The Critical Role of Lease Analysis in Investment Property Sales: What Every Commercial Real Estate Agent Should Know

Leases form the foundation of a commercial investment property’s value, attraction, and potential for a buyer of investment property. As the real estate agent, you have the foundation for establishing an effective property marketing and sales strategy when you identify a property’s current and potential income streams and, as part of that, then look at the other variables across the tenancy mix and the property improvements.

Effective marketing, clear communication, and property owner service achieve the best property sales. The property leases are part of the property promotion and sale preparation. Understand the property’s leases and income streams, and you have the investment performance factors to package the full property promotion around.

To prepare for a possible sale, it is recommended that all commercial real estate sales agents today thoroughly understand lease structures and how to analyse lease documentation. Leases determine an investment property’s worth and potential. It’s all about the numbers and the potential of the property.

Revenue Streams and Rentals

Before considering the other elements of the tenancy mix and improvements, a real estate agent must ascertain the property’s present and prospective revenue streams. Effective marketing, clear communication, and property owner service result in the highest property sales.

Given the property’s cash flow potential and the existing revenue stream, the agent can use that study to identify the most effective sale strategies. The agent can offer alternatives and precise recommendations regarding the sale procedure to get the greatest results in the current real estate market.

Strategic Sales and Lease Decisions

Successful property sales result from strategic decisions, recommendations, and agent involvement. Given the property market variables and trends in most locations, there are many things to consider when selling a property today.

Consider the property market in your location and how you can do more when listing a property for sale and achieving the best levels of enquiry and inspections. Become the best local real estate agent with a strategic approach to selling commercial property; in doing so, do not do the same things that other agents do. Get very involved with your exclusively listed properties, and then put yourself into marketing the property to the defined target audience.

The clients and the property owners in commercial real estate sales marketing campaigns like to be given directions and ideas about the sale, a complete explanation of a property and its sale potential, and then a series of recommendations from the agent acting on their behalf to help them proceed with the sale and make the right decisions in marketing and negotiations. That is precisely what top agents do. Are you ready to be a top agent?

Income Potential

Where should an agent start regarding property analysis and income potential? Given the property’s attributes in the prevailing market conditions, it’s all about passing income and potential income.

• What are the rent reviews going to do to the income streams?
• When do the leases expire?
• What are the chances of a higher vacancy rate in the property moving forward?
• How strong are the leases in the property moving forward?
• How do the current rents compare to the market rents in the location for the property type?

Questions like these are worth considering if you are an agent considering marketing a commercial property. Knowledgeable buyers in the property location will look at those questions and even more when making a buying decision, so have your facts ready regarding the property lease documentation. Look for the strengths and weaknesses in the lease documentation, tenant occupancy, and rental potential.

Real estate agents should work with their preferred property types, given that every property type will have trends and results to track. The agents should also look at the variables in tenant occupancy, lease documentation, property best use, and property owner requirements when preparing for any property sale. Add to that the trends in the property market, and you have a checklist approach to lease analysis when preparing the property for sale.

Starting Your Assessment and Lease Checklist

Let’s create your property lease assessment checklist for selling an investment property. Before selling a property, agents must assess lease structures, tenant commitments, and rental income stability.

Buyers, especially institutional investors, scrutinise leases to gauge risk and return potential. A thorough lease review can highlight strengths or expose weaknesses that impact property pricing, financing, and overall marketability. The lease documents are a critical part of sales promotion and marketing. Let’s look at creating an essential checklist for lease analysis in a sales promotion.

1: Lease Structures and the Impact on Property Value

There are different lease structures and rental types. The recovery of outgoings for the landlord becomes an essential factor to look at. Determine the kinds of rental in each tenancy across a property. These are some of the most common rent structures:

• Gross lease—in this case, the landlord will pay most, if not all, of the property outgoings.
• Net lease—in this situation, you must read the leases comprehensively, as the tenant will pay some or all of the property outgoings.
• Modified gross lease—this is most common when tenants pay part of the outgoings based on some formula or base year.

So, every lease is potentially different, and the income streams produced will interest potential property buyers. These lease types can impact buyer interest and any offer that could be made. Agents must always review leases to ensure that the full facts of rental and income are understood.

2: Reviewing Lease Expiry Dates, Tenant Selection, and Occupancy Rates

A commercial property can have more than one tenant in occupancy. A shopping centre is a good case in point. Each lease then needs to be examined to ensure that the burden of lease expiry across different parts of the property and the tenancy mix is not falling due simultaneously.
Think about these questions:

• When do the leases expire on the property?
• Do the tenants in the property add factors of attraction or weaknesses to the property as an investment?
• What are the chances of finding a new tenant for any vacancy?
• Are the improvements in the property well maintained to attract and support occupancy?
• How does the passing rent in the property or tenancy compare to the market rent?
• What tenant movement or retention factors could impact occupancy in an ongoing way?

Expanding on these factors, it becomes evident that the simultaneous occurrence of multiple vacancies in a commercial property can pose a significant drawback for prospective buyers. Conversely, many vacancies falling vacant simultaneously could be a factor of attraction to any property developer who may want to purchase the property and develop it further.

So, determining the target market of buyers for any investment property becomes the first level of assessment in preparing for a sale situation. When you know the property’s target market, you also know how they will look at the tenant mix, occupancy factors, and income streams.

3: Going Deeper into the Tenant Mix and Occupancy

Different tenants in a commercial investment property create strengths or weaknesses that should be individually considered. Some tenants may be of little benefit to the property investment or property owner in the long term. The question will be, ‘How can those weaker tenants be removed from the mix?’

So, the buyers of an investment property will look at the tenant mix from their perspective. Think about these questions:

• Are all the tenants financially stable?
• What is business like today for the tenants now, and how can that change?
• What is the property’s rental payment history over the last 24 months?
• What are the differences between the local versus the national tenant brands in the property, and how will that impact the property now or in the future?

The buyers active in the property market today will look at the property from their perspective, as will the lenders they use for the funding. If there are any weaknesses in the tenant mix from a tenant or lease perspective, it is better to remove the shortcomings before starting the sale campaign.

4: Lease Terms and Conditions – Risks and Liabilities

Every lease has terms and conditions that impact the landlord and/or tenant. Potential buyers of investment property will scrutinise all those terms and conditions before they make the final purchase.

Of particular interest to them will be hidden or onerous liabilities that can apply to the landlord. They will also look at the tenant risks and liabilities across the lease term and the factors that should happen at the lease’s end. Questions to think about would include:

• Options to renew the lease and whether that is a positive or negative position for the landlord
• Make-good provisions on the tenant, the definition of ‘make-good’ and how that will be imposed at the end of the lease
• Insurance obligations on the tenant and if they are fulfilled
• Maintenance obligations on the tenant and the landlord across the lease term
• Building compliances with codes
• Active incentive obligations and payments that could impact property value or rental payments.

These things will be displayed in the lease documents of an investment property. That says an agent should review all leases before the property goes to sale. Buyers will investigate, and the agent must obtain and provide the correct information and facts from the tenant occupancy and leases.

5: Understanding Operating Expenses and Recovery Structures

The recovery of outgoings forms part of the property’s income streams. Buyers will want to know the recovery of outgoings across all the tenancies; a spreadsheet is the best way to do that.
They will also want to look at the outgoings budgets and if they are realistic to the actuals being paid.

So, the outgoings categories and recoveries will be set out in the lease documentation.
When you look at the outgoings recoveries, there are elements of investigation that can apply. Notably, that is splitting the rates and taxes outgoings from the service charges such as energy, gas, and water, and then dividing the remaining outgoings into subcategories such as lifts, cleaning, security, air conditioning, fire services, and lighting.

When you split the outgoings into subcategories, you can identify the charges, the bigger ones, and how things have changed over the last few years.

So, what categories would help in the analysis of the property operational costs? Try some of these for starters:

• Rates and taxes
• Services
• Gas
• Water
• Energy
• Drainage
• Insurances
• Cleaning
• Security
• Air Conditioning (cooling, heating, ventilation)
• Lighting
• Plumbing and stormwater
• Maintenance of all types
• Essential services contracts
• Essential services maintenance, etc

So you can add to the list based on the property, the tenant mix, the improvements, and overall property operations. How will the operational costs change with known or predicted occupancy changes and vacancies? You will need to consider the budget for that.

Ask questions and get to the actual figures of how the property operates. Determine if that operational status and those costs are efficient or inefficient compared to other properties in the same category or location.

Conclusion—Lease Documentation Analysis in Commercial Property Sales

From all these factors, it is easy to see how the various tenants and their leases in a commercial investment property can influence the buying price, buyer sentiment, and the time the property is on the market.

When you are ready to sell a commercial investment property, review the lease documentation and consider how those leases can impact buyer sentiment and decisions.