Between the Lease Lines: Know how lenders review a property’s lease agreements
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Knowing that lenders pay particular attention to properties’ income streams, commercial mortgage brokers also must be prepared with the knowledge and skills to review — or at least understand — commercial leases. These leases are at the heart of any property’s income- stream analysis.
In a commercial lease, the property’s owner and tenant enter into a lease to establish the legality, stability and continuity of the property’s income stream for terms that often range between five years and 30 years. Although a lender is not a party to a lease agreement, determining the reliability and the risks of a property’s income significantly contributes to the lender’s decision to make the loan or not. If commercial mortgage brokers can look at commercial leases through lenders’ eyes, they will see the terms on which a lending decision may be made.
There are seven critical points in any lease contract:
- The rent-roll analysis: Lenders typically request copies of all leases, along with their amendments and modifications, and a rent roll from the owner. A rent roll is a list prepared by the owner that identifies each tenant location and size of rental space, leases’ commencement and termination dates, security deposits and rents, and additional rents charged per month or per year. It allows the lender to determine how the lease rents correlate to market rates.
- Tenant estoppels: These work as checks and balances on owner representations provided to the lender in the leases and rent roll. Estoppels are sworn statements made by tenants to the lender to verify the owner-tenant relationship as set forth in the lease without deviation — rent reduction, for example. If the estoppel’s terms contradict lease terms, the estoppel’s terms may override the lease and the owner’s representations.
- Debt-service coverage: Based upon the analysis of the lease agreements, rent rolls and tenant estoppels, a lender likely will verify the property’s income to make sure it meets the debt-service coverage ratio and allows some room for vacancy and collection costs, as well.
- Tenant profiles: A lender will study the mix of tenants to determine how reliable or risky property’s income stream will be based on a number of factors like tenant’s market share, whether the lease is signed by the national company or a local franchisee, the conditions the tenant’s business depend upon, etc.
- Collection: The lender will want to verify that the owner collects rents and additional income deemed rent like operating expenses, as well as rent escalations (periodic increases in the amount of rent) and additional rent.
- Terms: Lenders may require lease terms run concurrent and/or extend beyond the term of the loan. A major concern for lenders is that if a lease expires during the loan term, the space may remain vacant without a paying tenant, which will reduce the income stream.
- Assignment of leases and rents: When making the loan, a lender may require an owner to sign an assignment of leases and rents agreement. By doing so, if the owner defaults, this agreement grants the lender the right to collect the rent directly from tenants.
Commercial mortgage brokers who understand the preceding points will be in a good position to understand the reasons behind a lender’s financing decision, and they may advise clients on the best course of action to position deals for approval. Disclaimer: The above is for informational purposes only and does not constitute legal advice.
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