Commercial Real Estate Leasing Agents – Why You Should Understand Lease Covenants

As you service and help commercial real estate investment clients, lease covenants and terms can be a critical part of property performance and the established tenancy mix strategy. Every lease can be potentially different, and in a property with a number of tenants in occupancy, lease interpretation and management becomes really important.

To take matters a bit further, it is worthwhile establishing a checklist of lease topics and ideas to review with every property investor client. Understand what the client is looking for and how the terms and conditions of any lease will impact the clients overall investment result.

Ways to Review Leases

Here are some basic ideas and questions to raise and investigate as part of the lease structure and review process:

1. Property Usage – understand the legal use of the property and the current zoning that applies to existing planning regulations. The tenant and the lease should be matched to the legal use of the property. The lease itself should clearly determine and control how the property will be used by the tenant. The permitted use clause within the lease should be quite specific and detailed. In a property with many tenants this strategy becomes even more important and critical to the tenant mix.
2. Rental Structure and Strategy – the lease will reflect the strategy behind rental charges and collections. The lease may reflect gross or net rentals depending on the occupancy situation. Outgoings will also be recovered as part of the rental strategy across the year. Always review a lease in detail to understand how the rental structure works and the outgoings are recovered. When you understand the figures, you can compare them to the levels of market rental in the local area for the property type.
3. Lease Terms and Conditions – comprehensively review all the terms and conditions of every lease within a property. Look for the variations that could have an impact on the landlord and their investment requirements. Look at the expiry dates and the options situations that will occur during the lease term. Some leases will impact the property cash flow and hence the investment. Learn to read lease documentation and interpret the longer term property cash flow. Compare the net rental results regularly to the potential property value, and in doing so achieve the capitalization rate or yield result for the client. Compare those figures to the current market conditions and the property type.
4. Property Budget and Rental Budget – when working with an entire property and the lease strategies behind the investment, ask to see the overall property budget and particularly both income and expenditure in an itemized form. From the budget you can assess expenditure rates per unit of area and compare those expenditures to other properties locally; you can also see how outgoings expenditure is recovered from the tenants given the existing lease documentation. From an investment perspective, your leased property should be within the expenditure averages for the property type.

In reviewing these four topics, you can move further into issues of property performance. Start with the basic information and move into levels of greater detail with every lease document, each tenant in the mix, and cash flow opportunity.