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Leveraged Breakdowns

A Beginner’s Guide to Commercial Leases, Part Five: The Final Chapter

This final installment in our series on commercial leases (unless we decide to bring you Commercial Leases: Hobbs and Shaw) will focus on co-tenancy clauses and ground leases. Again, these topics are getting deep into the weeds, but if you are hunting for your first private equity real estate job, this info can really help you stand out during interviews. And if you are on the lookout for an excellent private equity real estate career development course, you can find those here and here!

Co-Tenancy Clauses

Co-tenancy clauses are mostly seen in retail leases, but you may come across them in office or other real estate sectors as well. The idea is that the tenant is willing to sign a lease, but the rent they will pay is contingent on there being other similar tenants open and operating. In an enclosed mall, a junior tenant may only be willing to lease the space (or be willing to pay market rent) as long as the anchor store (Macy’s, Nordstrom, Dillards, etc) is open and operating. This happens in grocery-anchored centers or shadow anchored centers as well.

In the event that the named co-tenant closes, the language in the lease will provide specific remedies. It may allow for the tenant to close and vacate the space with no penalty. It may allow for reduced rent (sometimes called “slack rent”) until the Landlord is able to re-lease the space with an acceptable tenant.

As an analyst, do not ever overlook co-tenancy clauses when underwriting a property. You need to dig into the leases and make sure you understand the conditions that can set off a co-tenancy problem, and understand how many leases have co-tenancy language that interact with one another. If there are multiple leases with co-tenancy clauses, the right circumstances can set off a chain reaction that destroys the investment.

Ground Leases

Ground leases are just what they sound like: a lease of the ground only. Typically this occurs on vacant land, with the expectation that the lessee plans to construct a building on the land. Because this is a significant investment, which the lessee will want to recoup over time, ground leases usually carry extended terms: 20, 50, or even 99 years.

Landlords love ground leases because they are very long term and the tenants rarely vacate because that means abandoning the building that the tenant paid for. If the tenant does vacate, the landlord gets the building for free. Ground leases also tend to be absolute net, with no responsibilities for the Landlord.

Tenants usually prefer not to sign ground leases, but in areas where land costs are very high, a long-term ground lease can be a way to reduce capital costs related to a new building. If the tenant is a national retailer with large expansion goals, ground leases can be a way of stretching their capex to open more units.

The Series Finale

Landing your first private equity real estate job takes time and persistence. The field is highly competitive, and the job openings can be hard to track down. When you do get an interview, you want to be ready. This series on commercial leases will help you speak like a business insider and set you apart from other candidates. And don’t delay in enrolling in the private equity real estate career development courses from Leveraged Breakdowns–they will prepare you and put you in top form for your interviews!

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