Chapter 12

Leasing Property

IN THIS CHAPTER

Bullet Understanding some lease jargon

Bullet Seeing what goes into a lease

Bullet Looking at different types of leases

Bullet Finding out about breaking a lease

As a real estate agent, you may represent the owners of apartment buildings, office buildings, or retail buildings like shopping centers as a leasing agent. Leasing activity is an especially important part of property management and commercial real estate work if your real estate career goes in that direction. Just as you can represent a buyer in a sales transaction, you can also represent a tenant, who is someone seeking to rent an apartment or commercial space, in a leasing transaction. State real estate exam writers expect you to know the basics of leasing. You can answer most of these questions if you simply have a clear understanding of the different related definitions.

In this chapter, I talk about various kinds of estates (interests in real estate) in connection with leases. (For a more complete discussion of estates and interests, see Chapter 6.) I also give you some information about the requirements of a typical lease agreement, the different types of leases, and some ways people break leases. I also cover some unique details of commercial space leasing.

Remember In this chapter, I sometimes use the term apartment, which could mean a garden apartment, a duplex, or a single-family house as a rental. I also use premises, which is a common word used to describe a defined piece of land, building, apartment, or other space.

Identifying Who’s Who and What’s What

When you read this section, remember that I simply cover the basic definitions and terms connected with leasing. I also give you some information about the different interests (estates) that exist with respect to leases. State exam writers want you to be able to identify terms and apply them to pretty simple cases.

Owning property: Leased fee estates

A lease is an agreement between two parties for possession and use of a particular space, usually for a certain length of time. The person who owns the space, usually referred to as the landlord, is technically called the lessor. The landlord owns what’s called the fee of the property. (For more in-depth information on fee simple interest and the various rights of ownership, see Chapter 6.)

Remember A lease separates two of the rights of ownership: ownership and possession. The owner still owns the property but has given possession to the tenant. The lessor’s (owner’s) interest in a property in a lease situation is called the leased fee estate. The lessor has a reversionary right to the possession of the premises when the lease expires, which simply means she gets possession of the property back. Sometimes the owner’s interest is referred to as a leased fee estate with reversionary right.

Renting property: Leasehold estates

The tenant’s interest in the property is called the leasehold estate. Another term for tenant is lessee. The tenant holds the lease, whereas the landlord gives the lease. In each of the following four types of leasehold estates, I use the term estate; however, note that the word tenancy can be substituted in each case.

Estate for years

An estate for years is a lease agreement with a definite starting and ending date. The tenant is required to leave when the lease expires, and the landlord isn’t required to give the tenant notification to leave the premises. Neither is the tenant required to give notification to the landlord that she’s leaving. Commercial property leases generally create an estate for years. No automatic renewal of an estate for years is available, but a new lease can be negotiated. Also, the agreement survives the landlord’s death or the sale of the property. Note: In spite of the name, the lease could be for a term shorter than a year.

Periodic estate

A periodic estate, also called an estate from period to period or periodic tenancy, occurs when the original agreement doesn’t contain any definite period of time. A month-to-month tenancy is an example of a periodic estate, though the period can be week to week or year to year. Essentially the agreement automatically renews itself from period to period with the original terms and conditions remaining in effect unless the landlord and the tenant renegotiate the agreement. In some parts of the United States, periodic estates are commonly used in residential leases. A periodic estate can be created when an estate for years (remember, a lease with an ending date) ends, the tenant doesn’t move out, and the landlord continues to accept the rent. The tenant may be referred to as a holdover tenant.

State specific In the event of the death of the landlord or the sale of the property, the new landlord may be able to terminate the periodic estate by refusing to accept the rent. A typical notice for termination is usually one period, such as one month for a month-to-month lease. Periodic estates and their terminations are governed by state law, so check out how they’re handled in your state.

Estate at will

An estate at will is when the landlord allows the tenant to occupy the premises, but there is no definite period of time when the arrangement will expire. An owner about to sell a building may allow a tenant to occupy an apartment under this type of arrangement. The estate at will can be terminated at any time with the proper legal notice (usually defined by state law), and it ends if the landlord or the tenant dies.

Estate at sufferance

An estate at sufferance occurs when a tenant who had a legal right to occupy the premises continues to occupy the space after the right of occupancy has expired, against the landlord’s will. One example is a tenant who continues to stay in an apartment after the lease expires. The tenant is sometimes referred to as a holdover. No actual tenancy exists because the landlord is not accepting rent. In the event of the property’s sale or the death of the landlord, the new owner has the same rights as the original owner to seek eviction (see “Breaking a Lease: Types of Eviction,” later in this chapter).

An estate at sufferance can be converted to a periodic estate, which I describe earlier in this chapter, if the tenant pays the rent and the landlord agrees to accept it.

The Usual Suspects: Preparing a Typical Lease

Because a lease is a legal document, I recommend that a landlord have an attorney prepare a lease. On the flip side, when signing a lease, I recommend that a tenant’s attorney reviews it. Even fill-in-the-blank lease forms should be reviewed by an attorney. In this section, I focus on the requirements for a valid lease, some of a lease’s typical provisions, and laws related to leases.

Looking at laws governing leases

State specific The statute of frauds, which all states have adopted in some form, usually requires that a lease for a term longer than one year be in writing (see Chapter 11 for more). Some states have also adopted another law, the Uniform Residential Landlord and Tenant Act, which provides additional terms and conditions that should be addressed in the lease. In the following section, I give you some of the requirements that many states use as a minimum for a valid lease.

State specific The Uniform Residential Landlord and Tenant Act also provides protection for both landlord and tenant. Check out your state and local municipality’s laws to determine if any provisions are applicable for specific tenant’s rights.

State specific Laws also govern rent control, which is sometimes used as a generic term for any type of government control over what a landlord may charge a tenant. These laws generally govern residential units and vary from state to state and city to city. Check out if any type of rent control exists in your state.

Examining typical provisions of a lease

A lease is a form of a real estate contract. (For general information on contracts, see Chapter 11.) Like all contracts, a lease needs a few items to be considered valid. The main provisions of a valid lease are

  • Legally competent parties: Also referred to as having the capacity to contract, this provision means that everyone signing the lease has met all the legal requirements of age and competence.
  • Mutual agreement: The lease must include an offer and acceptance of the terms. All parties must clearly understand the terms of the lease.
  • Legal objective: This provision states that what is being contracted for is lawful.
  • Consideration: The exchange of space for money or other items of value must be enough to make the lease valid. The consideration could be in the form of services such as a janitor being given an apartment in exchange for working in the building.
  • Agreement in writing: Depending on the provisions in your state’s version of the statute of frauds, the lease may have to be in writing. Typically leases for more than a year have to be written agreements.

State specific Your state may have additional, specific requirements for a valid lease, so be sure to check.

Although the minimum requirements technically create a valid lease, they really don’t provide useful and specific details. Most leases also contain the following language to clarify certain details:

  • A description of the leased premises: This could be an apartment number or floor number and may include an actual survey description if a piece of land is leased. I cover property descriptions in detail in Chapter 9. In a nonresidential lease the description could include a drawing that shows the dimensions and location of the space within the building.
  • The term of the lease: The lease typically provides a beginning and ending date.
  • The amount and date of rent payments: This statement includes how much the rent is, when the rent is due, any grace periods that may be offered, penalties for late payment, and where the rent is to be sent.

    State specific Check out when the default rent payment date is in your state. Lease provisions typically require rents to be paid in advance on the first of the month. The default position in some places is that rent is due at the end of the month for the previous month (in arrears).

  • Provisions for rent increases: Leases sometimes have provisions for automatic rent increases at certain intervals, which is sometimes called a graduated lease. Rent increases may be tied to the Consumer Price Index (an index that measures price increases and inflation), in which case the lease may be referred to as an index lease.
  • The amount of security deposit: Lease provisions provide for the deposit amount and clarify when the landlord must return it to the tenant at the end of the lease. State laws vary as to how security deposits may be used. For example, in some places (but not all) they may be used to cover defaults on the rent. State law or local ordinances may require that the security deposit be returned to the tenant within a specified period of time or an explanation be provided as to why all or a portion isn’t being returned. Find out the relevant time frame, if any, in your state.
  • How the premises can be used: A landlord can limit how the tenant uses the leased space. For example, commercial space couldn’t be used as living quarters.
  • Whether and how improvements can be made: Improvements to the space are often part of a commercial lease but also may be part of a residential lease. Whether the landlord or tenant does the improvements is a matter of negotiations. Typically, residential tenants are permitted to make improvements with the landlord’s permission and are required to return the space to its original condition at the end of the lease.
  • Provisions outlining maintenance responsibilities: Landlords are generally required to maintain the premises in useable and what is called habitable condition. Certain commercial leases may require tenants to pay for or assume certain maintenance responsibilities.
  • Details for destruction of the premises: In cases where a tenant is leasing land or has built a building on leased land, the tenant may be responsible if the building or other structures are destroyed. Tenants aren’t usually responsible for destruction of a building in which they lease only a part of the space. They would, however, always be responsible for their business equipment and personal items, just as the renter in a residential rental is responsible for their personal item insurance.
  • Provisions for occupancy limits: Depending on state or local law, a landlord may or may not be able to limit occupancy of the unit to the tenant who signed the lease.
  • Provisions for (or against) subleasing: The lease may provide for the renting of the space by the tenant to a subtenant through what is called a sublease. The sublease between the tenant and the subtenant is called a sandwich lease. Provisions may also be made for someone else taking over the lease. This is called assignment. In a sublease, the original tenant is still liable. An assignment to a new tenant usually needs the approval of the landlord even though the original tenant may remain liable.
  • Termination on sale clause: Under normal circumstances, if the landlord sells the building, the lease survives the sale and the new owner takes possession subject to the lease. If the lease contains a termination (or sale clause); however, the new owner can evict the tenant upon proper notice or renegotiate the lease with the tenant.
  • The right of quiet enjoyment: Whether stated or not, a lease generally conveys to the tenant the right of quiet enjoyment, a legal term that means the tenant has exclusive use of the leased premises without interference from the landlord. The landlord usually can’t enter the premises without the tenant’s permission except in an emergency.
  • Any options: A lease also may contain a renewal clause guaranteeing the tenant the right to renew the lease or a purchase option giving the tenant the right to purchase the property at or before the end of the lease term.

Distinguishing among Various Types of Leases

Though different types of leases have common features and have the same minimum legal requirements, they serve different purposes. The following sections can help you distinguish among the different types. Exam questions will likely focus on the major traits of various leases and may use short case studies to ask about types of leases used under certain circumstances.

Gross lease

A gross lease is where the tenant pays the same rent each month, and the landlord pays all the building’s expenses, such as maintenance and taxes. The landlord may also pay some or all of the utilities, but in some gross leases, a tenant may pay his own utilities. The typical apartment lease is a gross lease.

Ground or land lease

The ground lease or land lease is a lease where someone rents an empty (vacant) piece of land specifically to erect a building on it. These leases tend to be long term and often exceed 50 years or longer. This lease term allows the tenant time to make his investment in the building worthwhile. In a ground lease, the tenant owns the building and the landlord owns the land. Ground leases usually require the tenant to pay all property expenses, such as taxes, utilities, and maintenance. In this respect, a ground or land lease is similar to a net lease.

Lease for oil or gas rights

Some leases give a company the right to search for and extract oil and gas from someone’s property. The tenant usually pays a fee for the lease and then additional money is paid by the holder of the lease rights to the property owner according to how much gas or oil is removed. This type of lease is considered to be a limitation or cloud on the title to the property, which is anything that limits the rights you get when you buy a piece of property.

Net lease

A net lease is one where the tenant pays the building expenses on top of a base rent. Whether the tenant pays all or some of the expenses is negotiable. A triple net lease (sometimes referred to as a net net net lease) generally requires the tenant to pay all expenses such as taxes, utilities, maintenance, and insurance. The net or triple net lease is commonly used in renting commercial space.

State specific You may want to check whether a double net lease (or a net net lease) is common in your area. In some markets, the tenant pays two or three building expenses like taxes and maintenance or taxes and utilities but not all the other expenses.

Percentage lease

A percentage lease usually has a minimum monthly rental charge plus a percentage of the gross earned by the business. This arrangement is sometimes used in leases with retail stores, and the percentage is based on gross sales. The percentage lease may be either a gross or net lease, meaning that the tenant pays none, some, or all of the building expenses.

Proprietary lease

A proprietary lease is a lease that is given to the “owner” of a cooperative apartment. The owner doesn’t actually own the apartment itself but rather shares in the corporation that owns the building. He receives a proprietary lease that allows him to occupy the apartment. (For more on cooperatives, check out Chapter 7.)

Variable lease

A variable lease allows for the rent to change over the life of the lease. The graduated lease is a variable lease in which pre-agreed to rent increases occur on specific dates. Another form of variable lease, the index lease, ties the rent increases or decreases to an index such as the Consumer Price Index at set intervals.

Breaking a Lease: Types of Eviction

When a lease expires, unless the tenant and owner renegotiate it, the tenant is required to leave the premises. However, under some circumstances, the tenant may be forced to leave either by the landlord or by conditions in the building before the lease term expires. The two main types of eviction are as follows.

  • Actual eviction: Actual eviction occurs when the landlord sues for possession of the premises. This usually occurs when a tenant violates the terms of the lease agreement or stays in the premises beyond the lease expiration date.
  • Constructive eviction: Constructive eviction occurs when a landlord’s actions are such that the premises become uninhabitable. A landlord consistently over time not providing sufficient heat during the winter months may result in constructive eviction. In such a case, as soon as the leased premises are proved to be unusable, the lease is considered ended. Don’t consider this a good way to get rid of a tenant; such actions by the landlord are illegal.

Getting What You Paid For

There is a somewhat unique situation that happens when you rent nonresidential space. It’s a perfectly legal and accepted practice, but the fact is you may not actually get what you paid for. Read on to learn more about this concept.

Nonresidential building layouts

Think about the last office building you visited or the one you work in. Maybe it has a nice spacious lobby, some elevators, wide hallways, men’s and ladies’ rooms, and finally many separate offices housing doctors and lawyers and accountants and other businesses or professionals. The same goes for the last shopping mall you went to, only this time the space is divided up into stores instead of offices. It’s logical that each of the tenants in the building pay for their individual office space. But they and their clients use the lobby, the hallways, the washrooms and the elevator. Who pays for that?

Commercial property landlords and tenants understand that the so-called common spaces in these buildings have value and are necessary for the building to function properly. It would be relatively easy for the landlord to simply recoup the costs as part of the rent, the way apartment landlords do, if the individual rented space was more or less the same size. But a tenant renting a 1,000-square-foot office would feel that it’s unfair if he has to pay the same for the use of the common space as a tenant renting 5,000 square feet. What has developed to solve this problem is the concept of rentable and useable space.

Rentable space

Rentable space is the space that a tenant pays for when renting nonresidential space, say in an office building or shopping mall. It generally contains more square feet than the tenant is entitled to use exclusively and takes into account the common spaces used by the tenant and the tenant’s visitors. The rent is generally stated as so many dollars per square foot annually (even though it might be paid monthly). In some cases it’s stated as a monthly rent. In either case it is multiplied by the number of rentable square feet to arrive at the total annual or monthly base rent.

Useable space

Useable space is the square footage that the tenant is allowed to use exclusively. It’s the space behind the door to the hallway. It’s invariably less than the total square footage the tenant pays for.

Adding on and taking away

The difference between the rentable space and the useable space is called the add-on factor or the loss factor, depending on which way you do the calculations. It’s pretty easy to remember. The add-on factor is added to the useable square footage to arrive at the rentable total square footage. The loss factor is subtracted for the rentable square footage to arrive at the useable total square footage. Both are usually stated as a percentage.

Following are a couple of simple examples that you probably won’t have to do on an exam, but they help demonstrate the concept.

Loss factor

  • 5,000 square feet (rentable space) × l0% (loss factor) = 500 square feet lost space
  • 5,000 square feet (rentable space) – 500 square feet (lost space) = 4,500 square feet (useable space)

Add on factor

  • 4,500 square feet (useable space) × 10% (add on factor) = 450 square feet (proportionate common space)
  • 4,500 square feet (useable space) + 450 square feet (proportionate common space) = 4,950 square feet (rentable space)

Note that using the same numbers, the 10 percent has a different result depending on whether it’s used as an add-on factor or a loss factor.

Review Questions and Answers

Expect a few exam questions that deal with recognizing different types of leases and some of the basic terminology.

1. A retail store tenant pays $3,000 a month rent plus a portion of gross sales. This rental arrangement is most likely

(A) a term lease.

(B) a net lease.

(C) an index lease.

(D) a percentage lease.

Correct answer: (D). A percentage lease requires payment of a base rent plus some portion of the income of the business occupying the space.

2. Tenant A moves out of an apartment six months before the end of the lease. Tenant B moves in and pays rent to Tenant A for the remainder of the lease. Tenant B is

(A) an assignee.

(B) an assignor.

(C) a sublessee.

(D) a sublessor.

Correct answer: (C). The key to this answer is that Tenant B pays rent to Tenant A and not to the landlord. When you assign a lease, the new tenant takes over the lease and pays rent to the landlord. This isn’t the case in this question.

3. A landlord refuses to repair the broken furnace in an apartment building in the middle of winter. The situation may result in

(A) actual eviction.

(B) constructive eviction.

(C) abandonment.

(D) condemnation.

Correct answer: (B). Focus on the types of eviction here. When a tenant leaves as a result of the landlord creating circumstances by which the unit is uninhabitable, constructive eviction has occurred. Actual eviction is usually a result of the landlord taking action against the tenant for violating the terms of the lease.

4. Can a new owner force a tenant to renegotiate an existing lease when he takes ownership of the property?

(A) Yes, if the lease has a purchase option in it.

(B) Yes, if the lease has a sale clause.

(C) Yes, under any circumstances.

(D) No, under no circumstances.

Correct answer: (B). The only circumstance under which this situation occurs is the inclusion of a sale clause in the lease. Otherwise a lease survives the sale of a property.

5. A tenant refuses to leave an apartment after the expiration of the lease. The landlord continues to accept the tenant’s rent. The tenant may be said to have

(A) a tenancy at law.

(B) a tenancy at sufferance.

(C) a tenancy by the entirety.

(D) a periodic tenancy.

Correct answer: (D). A tenancy at sufferance would have been created if the tenant stayed without the landlord’s permission.

6. A net lease requires the tenant to pay

(A) all or some of the building expenses.

(B) all of the building expenses, including the mortgage payment.

(C) none of the building expenses.

(D) a percentage of income earned by the tenant’s business.

Correct answer: (A). A tenant never has to make mortgage payments. Paying none of the building expenses is the opposite of the correct answer. A percentage payment is a trait of a percentage lease.

7. The principal difference between tenancy at will and tenancy at sufferance is

(A) the term of the lease.

(B) the expenses paid.

(C) whether rent is paid in arrears or in advance.

(D) the landlord’s consent.

Correct answer: (D). In tenancy at will, the landlord allows the tenant to stay in the premises, but there is no definite period of time when the arrangement will expire. In tenancy at sufferance, the tenant is staying against the landlord’s will.

8. A typical apartment lease with a beginning and ending date is

(A) an estate for years.

(B) a periodic estate.

(C) a net lease.

(D) a percentage lease.

Correct answer: (A). This is a definitional question. A typical apartment lease has a beginning and ending date, but it isn’t automatically renewed from period to period, ruling out a periodic estate. It also tends to be gross (not net or percentage).

9. The landlord’s interest in a lease is called

(A) the leasehold interest.

(B) the leased fee interest.

(C) the gross lease interest.

(D) the possessory interest.

Correct answer: (B). The landlord owns the fee of the property and therefore has the leased fee interest. The tenant holds the lease and therefore has the leasehold interest.

10. A tenant remains in possession of a rented house after the bank has sold the property through foreclosure for nonpayment of the mortgage, and the bank wants to evict the tenant. The tenant has

(A) a tenancy at will.

(B) a tenancy at sufferance.

(C) a lawful occupancy.

(D) a periodic tenancy.

Correct answer: (B). The key here is consent. If the landlord (the bank in this case) wants you out but you stay, it’s a tenancy at sufferance.

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