Understanding the lease - part six
We have covered significant ground in this series of articles on leasing. In this final article, we are going to examine a case study where we look at the high-points of a recent lease I completed.
We started with part one where we compared a lease to a month-to-month rental agreement and what happens when your lease expires while the commencement date and rent payments were highlighted in part two.
Part three explained the security deposit and why to pay attention to the property condition and maintenance.
In part four we discussed how to handle repairs and alterations, the landlord entering the premises, subletting and terminating a lease early and in part five the types of forms and leases were illustrated.
Our case study is for a 7,500 square foot industrial building in the Napa Valley used for the production and storage of wine as well as retail sales, tasting, events and an office. I have withheld any identifiable features from our discussion for privacy.
Basic lease terms of “NV Wine Co.”
The executed lease for the property is for five years at $12,375 per month base rent and adjusts three percent annually. The lessee (also known as the tenant) retains the right of two, five-year options to extend. The rent adjusts to market rent at the start of each five year period as well as annually.
I used the “AIR CRE Standard Industrial/Commercial Single-Tenant Lease-Gross” form of 31 final pages which may seem like many pages to read, but I recommend the lessee and lessor (also known as the landlord) take the time to familiarize themselves with its contents.
The not-so-apparent lease terms
Condition, warranty, and maintenance
Often a property is leased in “as-is” condition, but this does not relieve the lessor from obligations. The lease allows for all building systems to be operational and the roof free of leaks.
Additionally, the lessee is provided a one month warranty on all the building systems and six month's on the HVAC (heating, ventilating and air conditioning) systems with the lessor responsible if a problem arises and after that the lessee is responsible.
The maintenance and repair of the premises is the responsibility of the lessee usually except for the roof system, foundation and bearing walls which are the lessor’s responsibility.
Payment of taxes and insurance increases
The lease allows for the lessee to reimburse the lessor each year the increase in the lessor’s insurance premium and property tax expenses.
The base year cost for these items are established at the lease commencement date, and as these expenses increase each year the lessor will collect the difference from the lessee which could be a nominal amount, but the lessee should pay particular attention to the lessor’s property taxes in the event of a sale of the building.
If the lessor has owned the property for decades, the property taxes could be low because in California taxes are calculated on the building value when purchased with annual nominal valuation increases each year.
When the property is sold, it is reassessed and in our case could result in a $30,000 increase in annual property taxes becoming the responsibility of the lessee. So, in our lease, we made provisions to lessen the impact.
With the lease agreement being 31 pages I am barely scratching the surface, but I hope our discussion brings to light the complexity of a commercial lease and the need to thoroughly understand what you are signing.
Burt M. Polson, CCIM, is an active commercial real estate broker. Reach him at 707-254-8000, or email@example.com. Sign up for his email newsletter at BurtPolson.com.