Lease Provisions that Affect the Resale Value of Investment Properties

Welcome to CRE Fast Five where we
detail hot topics in commercial real estate in five minutes or less. I’m Karly
Iacono and today we’ll be talking about lease provisions that impact the
resale value of investment properties. We’re going to cover six different
factors today. We’re going to start pretty basic and then move to more detailed so
stick with me for the full five minutes. The first is the term. How long your
base term is and what your option structure looks like is very important.
Whether that be 25 years remaining, 5 years 15, whatever it is typically the
longer term the higher the value. Your option structure is also important for
example Walgreens has a lease form that is fifty one year options. They have
another form that is ten five-year options so the ten five-year option
structure is obviously more desirable than 50 one-year options so pay
attention to not only the full term of your base and options but what the
structure looks like as well. The second is rent bumps. Income growth of course
is always preferred as an investor because it will drive the price of the
investment up all other factors considered. But the rent bumps being
timed to CPI or fair market value don’t hold as much weight as a fixed
rent structure so you want to push for the highest rent increases you can
whether that be 10% every five, 7.5% every five, 2% annually, those are all common structures. but you don’t want things, if you can
help it, that are tied to CPI or fair market value. The third is landlord
responsibilities now if you’re a developer building a brand-new project
having roof and structural responsibilities is obviously not going
to impact you because the construction is new however if you’re an investor
looking at 10 to 15 year-old period, roof and structural responsibilities could be an issue for you and it will certainly
impact resale value so you want to push as much of the responsibility on to the
tenant as you possibly can. Make that lease form absolute net make it as clean
as you can and then you’ll get often up to a 50 basis point spread between
something that’s double net and absolute net. so the real dollars on the bottom line are material based on that type of lease
structure. The fourth is the guarantor so again for those of you who are
professional clients this is obvious, Wendy’s may not be a Wendy’s corporate
guarantee just because Wendy’s is your tenant it could be a small franchisee. For our new investors don’t just look at who your tenant is look at who’s behind
the lease and again corporate guarantees are preferred followed by franchisee
followed by personal. You want the strongest name on the lease conceivably
possible. The fifth is assignment. Now this is not usually an issue on the
front end but it does come up during due diligence on deals quite a bit. You want
your deal to be not assignable if at all possible but that’s very difficult so if
it is assignable then you want the assignment language to be as rigorous as
possible. If you’re going from franchisee to franchisee you want to try to put in
some limitations. Whether that be 25 units or five million dollars net worth.
As strong as you can make it will give you the best long-term security in the
deal and minimize problems during due diligence. The sixth and final thing for
our discussion today is indemnification language. Now I am not an attorney. I cannot give you legal advice but these are things that we see all the time.
This is relevant on all deals but especially important if you’re building
something in the gas convenience space because indemnification against
environmental issues gives investors a lot of security over the long term.
Again a new-build it’s not an issue 15-20 years down the
it could be so you want your indemnification language to be as tight
as possible and you want ideally the tenant to have full indemnification
against any environmental issues long-term. So there you have it at the
term, the base plus the options, the rent bumps , the guarantor, landlord
responsibilities, assignment and indemnification. This is just one piece
of the full puzzle but leases are very important so make them as clean as
possible and you will get the maximum dollar for your investment on resale.
That was CRE Fast Five. I’m Karly Iacono. Join us again soon

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