Chapter 12
IN THIS CHAPTER
Understanding some lease jargon
Seeing what goes into a lease
Looking at different types of leases
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.
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.
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.)
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.
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.
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.
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.
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.
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.
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
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:
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.
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).
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.
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.
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.
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.
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.
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.
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.)
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.
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.
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.
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 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 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.
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
Add on factor
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.
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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