How to Review Lease Details in Selling a Commercial Property

‘As the opportunity for listing commercial investment property arises, we can sometimes be too eager to take the listing without getting all the important facts that effect price. Leases really matter.’

Check the leases on a commercial investment property before you talk about price on the property as the leases may assist or hinder the sale. They can also dictate a sale strategy. This says that a good commercial real estate broker or agent must know the structures of a lease and what makes a good lease.

Depending on the age of a property, the next phase of its lifecycle may be refurbishment, demolition or remix of tenancies. Every phase is different. The demographics of the region in which the property is located will also have something to do with the future of the property.

A property that has a majority of leases that are soon to expire may be attractive to a purchaser that wants to owner occupy the property or a developer that wants to change the site and create a new building. On the other hand the same property in such circumstances will not be attractive to a new investor unless they want to undertake refurbishment works and re-position the property with new tenants. Decisions are based around strategy needs and timing; as agent or broker for commercial property you need to be the ultimate strategist.

When looking at the potential sale of the property, the lease aspects requiring future awareness and understanding in the sale include:

  • Rent review profiles – are they strong and well timed or do they just gear to the consumer price index? Also look for the market rent reviews and see if they are well timed or
  • Lease expiries – these are always a concern if the property requires stable cashflow, so look for multiple lease expiries that are close to each other and that may consist of a majority of the lettable space in the building.
  • Option periods – from a landlord perspective, lease options are not always a good thing to have as they can frustrate the future of the property; it really depends on what the landlord thinks that they want to do with the property. It is of note that many large shopping centres and malls do not allow lease options for that very reason.
  • Details of any current incentives with existing tenants – some lease incentives carry on impacting the property for some months or even years. When the property is to be sold, these incentives must be offset or discharged at settlement as the future purchaser may not want to take over the burden of such.
  • Outgoings recoveries – leases and most particularly net leases will allow the landlord to get back some of the building operating costs. It pays to check the leases to see exactly what those recoverable items may be as it can impact the property sale or buyer interest
  • History of income and expenditure performance – I always go back at least 3 years to check these numbers and to see what have been the major changes in the outgoings. What you are looking for is overly large imbalances in outgoings from year to year that indicate that something major has impacted the property or a strategy has changed. Get reasons for any changes of this type so that any astute buyer can be given logical explanations.
  • Current budget of income and expenditure performance – every commercial investment building of any type should function to a budget each year and the details should be available for your review. Parts of the expenditure that impact greatly on the property are the rates and taxes as they take up on average a full 33% of most building expenditure. You need to know that these rates and taxes are on average with other properties in the region.

 

Property performance elements such as these will affect the potential income from the property well into the future and will also dictate the best time to sell the property.

In an ideal world you would time the sale so that the income is optimised and the outgoings are controlled to acceptable levels. This cannot always be done especially in markets like that which we have today, but you should know where you stand on the property performance before you proceed into a sales program. Strengths and weaknesses of cash flow should be identified and logical reasons provided before any sale campaign starts.

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