- When purchasing a commercial real estate asset, it is likely that there are existing tenants with leases. Understanding the terms and conditions of each lease are an integral component of the pre-purchase due diligence process.
- The process of reviewing each lease and pulling out the key data is called “lease abstracting.”
- The document that contains the output from the lease abstracting process is called a “lease abstract” and one should be created for each lease.
If there is one thing that all commercial real estate (CRE) assets have in common, it is tenants with leases. Each lease contains key information about the tenant, their lease term, the amount of rent they pay, and what amount of the property’s operating expenses they are responsible for paying.
Obtaining this information is an important part of the pre-purchase due diligence process and the only way to get it is to review each lease. This process is known as creating a “lease abstract” or just “abstracting” and it is the subject of this article.
Lease Abstracts – Explained
Simply, a lease abstraction is a document that summarizes the most important details in the lease. Prior to purchasing an asset, it is a best practice for investors to complete an abstraction template for each lease in the target property (NOTE: for some property types, like multifamily, it may not be necessary to review all leases since they are all so similar). If there are dozens of tenants, this can be a very time consuming process.
There are a few reasons why the abstracting process is important:
- It allows investors to create a more accurate financial model
- It provides investors with the information necessary to create an accurate risk/return profile for the property
- Saves time by providing key information at a summary level versus reviewing lengthy, dense, lease documents
- They can save the property owner money by identifying areas for potential cost savings
- They can allow the property owner to generate more income by identifying opportunities for rent increases or the addition of other income sources.
Lease abstracts are typically completed by the investor themselves, a junior member of their team, or they can be outsourced to a third party. Regardless of how they are completed, all lease abstracts contain the same basic information.
What Information is in a Lease Abstract?
It is important to note that the format and style of a lease abstract can vary from one investor to another, but they all contain the same general information, as described below:
- Tenant Name: The name of the tenant, as stated in the lease agreement.
- Rent Amount: The amount of rent that the tenant is required to pay and whether or not there are any escalations.
- Dates: There are four important dates: The date the lease is signed; the date the lease term begins, the date that the tenant is required to start paying rent (in case the lease contains rental concessions); and the date the lease term expires.
- Leased Premises: A legal definition of the exact space the tenant is permitted to occupy by virtue of signing the lease.
- Permitted Uses: A listing of the permitted (and non-permitted) uses of the leased premises. For example, it is common for leases to contain language stating that the tenant is not permitted to engage in any illegal business.
- Square Footage: A description of the size of the leased premises.
- Parking Requirements: A description of the number of parking spaces provided to the tenant as part of the lease agreement. For example, in an office lease, the tenant may negotiate 25 reserved parking spaces in the garage.
- Lease Term: Identification of the defined lease term. For example, it could say, January 1st, 2000 to December 31st, 2010.
- Security Deposit: Amount of the security deposit, if any, required to support the lease.
- Renewal Options: Description of the renewal options, if any, offered as part of the lease. For example, a lease could have 2 renewal options of 5 years each.
- Rental Concessions: If the tenant received any incentives to get them to sign the lease, they should be included in the abstract. These may include things like months of free rent or some amount of tenant improvement allowance.
- Repairs: If something breaks during the term of the lease, the abstract should identify who is responsible for making – and paying for – the repairs.
- Operating Expenses: Some leases require the tenant to pay for some or all of the property’s operating expenses. The tenant’s responsibility should be identified in the lease abstract. Specifically, it should identify who pays for utilities, property taxes, Common Area Maintenance, and insurance.
- Co-Tenancy: Some leases contain a co-tenancy clause, which allows the tenant to seek rent relief if a certain portion of the property’s space becomes. If the lease has one, it should be highlighted in the abstract, along with what level of vacancy triggers the clause and what sort of relief is available.
- Expansion Rights: If a new space becomes available in the same building, the tenant may want to lease it. If their lease contains “expansion rights” they may have the first chance to do so. This information should be included in the abstract.
- Assignability and Exclusivity: The abstract should highlight whether the lease is assignable – meaning it can be transferred to another party. The abstract should also note whether or not the tenant has any exclusivity rights. Exclusivity is particularly common in retail properties where a tenant may want to limit similar businesses in the same property.
- Estoppel: An estoppel is a legal document that shows all of an association’s outstanding fees and/or fines. Some leases require the tenant to sign an Estoppel letter. If they do, it should be identified in the lease abstract.
- Early Termination: All leases have a defined term, but some allow for the tenant to leave early under certain circumstances. If a lease has early termination options, they should be identified in the abstract.
- Subleasing: If a tenant is allowed to lease all or some of their space to another party, this is called subleasing. If this is allowed, it should be highlighted in the lease abstract.
From the list of detailed information above, it can be seen that the abstraction process requires a significant amount of lease data to be pulled out of the document. It can be incredibly time consuming, but it is time well spent because the key data points provide a portrait of each lease that serves as a valuable input in the ultimate investment decision.
Interested In Learning More?
First National Realty Partners is one of the country’s leading private equity commercial real estate investment firms. We leverage our decades of expertise and our available liquidity to find world-class, multi-tenanted assets below intrinsic value. In doing so, we seek to create superior long-term, risk-adjusted returns for our investors while creating strong economic assets for the communities we invest in.
If you are an Accredited Investor and would like to learn more about our investment opportunities, contact us at (800) 605-4966 or firstname.lastname@example.org for more information.
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