FSP0002 – Real Estate Leases – Facility Science Podcast #2

By | May 7, 2019
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Notes for FSP0002 – Real Estate Leases
Lease Types and Terminology
  • Lessee = Tenant,  User of the property, pays rent.
  • Lessor = Landlord, owner of the property, collects rent
  • Lease Types by What you pay for
    • Full Service Lease – Usually in office buildings. Rent includes “everything” (base rent, taxes, insurance, maintenance, cleaning, garbage removal, possible water and electric, etc.)
    • Gross Lease – Includes base rent + operating expenses, usually insurance, taxes, maintenance, etc. Usually utilities paid by tenant but terminology varies.
    • Net Lease
      • Lease payment is net some specific operating expense (taxes, insurance, maintenance)
      • Single net (property taxes)
      • double net (taxes, insurance)
      • triple net (taxes, insurance, maintenance)
      • ground – lease ground only, build and operate your own building.  Land owner usually gets the building at the end of the lease.  Various tax and cash flow reasons to do this. The lease would be structured in such a way as to make this make sense to the tenant.
      • bondable
        • often includes construction
        • absolute triple net
        • tenant carries all risk including destruction of building
        • typically not terminable by the tenant even in the event of destruction or condemnation
        • tenant would be “investment grade” as in expected to not fail during the term of the lease. (Home Depot, WalMart)
        • “Bondable” because the structure of the lease and quality of the tenant allows the property to be viewed as a bond for investment purposes.
  • SNDA Clause – Determines the rights of the lender(s) and tenant in the event of a landlord default and foreclosure of the property. Subordination, Non-Disturbance, and Attornment (SNDA) Agreements
    • Subordination – Tenant agrees to take a lower interest to 3rd party lender.  Lenders will require subordination and landlord may include language to compel the tenant to subordinate to any new lender. (So what does that mean? Say you enter a lease agreement with the owner of a property, so only you and the owner have any legal rights to the property and those rights are specified in the lease agreement. Later, the owner takes a mortgage on the property. Since you signed a lease agreement, gaining a legal right to use the property, before the lender was involved with the property, and you also didn’t make any subsequent agreement with the lender, you could conceivably, for example,  prevent the bank from taking over the property if the owner doesn’t pay back the loan. No bank would want to make loan under those circumstances which is why pretty much all leases include a subordination clause. What Does a “Lease Subordinate to Any Mortgage” Mean?
    • Non-Disturbance – in exchange for subordination, the tenant would want non-disturbance. Protects the tenant from being removed from the property in the event of foreclosure or sale of the property.  The extent of non-disturbance can be negotiated so that the lender may not be bound to all the obligations of the original landlord or may only be obligated to allow the tenant to continue to occupy the property.
    • Attornment – If ownership changes, tenant agrees to recognize the new owner (possibly lender) as the landlord and continue to satisfy tenant’s lease obligations for the full term.
  • Leaseback (sale and leaseback) The main reason: Bet that money has a higher rate of return in business than in real estate. Owning the building isn’t one of the goals of the business, but owning the building ties up some non-trivial portion of the portion of the business’s capital. (other benefit) Also, if the business has a loan on the property, that has to be on their balance sheet as a debt. With a sale-leaseback arrangement, they have the same monthly expense (debt service vs lease payments) but they no longer have a debt on the balance sheet. New accounting rules require leases to be declared on balance sheet to prevent dishonest accounting in this area. See: FASB Accounting Standards Update 2016-02
Facility Related Lease Issues
  • Full service lease issues
    • Hours of operation
      • HVAC setpoints, setbacks
      • Cleaning service
    • Recourse for lack of agreed upon level of service
      • First have service level agreement
      • Clause that allows for reimbursement if you have to make repairs to keep business running and management is not responsive
    • Change in space usage
      • Use of space for different than original purpose
  • Repair and Maintenance
    • On a net maintenance lease make sure it is very clear who is responsible for what
      • Leaky faucet, hole in wall is you
      • Parking lot paving or roof replacement probably shouldn’t be you on a short lease term.
  • Legal Compliance (who pays to bring to compliance) Landlord should warrant initial compliance.  Tenant may take on cost of future compliance or “particular use” compliance. “Are You Losing Money?” 10 Common Pitfalls for Commercial Tenants to Avoid
    • ADA compliance in existing build
    • Fire sprinkler at existing occupancy. Tenant responsible for compliance with particular tenant changes.
    • Earthquake/hurricane/flood retrofitting
  • Tenant improvements
    • Allowance vs turnkey
    • IF allowance, make sure allowance doesn’t go toward common areas or legal compliance retrofit (asbestos abatement, sprinklers)
    • Rent payments start before, during, or after tenant improvements?