Lease abstraction is an essential component of due diligence for a multi-tenant commercial property. Lease terms often vary from tenant to tenant. Lease terms and options impact both the quantity and quality of rental income. Lease terms affect the quantity of rental income by adjustments made for factors such as rental rates and escalations. Lease terms affect the quality of rental income based upon factors such as the tenants rights to lease additional space at a predetermined price or to give backspace if they no longer need it.
Lease abstraction is a tedious and time-consuming process, particularly for properties with numerous tenants. Each lease is often 20 to 100 pages in length. In many cases, the lease form varies from tenant to tenant depending on whether the tenant or the landlord originated the lease form and which of a series of owners executed the original lease. Multiple special terms can be included in various portions of the lease. These modifications can substantially impact cash flow and the value of the property. Following are some of the lease terms which should be considered when conducting a lease abstraction:
First right of refusal;
Co-tenancy clauses (tenant A can terminate lease if tenant B leaves the center);
Right to terminate if the building does not have adequate space to meet the tenants requirements or if other factors occur;
Pricing for after-hours electric;
Parking rights and pricing;
First right of refusal to purchase the building;
Right to reduce rent if certain conditions are met to;
Write to give back space which is no longer needed;
Right to take additional space at a predetermined price.
A complete lease abstraction must be prepared before it is possible to perform financial modeling for an acquisition. The lease terms will dramatically affect current and future cash flows. The combination of lease abstraction and financial modeling (performed using a program such as Excel or Argus) provides the investor meaningful insights into the probable cash flow for the investment.