In the world of real estate and commercial property evaluation, one of the most important factors to consider is lease agreement. No matter if you are a property owner or an investor, understanding lease agreements could be extremely influential on commercial valuation.
Explore with us the impact of lease agreements on commercial valuation and what you should look for.
What Is A Lease Agreement?
A lease agreement is a legal contract that binds the tenant and the landlord. It provides details regarding the rent amount, duration of the lease, and the responsibilities that both parties are obliged to. The type, length, and terms of the lease directly affect the property value. For commercial properties, lease agreements can be more complex as they cover many other issues, such as maintenance, repair, and insurance. In some cases, they also cover property taxes.
Types Of Lease Agreements
- Gross lease
The tenant is responsible for paying the rent only, while the landlord covers all other expenses such as maintenance, taxes, repair costs, etc.
- Net lease
In this type of lease, the tenant covers some or almost all the expenses related to the property. The tenant is responsible for all the property’s cost-related issues depending on the agreement type.
- Percentage lease
This lease agreement is mostly effective in retail spaces. The tenant pays the rent and also a percentage of its gross sales. This type of agreement is beneficial for landlords when the business is flourishing, whilst it could cause loss in case of low sales.
- Short-term lease OR Long-term Lease
In these types of agreements, short-term lease agreements provide flexibility. However, they could be costly and often result in less predictable income streams. On the other hand, long-term lease agreements offer stability and predictability for both parties.
How Lease Agreements Impact Commercial Valuation
Lease agreements significantly impact the market value of the property. Let’s examine how different lease agreements influence commercial valuation.
Tenure Of Lease And Stability
The length of the lease is directly proportional to the stability of both parties, the landlord and investors. A property with tenants who sign long-term lease agreements is considered more secure, and its value increases because there is less risk of it being vacant. On the other hand, a property with tenants who sign short-term agreements loses its value because it is more likely to be vacant.
Rent Escalation
One primary factor affecting a property’s income is the rent agreed upon in the lease agreement. Properties with tenants with higher rental contracts attract more investors and buyers because of their profitability ratio. Many agreements have periodic rental escalation clauses, which ensure the gradual increment of rent value. It could be particularly appealing to investors as it promises a high-profit value.
Tenant Quality And Trustworthy Credentials
Leasing properties to tenants with strong financial credentials could attract more investors, as these tenants promise higher income streams and are less likely to default on payments. It would eventually positively impact the property value.
Operating Expenses
Properties leased on net lease agreements tend to attract more investors and buyers, as the tenant bears the responsibility, making it a hassle-free investment for a buyer.
Conclusion
Lease agreements greatly influence property values. They showcase the income, stability, and risks involved with the property. It is recommended that you go through the lease agreement before finalising the bond. Both tenants and landlords can make beneficial agreements if they understand and settle on a bond that is equally profitable for them.
FAQs
How would it affect the value of my property if I break a clause in the lease?
Breaking a clause in the lease agreement can negatively impact the value of the property. It would introduce uncertainty whether the tenant or the landlord breaks the clause. It would be viewed as a risk by the investors and buyers.
What could be the best lease strategy that would help in maximising both the rental value and property value?
To maximise both, you must look for long-term lease contracts with tenants that are financially stable and also include rent escalation clauses. Also, try to bond using net leases so that the financial burden is shifted towards tenants, thus reducing your financial burden.
