What is a Lease Abstract? (in Commercial Real Estate)
A lease abstract provides a concise analysis of lease documents in a format that is easily understood. It also gives structure to ensure any material items will be found and information in the form can be quickly referenced in the lease for further detail. The lease abstract should be created in a format that is easy to read but also easily updated as changes are made throughout the term of the lease.
Focus on Fundamentals with a Lease Abstract
The complexities of commercial real estate (CRE) leases typically require a review by an expert who understands and can decipher the terms of the agreement. As an investor, you’re more likely to want to immediately understand just the key elements of the lease that could impact the profitability of your investment. This becomes even more crucial if you’re investing in a portfolio of properties with many different leases or even a single property with multiple tenants. Rather than spending your time analyzing the terms of each of a dozen or 100 leases, or reviewing thousands of pages, you can rely on a lease abstract to provide you with the essential facts that could influence your investment decisions. A series of lease abstracts with a consistent structure can also make it easier to make comparisons.
Remember back in school when you relied on Cliff Notes or Spark Notes to help you understand key elements of “Macbeth” or “A Tale of Two Cities?” A lease abstract is similar to the Cliff Notes of CRE leases. A lease abstract summarizes key points in a commercial lease, including financial, business and legal information pertinent to tenants, landlords and investors. Abstracts can be completed for other types of documents, too. Lease abstracts can highlight inconsistencies, errors and missing information that can be vital to an informed decision.
Lease abstracts can be targeted to specific audiences. For example, owners, investors and property managers need accurate financial information as well as detailed information that can impact the management of the property. Lenders and equity partners need different information for underwriting. Instead of personally reviewing hundreds of pages of legalese, a well-written, accurate lease abstract can save you time and protect you from mistakes arising from misunderstood lease terms. In addition, a lease abstract can highlight issues that may need to be brought up for discussion at the settlement table or after ownership is established. An acquisitions department will review a lease in a different way than a property manager. A different lease abstract can be provided to different audiences that provides information in the most valuable way.
An accurate, valuable lease abstract requires the expertise of an experienced team with tested real estate experience, some legal knowledge, strong analytical abilities, established data management skills and the ability to summarize lease data in an easy-to-read format. At the same time, a solid lease abstract should point out anything unusual in the lease as well as where to find specific information in the lease that has been referenced in the abstract.
Benefits of lease abstracts
Lease abstraction provides four fundamental benefits to CRE investors:
- Risk mitigation. Compliance with all aspects of a lease as well as understanding the rights and responsibilities of every stakeholder reduces the possibility of mistakes that could cost money or even the loss of a property. A lease abstract makes it easier for owners and investors to avoid missing critical dates that could impact the bottom line or result in lost opportunities.
- Cost-savings. A lease abstract can work together with a software database to track events and set reminders that help owners avoid paying unnecessary fees or skipping the collection of late fees, interest, rent, taxes, maintenance costs or increased renewal rates.
- Leverage strategic use of data. Technology and lease abstracts can be combined to provide infinite and easily analyzed information that organizations can use when reviewing their portfolio and its performance. The data can be used to make strategic decisions about acquisitions and divestments, to determine whether the portfolio is adequately diversified and to evaluate opportunities for management efficiencies.
- Value creation. Having a keen eye for lease terms can help you find value in existing rent provisions or additional rent provisions that prior owners or managers may have missed.
If you’ve ever tried to study a stack of leases, or even just two or three leases, to compare their details, you know it can be a time-consuming and complicated task. When one or two analysts study lease terms one-by-one, the chances are high that they will miss important facts. When you hire an outside team to review leases, technology and experience can work together to review large numbers of leases in parallel.
Reviewing a handful of leases can be arduous, but think about what must occur when you’re purchasing a portfolio of properties. The value of lease abstracts increases exponentially with the size of the portfolio investors are reviewing. In particular, you can save days of time when reviewing the situation of numerous tenants when you are able to cut down the time spent on each tenant.
Essential elements in a lease abstract
A lease abstract, particularly when an investor wants to compare numerous leases, should include some basic information in a uniform format, such as the property address, addresses of the landlord and tenant, information about any guarantors, description of the premises and lease dates.
A good lease abstract will also include:
- basic tenant information such as name, square footage, pro rata share and premises address;
- tenant’s past, present, and future rents, including option rents, abatements or any reductions;
- any associated tenant improvements and respective allocations;
- security deposit information;
- additional rent provisions, including recoveries, maintenance, CAM, taxes, and caps;
- other opportunities for the landlord to earn revenue from a tenant (i.e. parking fees, signage, percentage rent for retail, after hours HVAC for office, etc.);
- renewal options and whether previous options have been exercised, as well as lease start and expiration dates;
- information about whether tenants have the first right of refusal in the event of a sale or leasing additional space;
- exclusive use clauses; and
- hidden termination clauses.
Several issues that deserve special attention in a lease abstract include:
- Tenant termination rights. The danger for investors is that if they are unaware of the tenant’s rights, they could potentially lose cash flow and have difficulty selling a property if they inadvertently create a situation in which tenants could legally exercise their termination rights. For example, these rights can include the ability of the tenant to end a lease for a retail property if the tenant doesn’t achieve a targeted gross sales amount. Another possibility would be the ability to cancel a lease if a nearby space is leased to a similar tenant which could violate a tenant’s right of exclusivity. Another potential tenant right could be the option of not paying rent if other tenants in the same center or property are not open for business.
- Tenants’ right of first refusal or right of first offer. Similar to understanding termination rights, investors need to be aware of the potential rules that would allow tenants the right of first refusal or the right of first offer when the investors want to sell their property. Those rights could delay a sale and potentially influence the profitability of the transaction. In addition, prospective buyers need to know if they are stuck with a commitment by the previous owner to an agreed-upon lease rate.
- Tenant options for altering the premises. Owners and investors need to be aware of the tenants’ rights to remodel or adjust the size of their property. If tenants can shrink the size of their rented space that can impact cash flow. At the same time, allowing remodeling to take place can impact resale value negatively or positively.
- Ground leases. A lease abstract should include information as to whether the property has a ground lease, which typically means the tenant owns the building until the end of the lease term, or a build-to-suit contract in which the landlord owns the land and the development. A ground lease could impact the ability of investors to sell or refinance a property.
- Real estate taxes. A lease abstract, particularly if it is part of a package of leases on properties located in different states, should include information about state regulations regarding real estate taxes. Some states prohibit landlords from passing on the cost of real estate taxes to their tenants. Some leases include clauses prohibiting property taxes to be charged to tenants or limit the number of times tax increases are charged to the tenant during the term of the lease.
- Reimbursements. A lease abstract should include language that clearly identifies expenses that are to be reimbursed by the tenant to the landlord. Without that information, an investor would not have a completely accurate view of cash flow for the property. A landlord might not request reimbursement from tenants to the full extent possible. Another possibility is that the landlord could overcharge the tenants and face litigation if discovered. There are specific abstracts created just for CAM reimbursement purposes. A lease abstract can also address pro rata share issues that could point out potential recoveries from miscalculations.
A good lease abstract will address all of these issues succinctly and provide links to detailed information.
Challenges of lease abstracts
In an ideal world, every lease would be written in the same format with the same data points and attachments, all written in easily understood language. Unfortunately, this isn’t always the case. One reason lease abstracts are so essential to investors is that they can be used to create a system and uniformity to make it easier to compare properties and portfolios.
At the same time, systems need to be put in place to create consistency and to determine how to include important information such as correspondence related to a property. There’s an art to designing a lease abstract that provides specific knowledge in a consistent way.
Working with a dedicated team with real estate, legal, due diligence, operations reconciliation and project management expertise can mitigate these challenges.
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