The Anatomy of a Lease

Abstract

The review of commercial leases is a key component of an investor’s (or a lender’s) due diligence prior to purchase (or financing) of an investment real estate property. The length of the lease income, in conjunction with the amount of competing, available space in the market, represents the durability of the income stream in our aforementioned QQD framework. The lease is a contractual obligation between the lessor (owner) and the lessee (tenant). The lease documents how much rent will be paid, for how long it should be paid, and how expenses may be shared. In this section, we will discuss how the price of rent is determined, how rent is calculated, and how expenses can be shared between the lessor and the lessee.

The human race is divided into two classes: landlords and tenants.

Gustave Flaubert

Mini-Case: Interpreting a Sample Lease

5.1.1 Commercial Lease Agreement

This LEASE AGREEMENT is made and entered into June 30, 2012, by and between John Landlord, whose address is 100 Main Street (hereinafter referred to as “LESSOR”), and Jane Tenant, Inc., whose address is 150 Deacon Boulevard (hereinafter referred to as “LESSEE”).

5.1.1.1 Article I: Grant of Lease

LESSOR, in consideration of the rents to be paid and the covenants and agreements to be performed and observed by the tenant, does hereby lease to the LESSEE, and the LESSEE does hereby lease and take from the LESSOR, the property described in Exhibit “A” attached hereto, and by reference made a part hereof (the “Leased Premises”), together with, as part of the parcel, all improvements located thereon.

5.1.1.2 Article II: Lease Term

Section 1. Total Term of Lease. The term of this lease shall begin on the commencement date, as defined in Section 2 of this Article II, and shall terminate 5 years from this same said date (the “Lease Term”).

Section 2. Commencement Date. The “Commencement Date” shall mean the date on which the tenant signs this lease.

5.1.1.3 Article III: Extensions

The parties hereto may elect to extend this Agreement for two periods after the termination date, each period being 5 years in duration. Either party must give the other written notice 120 in advance of lease termination date or the previous extension termination date stating its desire to execute the said extension.

5.1.1.4 Article IV: Determination of Rent

The LESSOR agrees to pay the LESSEE and the LESSEE agrees to accept, during the term hereof, at such place as the LESSOR shall from time to time direct by notice to the LESSEE, rent at the following rates and times:

Section 1. Annual Rent. Annual Rent for the first year of this lease shall be Twenty-Five Thousand dollars ($25,000.00), plus applicable sales tax. For each successive year of the lease term, the rent shall increase by the same percentage increase in the annual CPI index.

Section 2. Payment of Yearly Rent. The annual rent shall be payable in advance in equal monthly installments of one-twelfth (1/12th) of the total yearly rent, which shall be 2,083 dollars and 33 cents ($2,083.33) during the first 12 months on the first day of each and every calendar month during the term hereof, and pro-rata for the fractional portion of any month, except that on the first day of the calendar month immediately following the Commencement Data, the LESSEE shall also pay to the LESSOR rent at the said rate for any portion of the preceding calendar month included in the term of this lease. Reference to the yearly rent hereunder shall not be implied or construed to the effect that this Lease or the obligation to pay rent hereunder is from year to year, or for any term shorter than the existing Lease term, plus any extensions as may be agreed upon. It also does not imply or construe that the payments of annual rents are fixed at the amount stated above, as each year the rental payments due will adjust with the CPI index as is noted in Section 1 above. A late fee in the amount of 200 dollars ($200.00) shall be assessed if payment is not postmarked or received by the LESSOR on or before the tenth day of each month.

5.1.1.5 Article V: Taxes

Section 1. Real Estate Taxes. During the continuance of this lease, the LESSOR shall deliver to the LESSEE a copy of any real estate taxes and assessments against the Leased property. From and after the Commencement Date, the LESSEE shall pay to LESSOR not later than twenty-one (21) days after the day on which the same may become initially due, all real estate taxes and assessments applicable to the Leased premises, together with any interest and penalties lawfully imposed thereon as a result of the LESSEE’S late payment thereof, which shall be levied upon the Leased premises during the term of this lease.

5.1.1.6 Article VI: Utilities

Section 1. Utilities. LESSEE shall pay for all water, sanitation, sewer, electricity, light, heat, gas, power, fuel, and other services incident to the LESSEE’S use of the Leased Premises, whether or not the cost thereof be a charge or imposition against the Leased Premises.

5.1.1.7 Article VII: Obligations for Repairs

Section 1. LESSOR’S Repairs. Subject to any provisions herein to the contrary, and except for maintenance or replacement necessitated as the result of the act or omission of sub-lessees, licenses or contractors, the LESSOR shall be required to repair only defects, deficiencies, deviations, or failures of materials or workmanship in the building. The LESSOR shall keep the Leased Premises free of such defects, deficiencies, deviations, or failures during the first twelve (12) months of the term hereof.

Section 2. LESSEE’S Repairs. The LESSEE shall repair and maintain the Leased Premises in good order and condition, except for reasonable wear and tear, the repairs required of LESSOR pursuant hereto, and maintenance or replacement necessitated as the result of the act of omission or negligence of the LESSOR, its employees, agents, or contractors.

Section 3. Requirements of the Law. The LESSEE agrees that if any federal, state, or municipal government or any department or division thereof shall condemn the Leased Premises or any part thereof as not in conformity with the laws and regulations relating to the construction thereof as of the commencement date with respect to conditions latent or otherwise which existed on the Commencement Date, or, with respect to items which are the LESSOR’S duty to repair pursuant to Section 1 and 3 of this Article; and such federal, state, or municipal government or any other department or division thereof, has ordered or required, or shall hereafter order or require, any alterations or repairs thereof or installations and repairs as may be necessary to comply with such laws, orders or requirements (the validity of which the LESSEE shall be entitled to contest); and if by reason of such laws, orders, or the work done by the LESSOR in connection therewith, the LESSEE is deprived of the use of the Leased Premises, the rent shall be abated or adjusted, as the case may be, in proportion to that time during which, and to that portion of the Leased Premises of which, the LESSEE shall be deprived as a result thereof, and the LESSOR shall be obligated to make such repairs, alterations, or modifications at LESSOR’S expense. All such rebuilding, altering, installing, and repairing shall be done in accordance with Plans and Specifications approved by the LESSEE, which approval shall not be unreasonably withheld. If, however, such condemnation, law, order, or requirement, as in this Article set forth, shall be with respect to an item which shall be the LESSEE’S own costs and expenses, no abatement or adjustment of rent shall be granted; provided, however, that LESSEE shall also be entitled to contest the validity thereof.

5.1.1.8 Article VIII: Use of Property by Lessee

Section 1. Use. The Leased Premises may be occupied and used by the LESSEE exclusively as a Hair Salon, to be known as Marvelous Marvin’s. Nothing herein shall give the LESSEE the right to use the property for any other purpose or to sublease, assign, or license the use of the property to any sublessee, assignee, or licensee, which or who shall use the property for any other use.

5.1.1.9 Article IX: Signage

Section 1. Exterior Signs. Tenant shall have the right, at its sole risk and expense and in conformity with applicable laws and ordinances, to erect and thereafter, to repair or replace, if it shall so elect signs on any portion of the Leased Premises, providing that LESSEE shall remove any such signs upon termination of this lease, and repair all damage occasioned thereby to the Leased Premises.

Section 2. Interior Signs. LESSEE shall have the right, at its sole risk and expense and in conformity with applicable laws and ordinances, to erect, maintain, place and install it usual and customary signs and fixtures in the interior of the Leased Premises.

5.1.1.10 Article X: Insurance

Section 1. Subrogation. LESSOR and LESSEE hereby release each other, to the extent of the insurance coverage provided hereunder, from any and all liability or responsibility (to the other or anyone claiming through or under the other way by way of subrogation or otherwise) for any loss to or damage of property covered by the fire and extended coverage insurance policies insuring the Leased Premises and any of the LESSEE’S property, even if such loss or damage shall have been caused by the fault or negligence of the other party.

Section 2. Contribution. The LESSEE shall reimburse the LESSOR for all insurance premiums connected with or applicable to the Leased Premises for whatever insurance policy the LESSOR, at its sole and exclusive option, shall select.

5.1.1.11 Article XI: Damage to Demised Premises

Section 1. Abatement or Adjustment or Rent. If the whole or any part of the Leased Premises shall be damaged or destroyed by fire or other casualty after the execution of this Lease and before the termination hereof, then in every case the rent reserved in Article IV herein and other charges, if any, shall be abated or adjusted, as the case may be, in proportion to that portion of the Leased Premises of which the LESSEE shall be deprived on account of such damage or destruction and the work of repair, restoration, rebuilding, or replacement or any combination thereof, of the improvements so damaged or destroyed, shall in no way be construed by any person to effect any reduction of sums or proceeds payable under any rent insurance policy.

Section 2. Repairs and Restoration. LESSOR agrees that in the event of the damage or destruction of the Leased Premises, the LESSOR forthwith shall proceed to repair, restore, replace, or rebuild the Leased Premises (excluding LESSEE’S leasehold improvements), to substantially the condition in which the same were immediately prior to such damage or destruction. The LESSOR thereafter shall diligently prosecute said work to completion without delay or interruption except for events beyond the reasonable control of the LESSOR. Notwithstanding the foregoing, if LESSOR does not either obtain a building permit within ninety (90) days of the date of such damage or destruction, or complete such repairs, rebuilding, or restoration within nine (9) months of such damage or destruction, then LESSEE may at any time thereafter cancel and terminate this Lease by sending ninety (90) days written notice thereof to the LESSOR, or, in the alternative, LESSEE may, during said ninety (90) day period, apply for the same and LESSOR shall cooperate with LESSEE in LESSE’S application. Notwithstanding the foregoing, is such damage or destruction shall occur during the last year of the term of this Lease, or during any renewal term, and shall amount to twenty-five (25%) percent or more of the replacement cost (exclusive of the land and foundations), this Lease, may be terminated at the election of either LESSOR or LESSEE, provided that notice of such election shall be sent by the party so electing to the other within thirty (30) days after the occurrence of such damage or destruction. Upon termination, as aforesaid, by either party hereto, this Lease and the term thereof shall cease and come to an end, any unearned rent or other charges paid in advanced by the LESSEE shall be refunded to the LESSEE, and the parties shall be released hereunder, each to the other, from all liability and obligations hereunder thereafter arising.

IN WITNESS WHEREOF, the parties hereto have executed this Lease the day and year first above written or have caused this Lease to be executed by their respective officers thereunto duly authorized. Signed, sealed and delivered in the presence of:

____________________       ____________________

“LESSOR”                 “LESSEE”

Date: June 30, 2012

Questions for Discussion

• 1. What type of lease structure is this proposed lease?

• 2. What type of property is this? What business is conducted on site? Who pays the following expenses:

  Expense type	Landlord pays	Tenant pays
  Taxes
  Insurance
  Utilities
  Repairs (structural)
  Repairs (maintenance)
  Insurance

• 3. What would a prudent lender require in terms of the amount of insurance coverage on the subject property?

• 4. Are their any risks to the landlord in structuring a lease in this manner?

• 5. What other lease provisions might you consider adding to this lease agreement prior to execution?