlord grants to the tenant the right to possession and use of all or part of the property, subject to certain terms and conditions, for a specified period of time. In most types of commercial real estate, leasing provides the bulk of revenues available to service the mortgage loan; thus, understanding and accurate evaluation of lease terms and conditions is crucial to underwriting a loan. Lease obligations often require post closing management by loan administrators as well.
There are two primary considerations from the investor’s perspective:
- Poorly drafted leases can create economic problems for the borrowers, which may put at risk his or her ability to make loan payments.
- If the investor takes the property back, he or she will have to live with the terms and conditions of the lease, unless provision is made that the investor has the option to terminate it. In most foreclosure situations, however, tenants paying rent are a valuable commodity.
The rules and regulations should be understood before leasing the property, and an agreement should be drafted. There are some items to be followed.
- It must be perfectly defined and include all details of the parties of the lease, including the correctly-spelled full name of each party, the nature of the legal form, and the state of domicile for the partnership, or corporation. Individuals may sign for themselves, any general partner for a partnership, and the president or secretary for a corporation. If there is any question on a corporation, a copy of the resolution of the board of directors granting signing authority should be attached. If the signer is acting as an agent for a principal, written authority from that principal should be attached.
- Demised premises should be precisely identified, in terms of building address, floor number, suite and store number, and area in square feet to be leased. A floor plan or drawing of the space in relation to the entire property is very helpful. Inadequate identification can invalidate the lease. The lease should also state whether parking rights are exclusive or nonexclusive, and whether specific parking spaces are designated for the tenant. For parking, separate charges should be noted by the reviewer.
- The term of the lease should be stipulated, in years and odd months. Lease commencement and termination dates should be clearly stated, as well as the date on which the first rent payment is due. Any renewal options should also be noted.
- The tenant should clearly understand exactly how the rent and contributions for expenses are to be paid, because there are considerable variances, even within a given market.
- The lease should define a number of conditions for maintenance, utilities, and equipment. The tenant’s obligations related to repairs should be clear to ensure they maintain the space in good order. The tenant’s rights to alter the leased space must also be carefully defined.
- If the landlord abates rent during restoration and agrees to restore it in a reasonable time, the tenant cannot cancel the lease or sue the landlord for a breach of the lease if the tenant’s space is damaged.
- The lease should be clear that it is retained by the landlord. In the age of sometimes-unnecessary lawsuits, the landlord may be sued because of external environment problems beyond his control.
- The rules and regulations of the building should be attached as an exhibit to the lease.