Income property, commercial real estate, income-producing real estate…no matter what it’s called, it’s a business whose value is determined by the quantity

and quality of earnings. And it’s a business where leases are critical for determining earnings. From a quantitative perspective, when real estate has

positive earnings, it is succeeding, and when real estate has negative earnings, it is failing. From a qualitative perspective, a given real estate’s

earnings (positive or negative) define what premiums or discounts are attributed to its value.

Physically, the business of commercial real estate is a combination of land and improvements. Its product is space. The clients of commercial real estate are

the tenants (lessees) that use its space. The financial arrangement between the lessee(s) and the owner (lessor) is described in a binding document called a

lease.

There are two conditions under which a lease doesn’t exist.

1. There are no lessees. When there are no lessees, there are no leases. If there are no lessees, then there are no clients. When there are no clients,

   there is no income. With no income, your expenses stand alone. Those expenses plus debt service then become the negative cash flow of that income property

   business. Real estate with a negative cash flow is a failing business. The value given to a failing income property business is much less than one that is

   succeeding.

2. There is a tenant, but there is no signed lease between the tenant and the owner. So how important is a lease? Without a lease there is no binding

   obligation that defines the financial obligations and responsibilities between the tenant and the owner. Under these conditions, tenants can move in or out

   at will. The tenant can argue for lower rent payments, common-area maintenance obligations, and so forth. If the owner disagrees and the dispute can’t be

   resolved, then the tenant can bring the dispute to court. This is costly and usually delays bringing the problem to a conclusion.
   Additionally, without leases, there is an increased potential for higher turnover. This leads to more dollars paid for leasing commissions. Without leases in

   place, added turnover increases the amount of money that the owner will spend for tenant improvements. The result is lower earnings.

Given all the problems of not having a lease, there is yet another scenario that is even worse. That scenario is having a lease that binds the lessor to

unfavorable financial conditions. The following is a list of lease issues with which every lessor should be concerned.

The Name of the Lessee

The name of the business that will be occupying the premises should be on the lease. A financial statement of that business and its proprietor should be

obtained. Due diligence should be performed concerning credit history, financial history, and the resumes of the key principals. If the credit of the

business is not satisfactory, then the lessor should include the proprietor(s) on the lease.

Use of the Premises

The business activity of the lessee should be described. The lessor should exert sufficient due diligence to determine what affect the lessee’s business can

have on the property. The lessee should not be allowed to conduct any other type of business activity without the lessor’s permission.

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