What Happens to Leases When a Property is Sold?

Leases are contracts that encumber a property even after a real property is sold. So if you acquire an industrial building that is already leased and the lease allows five options to the tenant for 5 year for each option the tenant has rights to rent the building for at least 25 more years. So if you think you are going to purchase the building and eject the tenant you are in for a big disappointment.

Why would an owner give a tenant renewal options that can continue to control the use of a property over a 25-year term? There are a number of motivations. Some tenants have to make significant tenant improvements. A dentist for example may want to make improvements that cost hundreds of thousands of dollars and they can't make them if their lease will expire after 3 to 5 years.

Some tenants negotiate below-market lease rates when they move in and then they want to lock the rental rates in for as long as possible, so some tenants want options for long terms to insure they know what their rent will be over the long-term. If an established lease or leases fix an overall below market rental rate those rental rates can negatively influence the value of a real property. So someone signing a lease that gives a preferential rental rate to a friend or relative before they die can effectively reduce the value of the building. You could inherit a building that's worth $ 1,000,000 with no leases but with below market leases in place it may be worth $ 300,000.

If grandpa decides to take care of his friends and old partners before he departs and you are his heir you could lose millions when he signs a new lease or leases. I have seen it happen. Members of the family find out that they now own a large building with a great national tenant and the rent doesn't even pay the property tax bill! Yes you can inherit a property that costs you money each and every month. You can always get rid of your interest but some just can't let the asset go. Appraisers look at competitive properties to form their opinions of a market rental rates for subject properties. If the market rental rate is determined to be $ 1.20 per square foot (SF) per month triple-net (NNN) and the building is leased for 20 years at $ 0.50 per SF per month NNN then the appraisal is going to reflect a much lower value.

So real estate leases not only stay in place after a sale but they also have a significant influence on property value. That's why your commercial appraiser will insist on having copies of building leases or an abstract that details lease terms.

It's important to check with a real estate attorney if you have no understanding to real estate contracts, if not you may find that your property is worth a lot less than you imagined because of a lease or leases that control it over the next several years.

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