As the market climbs out of the doldrums and lease activity picks up, if not accelerates, it may be time to wipe off that offering memorandum and take a closer look at that commercial real estate investment.   While, in this environment, we defer to the buyer to make that determination based on associated need and risk, we have determined that some buildings and pockets of Houston will attract attention from the pent-up commercial real estate investor class.

Because we understand that the market has changed so quickly, in such a short period of time, new investment capital is no longer looking for land appreciation as the sole driver to the investment decision.  They will now be focused on what makes the property truly worth its weight: strong leases.

The buildings that have the strongest leases and are located favorably, per their specific asset type, will be the most marketable and sellable over the next few years. For the others, and there are many, the asset values will continue to decline on a similar path with land values.  And, if maintenance for the property becomes deferred and tenants not properly managed, the outcome will be much worse.

Regarding those buildings that are truly sellable, we have provided you, the user/investor, with some expertise regarding the examination of leases when purchasing commercial investment property.  Here are seven important lease items to analyze prior to, and during, the due diligence period:

1. Bank and Personal Guarantees: An investment property comprises leases and other documents which support tenant occupancy. A normal leasing process would involve and create some form of guarantee to be provided by the tenant to the landlord for the duration of the lease. It is important that this guarantee has both strength and substance to reimburse the landlord in situations where the tenant defaults under the terms of the lease. At the time of property sale, these guarantee documents should have some form of ability to be transferred or re-issued to the incoming purchaser. This process is called an assignment of the guarantees. You should consult with the landlord’s solicitor to identify the types of guarantees involved and the ease in which this can be achieved at time of sale.
2. Income and Rent Analysis: The income for the property is a reflection of the leases and occupancy licenses therein. It is essential to understand that the rent has been collected in accordance with the leases or licenses and that all rental matters are up to date. Part of this process will also involve the checking of the rent review profile and the expiry profile of all leases. A property with a volatile leases or leases that are soon to expire is likely to impact the price or the buyer interest. When reviewing tenant occupancy against leases, you should review the original documents and cross reference this to the tenancy schedule and any discussions or information provided by the landlord.
3. Lease disputes: Rarely is there a property that does not have an existing lease dispute or has been impacted by a previous lease dispute. For this reason it pays to question the matters of lease dispute and resolution. If in doubt, seek a copy of correspondence and any subsequent agreement between the appropriate parties. Unresolved lease disputes can jeopardize or slow the process of property sale.
4. Rent reviews: A significant concern in the sale of a property is the size and stability of future rent reviews. It is the rent reviews which will underpin the cash flow and hence the attractiveness of the property to purchasers. It is essential that the real estate broker or agent read all of the leases, before any assessment of price or method of sale is given. It is quite possible that the rent reviews projected and detailed in the leases can either hinder or attract purchasers to the property.
5. Rent arrears: Existing rent arrears should be identified with the owner of a property. Any matters of associated legal pursuit should also be identified. It is possible that the property has had a history of rent arrears and instability. Look for these matters and question the cash flow stability. A history of financial performance from the property over the last few years is the best way to achieve this.
6. Short term leases: Many properties have short term leases or casual occupancy active at any point in time. It is vital to know the mechanism under which this occupancy occurs and how it will be terminated. You do not want a short-term occupancy to jeopardize the stability and processes of the sale.
7. Undocumented lease occupancy: Some may call this a casual lease; however a casual lease can create concern and uncertainty in the process of sale. Some tenants may claim a long-term occupancy from the existence of a previous casual lease arrangement with the landlord. Claims of this type must naturally satisfy the requirements of law to be sustained or upheld by the courts; however you should be cautious in such circumstances given that it can slow down or hinder the sale process.