Income Approach - Lease Clauses

Competition Clauses

It is common for leases to include a clause that prohibits the Lessor from leasing another unit in a shopping center or office complex to another tenant in the same type of business. For example: if one bicycle shop is in the center, leasing to another bicycle shop would be prohibited. Should the Lessor violate that provision, it could drastically impact the first bicycle shop owner’s business and the value of that lease to that Lessee.

Escalation Clauses

Most commercial leases contain some sort of escalation clause keyed to actual increases in the Lessor’s costs or, in some cases, tied to some index such as the Consumer Price Index (CPI). Depending on the nature of these escalation provisions, they can in some cases increase rents significantly and the impact on value can fluctuate from very little to quite significant. Sometimes stops or caps are included to set a maximum for a given period, which is something tenants often try to negotiate into the lease agreement.

Escape Clauses

This clause allows Lessees to cancel a lease under abnormal conditions, such as provisions in a damages clause that allow the Lessee to cancel the lease if it negatively impacts business operations. That clause also may allow the Lessor a time period in which to cure the adversity and waive rents during the correction period.

Kick-out Clauses

This clause allows a Lessee with a long-term lease to cancel that lease if business revenues have not reached a pre-set level after a certain pre-set time frame (e.g., one year, three years); or if an anchor tenant is not replaced; or some other predetermined trigger tied to the Lessee’s business volume at that particular location. This could weaken the value of a lease interest.

Tenant Going Dark

Many smaller tenants in shopping centers, especially those in smaller complexes where there is just one anchor tenant and six to ten other shops, are concerned that the anchor may close its store and not renew the lease, also known as “going dark.” One remedy is to negotiate a “go dark” clause that allows the Lessee to close its store or receive significant rent reductions if that anchor, or even a specified number of other smaller tenants, go dark.

Net Lease (alternatively Triple Net Lease)

A lease in which the landlord recovers all operating expenses from the tenants.

Net, Net Lease

Lessee pays for one or two of the three categories of operating expenses and the lessor pays the other(s).

Full Service Gross Lease

This lease is used primarily in multi-tenant office buildings where the landlord pays for all operating expenses in the building, including the janitorial, utilities and maintenance inside the individual leased office spaces. There is no reimbursement to the lessor by the lessees for any of the operating expenses. These leases sometimes have “expense stops” that provide for the tenant to reimburse certain expenses when those expenses exceed a specified limit. But until that limit is reached, the landlord pays without recovery from the tenants.

Gross Lease

This lease is the most common on smaller single tenant commercial buildings. The tenant pays the utilities, minor maintenance and janitorial inside the tenant’s leased space and the landlord pays for three categories of operating expenses without reimbursement.

Modified Gross Lease

This is similar to the Net, Net lease in the older system. The tenant pays for the utilities, minor maintenance and janitorial inside the leased space. However, the three categories of taxes, insurance, and common area maintenance are shared in some manner based on the lease provisions. In this lease, the appraiser needs to carefully analyze the lease to see how these three categories are allocated between tenant and landlord.

Net Lease

This is the same as the “Triple Net” or “Net, Net, Net” lease in the older system. The tenant is responsible for all of the three categories of operating expenses.

Absolute Net Lease

This lease is “more net than the Net Lease.” In this lease there are some capital expenditures and/or financing expenses that are paid by the tenant in addition to all of the above operating expenses. This is most common in single tenant long term leases with national credit tenants like Walgreens or McDonalds where the tenant pays for new roofs, new HVAC, etc, when they wear out during the long lease term.