Only as Good as the Data

By Manuel Fishman, Shareholder, Buchalter Nemer: As the demand for sublease space grows, it's critical to follow proper lease abstracting procedures.

Fishman_web-200x200The commercial real estate market in major metropolitan cities remains very robust, with the pipeline for lease transactions for renewals, expansions, contractions and relocations very active. The demand for sublease space continues to grow, as many new companies see value in short-term exposure to real estate as they develop their business model.

When conducting a real estate transaction that leverages an existing lease–whether a sublease or a lease modification, renewal, contraction or expansion–knowing what is in the existing lease is vital, and communicating that to the brokerage team up front expedites the transaction. Failure to have proper lease abstracting procedures and data retrieval capabilities always slows down the transaction, and in the worst case, leads to a broken deal and a missed opportunity.

In my view, the proper place to start before entering into a letter of intent with a prospective subtenant or for a lease modification with an existing tenant is with a review of a lease abstract. While most lease abstracts focus on the monetary pro forma, it’s equally important that they identify other rights granted to the prime tenant that may impact future owners, be inadvertently triggered in a sublease or be made applicable to expansion premises or during a renewal term, when that was not the intent of the original deal.

Two examples from recent actual lease transactions may be helpful:

A lease grants tenant rent abatement during the first month of the third year of the lease term. In year two of the lease term, the parties reach a business deal for the tenant to relocate to smaller space–which benefits the tenant by reducing its real estate exposure and benefits the landlord by enabling it to recapture more leasable space in a rising market. But by not looking at the underlying lease that is to be amended in connection with the relocation, neither party focused on the year three rent abatement–and the brokerage team didn’t have a full lease abstract or didn’t have procedures in place to check the concessions in the existing lease. Is the rent abatement applicable to the new space? What about a right of first offer or right of first refusal to lease space on a certain floor in the building that was in the original lease but may no longer be relevant to the tenant now that it’s downsized?

Another example is when a lease contains an option to extend, and the parties agree (outside the formal extension option terms) to extend the lease. Does the extension option continue or is it deleted? Do expansion rights the tenant had during the “initial term of the lease” continue because the lease term is being extended outside of the option procedure or not?

When an owner relies solely on third-party analysts to prepare standard lease abstracts, there is a risk that key non-monetary provisions will not be addressed in a term sheet, and may only be identified during the legal negotiation and documentation stage, at which point it may be too late to raise the claw back of a concession that one side perceives to be material.

My recommendation is to follow best practices in two ways: Review lease abstracting forms and the manner in which data entries are presented, and always have the brokerage side and the deal person review the underlying lease–and if there is a good relationship with legal counsel, have it do the same–before penning a letter of intent for the transaction.