When evaluating a commercial property for a potential investment, one of the key concerns for prospective buyers is the tenant leases, including how much income they produce, and whether or not they are legally enforceable. On this last point, one of the things that an investor or lender may ask for is an “Estoppel Certificate.”
What is a Tenant Estoppel Certificate?
According to Black’s Law Dictionary, a tenant estoppel is “a signed statement by a party (such as a tenant or mortgagee) certifying for another’s benefit that certain facts are correct, such as that a lease exists, that there are no defaults, and that rent is paid to a certain date. A party’s delivery of this statement ‘estops’ that party [from] later claiming a different state of facts.”
As the above definition suggests, the term “estoppel” is a legal term that prevents a person from asserting a claim that is inconsistent with a previous set of facts. To that end, the purpose of an estoppel certificate in a commercial real estate transaction is:
- To provide a prospective lender and/or purchaser with information about the leases in the target property and the physically leased space.
- To provide the lender and/or prospective purchaser with assurance that that the tenants will not make later claims that are inconsistent with those asserted in the estoppel.
For these reasons, it is common for a lender and/or potential buyer to ask tenants for estoppel certificates as part of the due diligence phase of a transaction.
What Information Does a Tenant Estoppel Certificate Contain?
Most commercial real estate leases contain a clause that requires a tenant to provide an estoppel certificate upon request—meaning they are legally required to provide one when asked.
The exact contents of an estoppel certificate may vary, but they usually contain the same basic information:
- Lease start date
- Date that rents are paid/due
- Whether there is more than one month of prepaid rent
- Tenant names
- Lease renewal options
- Whether the tenant has subleased or assigned any part of the leased premises
- Whether or not the property owner has made any tenant improvement allowances
- Whether or not the property owner is currently holding a security deposit for the tenant
- A confirmation that there are no events of default by the tenant or property owner
- If an event of default exists, further information is provided about the specifics of the default and what actions must be taken to cure it
- Acknowledgement that the terms of the lease have not been modified and that it is currently in full force and effect
- If the lease agreement has been modified, then the estoppel should detail what modifications have been made
The estoppel is typically prepared by an attorney or by using template language.
What Happens if The Tenant Does Not Provide the Estoppel?
Although the tenant is obligated to provide an estoppel under the terms of their lease, it doesn’t necessarily mean that they will provide one when asked. If they don’t, it is technically a breach of the lease. However, there are three primary reasons why the tenant may not provide the estoppel when asked:
- They don’t understand it: Perhaps the tenant does not understand the request and why it is needed.
- They object to the language: Often, a property owner will provide the language in his or her letter to the tenant who is requesting the estoppel. If the tenant does not agree with the legal language, they may refuse to sign it and seek their own legal advice.
- There is a dispute: In some cases, the tenant may be embroiled in a dispute with the landlord and simply refuse to provide the estoppel when asked.
The solution to the tenant’s reluctance to provide the estoppel depends on the reason why they have refused to provide it in the first place. If they simply didn’t understand the request, then an explanation may be all that is needed. If they objected to the language, the landlord should identify exactly which parts are in objection, and try to negotiate a solution. If the tenant refuses to provide the estoppel because of a dispute, the solution may be more drastic. Depending on the specific language in the lease clause, potential penalties could include:
- An acknowledgement that the tenant’s silence is a tacit acceptance of the estoppel
- The estoppel being prepared by the landlord’s attorney anyway
- Financial penalties, such as fees or in some cases, one month’s rent
- Litigation
The last option is expensive for all parties and as such, it is only a last resort.
Why This Matters for Investors
As a potential investor in a private real estate transaction, it is important to know that the transaction sponsor has obtained estoppel agreements for all of the commercial leases associated with the asset. When this happens, investors can have some comfort knowing there is proof of cash flow for each commercial tenant, and that this cash flow is transferred into the financial model that projects the investment’s returns.
The point is, as part of the transaction sponsor underwriting process, investors should ask if tenant estoppel letters have been obtained.
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 info@fnrpusa.com for more information.
