Definition
A lease is a written agreement between a landlord (property owner) and a tenant that grants the tenant the right to occupy or use a property for a specified time period in exchange for rent and compliance with stated rules and responsibilities.
What a Lease Controls
From an investor standpoint, the lease is the “cash flow contract.†It determines how income is earned, how expenses are allocated, and how risk is shared.
- Income: base rent, escalations, fees, reimbursements, late charges.
- Timing: when rent is due, grace periods, prorations, renewal/option windows.
- Operating responsibilities: who pays utilities, repairs, insurance, and maintenance.
- Restrictions: use, occupancy limits, pets, alterations, signage, subletting.
- Enforcement: default definitions, cure periods, remedies, eviction/termination rights.
Key Lease Terms to Know
- Lease term: the start and end date (and any renewal options).
- Rent: amount due and frequency (monthly is common; commercial may vary).
- Security deposit: funds held to cover damages, unpaid rent, or other defaults.
- Escalations: scheduled rent increases (fixed, step-ups, CPI-based, percentage).
- Concessions: free rent, discounts, or move-in credits that reduce effective rent.
- Utilities and reimbursements: how tenant payments for expenses are handled.
- Repairs and maintenance: who is responsible for what (unit vs. building vs. common areas).
- Assignment/subletting: whether the tenant can transfer the lease to another party.
- Guarantee: whether another party backs the tenant’s obligations (common in commercial; sometimes residential).
Common Lease Structures
Residential lease
Typically short-term (often 6–12 months) and standardized. The landlord generally pays building-level expenses, while tenants may pay some utilities depending on the property’s setup.
Commercial leases
- Gross lease: landlord pays most operating expenses; tenant pays one rent amount (sometimes with limited pass-throughs).
- Modified gross: expenses are shared based on a negotiated structure (base year, expense stop, or defined categories).
- NNN (triple net) lease: tenant reimburses property taxes, insurance, and maintenance (often reduces expense volatility for the owner).
Why It Matters in Underwriting
- In-place income: rent roll is a summary of leases; the lease is the source document.
- Rollover risk: expirations can create vacancy and capex needs (tenant improvements, turns).
- Expense risk: lease type determines who bears inflation in taxes, insurance, and maintenance.
- Credit/collection risk: tenant quality and guarantees affect probability of payment.
- NOI quality: “high rent†is not the same as high effective rent if concessions or delinquencies are present.
Example
A tenant signs a 12-month residential lease for $1,850/month with a $1,000 security deposit and a one-time $300 move-in concession. For underwriting:
- Gross scheduled rent = $1,850 × 12 = $22,200
- Effective rent is lower due to the $300 concession (and any vacancy/delinquency assumptions).
Common Pitfalls
- Trusting the rent roll blindly: always reconcile rent roll to signed leases and collections history.
- Missing hidden concessions: “free month†promos, ongoing discounts, or employer deals reduce true income.
- Confusing who pays expenses: reimbursement language (especially commercial) can materially change NOI.
- Ignoring options: renewal options can cap rent growth or delay mark-to-market.
- Weak default language: unclear remedies or long cure periods slow enforcement.