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SHORT INTRODUCTION TO CALIFORNIA REAL ESTATE PRINCIPLES, 

 

1994 by Home Study, Inc.   dba American Schools

 


Click on link to go to:
Table of Contents; Chapter I: Real Property; Chapter II: Legal Ownership; Chapter III: Agency & Ethics; Chapter IV: Contracts; Chapter V: Real Estate Mathematics; Chapter VI: Financing; Chapter VII: Mortgage Insurance; Chapter VIII: Appraisal; Chapter IX: Transfers of Real Estate; Chapter X: Property Management; Chapter XI: Land Control; Chapter XII: Taxation; Chapter XIII: Fair Housing Laws; Chapter XIV: Macroeconomics; Chapter XV: Legal Professional Requirements; Chapter XVI: Notarial Law; Chapter XVII: Selling Real Estate; Chapter XVIII: Trust Funds Handling; Glossary; Index.

PART III: LAND USE

 

Chapter X: Property Management

 

Educational Objectives: Learn about Leases and leasing, Americans with Disabilities Act, Risk Management, R.   E.   TERMS GLOSSARY, INDEX.   

 

The increase in absentee ownership of real estate has produced a greater need for professional property management.   Most owners manage their own properties, but income properties tend to be developed in larger projects where great sums of owner and lender funds are required and where owners require the assistance of professional managers.   In recent years, property management has become a profitable subsidiary for successful brokerage firms.   

 

Since in California, in order to manage nonowned property, property managers have to have a real estate license, virtually all real estate brokers, at some time in their careers, consider adding a property management department or service as a means of increasing cash flow and net profit.  Desirable as this may be, several questions require answers before such a decision is concluded.   

 

1.   Is there a need for property management in the firm's service area?

 

2.  What evidence is there to indicate a desirable volume of property management business exists?

 

3.   Exactly what does a property manger/department do?

 

4.   Which area of property management should become the specialty?

 

The primary function of real estate property management is to operate residential, commercial and/or industrial properties for owners who are unable or unwilling to handle the details of renting, collecting rents, property maintenance and repair, and record keeping associated with property ownership.   In fulfilling his responsibilities to the owner, however, the property manager cannot ignore the obligation to seek accomplishment of the owner's goals regarding the property, including his desire to maximize the profitability of the property and to protect the owner from liability.   The property manager is also charged with social concerns, such as safeguarding the civil rights, health and safety of the tenants.   

 

Classification of real property

 

The major classifications of property include commercial properties, industrial buildings and residential properties.   Each of these can in turn be further divided into subcategories.   Commercial properties generally include offices, retail, entertainment and other operations which are highly individualistic and not subject to categorization or stratification within the project, and include such facilities as office buildings and shopping centers.   

 

Commercial Property

 

Commercial properties consist of those places where things are sold or services are rendered.   They are usually open to the public and exist for the transaction of business.   Examples include offices, retail stores, restaurants, health care facilities and recreational facilities.   

 

Industrial Property

 

Industrial properties are facilities which are occupied by a business for its own use or with house enterprises engaged in the processing, manufacture or distribution of products.   Examples include factories, plants and wholesale warehouses.   

 

Residential Property

 

Residential property is almost anywhere people live.   This does not include hotel, motels or resorts.  Residential property includes apartments, small multifamily developments such as duplexes, triplexes, quadruplexes, single family residences, condominiums, planned unit developments and townhouses.   

 

Duties of the Property Manager

 

The property manager can provide property owners with expert guidance in acquiring and disposing of investment properties.   This may be accomplished by:

 

1.  Developing a pool or network of potential buyers and sellers, including other property owners and tenants.   

 

2.  Keeping abreast of current market conditions and active investors at all

 

3.  Helping to minimize selling costs by arranging to exchange properties among clients.   

 

4.  Arranging sales to current tenants, which frequently reduces the cost of the sale and sale related repair work.   

 

5.  Identifying undervalued properties or favorably financed properties with immediate positive cash flow.   

 

Contracts In Real Estate Property Management

 

The property manager is, like the other specialties in real estate, also a contract specialist.   Virtually every activity of the property manager is related to some part of a contract.   

 

NOTE: Unless the property manager is an attorney, preparation of contracts is limited to filling in the blanks.   

 

The Property Management Agreement

 

The property management agreement is the employment contract between the owner(s) of the property and the property manager.   It is the vehicle wherein the results of the employment "meeting of the minds" is recorded.   It contains the usual elements of a contract and the terms of the property manager's employment.  It identifies the property(s), states the compensation of the property manager, lists the responsibilities and duties of the property manager and the owner(s), and begins the law of agency.   

 

The property management agreement is a personal service contract much like a listing agreement in real estate sales operations.   Both evoke the law of agency.   

 

Some typical clauses in a property management agreement may include:

 

Identification of the parties and purpose of the contract Duties of the agent Duties of the owner Miscellaneous

 

Other Contracts and Forms Used In Property Management

 

Some typical clauses which may be found in a commercial lease:

 

Identification of the leased premises

 

Term of the lease

 

Rent

 

Rent increases

 

Taxes

 

Utilities and services

 

Signs

 

Repairs and maintenance

 

Lessee's fixtures

 

Subleases

 

Inspections and repairs

 

Liability and personal injury

 

Insurance

 

Notices

 

Termination of lease

 

Condemnation

 

Landlord's and mechanic's liens

 

Alterations

 

Improvements

 

Holdover tenancy

 

Attorneys' fees and costs

 

Waiver

 

Legal responsibility

 

Special provisions

 

Some items which may be found in a typical rental application form:

 

Identification of the renter

 

Number of persons to occupy

 

Nearest living relative

 

Present and past housing record

 

Employment history

 

Financial information

 

Pets

 

Automobile

 

References

 

Authorization to check references

 

Some items which may be found in a typical security deposit agreement:

 

Identification of the parties

 

Amount of deposit

 

Conditions for refund of deposit

 

Holding over

 

Forwarding address

 

Cleaning/ failure to clean

 

Pet charges

 

Inspections

 

Special provisions

 

Insufficient deposits

 

Some typical clauses in a residential lease:

 

Identification of the parties

 

Identification of the property

 

Rent

 

Security deposits

 

Utilities

 

Occupants

 

Pets

 

Owner's responsibilities

 

Subletting

 

Rules

 

Repairs

 

Inspections

 

Liability

 

Default by resident Lien Notices

 

AMERICANS WITH DISABILITIES ACT

 

Title III of the Americans with Disabilities Act (ADA) became effective on January 26, 1992.   It requires businesses to be accessible to persons with a disability.   The ADA is having a more direct impact upon the real estate industry as it relates to the purchase and leasing of commercial properties.   The ADA does not directly impact residential property because Congress believed it had addressed those issues in the Fair Housing Act Amendments in 1988.   The importance of being aware and in compliance with the ADA for property managers is best illustrated by the fact that if a business owner is sued because a building he/she leased or purchased through a property manager is not in compliance, the property manager will be named in the suit.   

 

In addition, the property manager's place of business must be in compliance with ADA.   That means that the building should be free of barriers such as steps, narrow doorways, narrow bathroom stalls, etc.   The ADA standards for accessibility have been issued by the Architectural and Transportation Barriers Compliance Board and are available by contacting their office at (800) USA-ABLE.   

 

Some other accessibility requirements that may affect a property management operation may include having a Telecommunications Device for the Deaf (TDD) available and having any printed material distributed done in Braille, large print or on tape.   Of course, having these accessibility requirements met may have the effect of opening the business to a whole new market of potential customers and clients.   

 

The responsibility of property managers

 

The primary function of property management is the preservation or increase of the value of an investment while generating income for the owner.   The manager, therefore, attempts to maximize the income to the owners of investment property over its life.   The manager satisfies the basic objective for the owner by:

 

1.   Securing tenants for the property/ (the rental function).   

 

2.   Collecting rents from those tenants.   

 

3.   Maintaining the structure.   

 

4.   Servicing both tenant and owner requests.   

 

5.  Preparing budgets and managing the expenses regarding the operation of the properties

 

6.   Hiring and supervising employees to work at the structure,

 

7.   Documenting and accounting to the owner.   

 

Leasing and Rent Collection

 

The most visible functions of the property manager are leasing and rental collection.   The role of the property manager in the leasing function is that of

 

1.  Being able to determine the appropriate rent that the property would generate in the marketplace,

 

2.  Understanding the various lease provisions and types of leases appropriate to that space, and

 

3.  Being able to select the most appropriate tenants for the property.   

 

Adjustment of the rental rates involves both upward and downward changes to maximize the income that the property may generate and may minimize the loss due to vacancies.   It is important for the property manager to understand the various types of lease arrangements that exist for different types of properties.   For example, flat monthly rents may be in effect for residential properties while percentage leases requiring a relatively low annual rent with the provision that the rent will be increased by a specified percentage of sales volume experienced by the tenant will be in effect for commercial properties.   The selection of tenants is quite important.   For example, the choice of all appropriate anchor tenant, a major department or chain store is crucial to a shopping center giving maximum exposure to small satellite stores.   

 

The property manager may use subagents, real estate brokers or associates, to solicit tenants for the property.   In that case, the subagents may be paid a fee for the bringing of prospective tenants while the property manager will execute the leases and maintain future contacts with the tenants on an operating basis.   

 

The property manager will collect the rents and deposit the monies in a management operating account, set aside for this purpose only.  Any damage or security deposit required by a landlord of a tenant must be kept in a trust account for the tenant.   Misappropriation of the security deposit is unlawful and punishable.   

 

Rent collection and transfer to the property owner is one of the most important tasks of a property manager.   Legally speaking, rent is not due until the end of the rental period, unless there is an agreement to the contrary.   Almost without exception, however, rent is due the first day of the rental period and is normally paid monthly.   If the rent is not paid on the day specified, each day after it is due is a day in which the property owner is losing the use of that money.   One of the major reasons a manager is hired is to reduce slow rent payments.   The manager that handles this task is less than an efficient manner often will lose a client, even if all other services are property performed.  Much of the risk of unpaid rent can be eliminated of proper tenant selection has taken place at the outset.   

 

Methods of management follow-up on past-due rent vary from firm to firm.   In all cases they are modeled on the wishes of the property owner, and these preferences should be determined as soon as possible.  Experienced managers normally take a more moderate approach to follow-up accounts than might be expected.  Through experience, it has been found that dependable tenants who experience problems appreciate the consideration given to them by management and tend to renew without difficulty.   

 

On the more pragmatic level, the truth of the matter is that the legal process currently is so structured that immediate dispossession of tenants in arrears is virtually impossible if the tenant has the slightest knowledge of the legal methods available to impede eviction.   Whether actual dispossession is started on the fifth day the rent is in arrears or the forty-fifth day, the actual date of eviction will often be the same if the tenant contests.   Thus it is in the best interest of management and ownership to allow a certain period of grace to dependable tenants who are in difficulty.   Perhaps they will be able to produce the rent sum due.   If so, the management and ownership are spared the time and costs associated with finding a new tenant and redecorating the apartment to the choice of this tenant.   It should be stressed that this principle cannot be pushed to the extreme.   In all cases it applies only to normally dependable tenants.  Even so, it should be remembered that the tenant cannot find the money to pay for the June rent will find it even more difficult to pay the June and July rent simultaneously.   

 

Because eviction is a legal process, the proper form must be followed so that the tenant involved is not deprived of basic rights.   Management is obligated to be sure that the defaulting tenant has received proper notice of the default.   Failure to follow the legally satisfactory form could allow a nonpaying tenant to remain in possession until the proper notice provision, with all attendant waiting periods, has been fulfilled.   

 

Maintenance of the Premises

 

Management is responsible for the overall supervision of the physical care of the property.   Maintenance of the structure involves two specific kinds of activities for the manager.   First, there is the requirement that the structure be maintained from a capital point of view such that the long-range value and physical soundness of the property will be insured.   The second function involves the day-to-day maintenance in the form of cleaning and repairs of a minor nature.   

 

The provision of maintenance is normally through either a staff employed by the manager or outside firms who provide that type of work on a contract basis.   In order to satisfy the owner and make certain maintenance is expertly performed at a reasonable price, some managers employ their own repair staffs for use on properties they manage.   Others are reluctant to do this, and prefer to keep control by hiring the various sub-contractors needed.   Still others employ a general contractor to subcontract all necessary maintenance and repairs.   

 

In essence, the business of real estate management is to market a constantly aging housing stock, which at all times is headed toward economic, physical, and social obsolescence.   The manager can be of great assistance to the owner by foreseeing necessary repairs.   Timely anticipation of needed repairs often will save the owner from prohibitively costly major repairs later on The amount saved here could more than equal the managers fee for a year.   Planning for repairs on a regular basis is closely connected with the property budget, which the manager should discuss with the owner at the start of the contract.   By explaining the need for orderly repair schedules at the beginning, the manager can overcome later objections from the owner concerning the necessity of regular repairs.   

 

Risk Management

 

Because of the possible financial losses, property managers have a responsibility for managing risks.  Potential risks must be examined and decisions made as to whether these risks should be avoided, retained, controlled or transferred through the purchase of insurance.   The most common types of insurance needed by property owners are the standard fire insurance policy, extended coverage and collateral fire lines, equipment and machinery insurance, consequential loss, use and occupancy coverage, and general liability and workers' compensation coverage.   

 

Owners and property managers may be liable for injuries to trespassing children if they do not exercise reasonable care in the maintenance of attractive nuisances, such as swimming pools and discarded refrigerators which may be both dangerous and conceivably inviting to children.   

 

Servicing Tenant and Owner Requests

 

Similar to the maintenance function is that of servicing tenant and owner requests.   Depending on the type of property being managed, the functional requirements of a tenancy may require alterations to the interior structure.   In the lease of new buildings, the design of interior space may be done on a custom basis during the initial leasing period.   It is also possible that at certain times the owner of property may request changes be made.   The manager will evaluate those requests for the owner and, based upon the economics of such a request, make a recommendation as to whether it should be undertaken.   Overall, quick reaction to requests from either tenants or owners is a part of the service function and will help maintain a stable relationship with both parties.   

 

Budgeting and Controlling Expenses

 

Prior to operating any property, the manager should present a prospective operating budget (pro forma statement) projecting expected income, operating expenses and net operating income.   This target projection provides a basis for monitoring the performance of a building and controlling the expenses associated with its operation.   These expenses are typically broken down as either fixed required expenditures or variable expenditures that are associated with the level of occupancy.  Lastly, there are requirements for the maintenance of a working capital account that the manager has the ability to meet required payments at various points in time.   The amount of working capital required is usually determinable from previous operating experience.   

 

Hiring Employees

 

The management agreement typically creates the role of general agent for the property manager.   As a general agent, the manager's authority includes the general powers associated with the operation of the business.   The hiring and firing of employees or the hiring or firing of outside contractors who provide service are part of the functions of general agents for the management and operation of properties.   The manager will attempt to get the best possible arrangement in the provision of these employee or outside contractor assignments so as to maximize the net income available to the owners.   

 

Accounting and Reporting

 

The property manager, acting on behalf of an owner, is required to document activities, including accounting for income in the form of rents, the lease agreements for the tenants that substantiate that income stream, the maintenance expenditures incurred on the structure, and the various fixed expenditures normally associated with the operation of real estate.   These fixed expenditures usually include mortgage payments, property tax payments, and casualty insurance payments.   It is often the manager's responsibility to compute the tax liability for the property's revenue by drawing up a cash flow statement for the fiscal year.   The management agreement will stipulate at what period the manager is required to report to the owner and disburse to the Owner from the operation of the property.   

 

Management Employment Contracts

 

Management agreements will normally take one of two forms.   The manager may be hired as an employee of an owner or corporation when dealing with large commercial structures.   As such, the manager is typically paid a salary by the corporation.   This employer-employee relationship is common in large organizations.   The other form of arrangement is as a principal and agent relationship similar to other real estate contracts.   Under the principal and agent relationship, the broker is typically authorized to act as a general agent for the operation of the property on behalf of the owner.   

 

Regardless of whether the association is as employer-employee or principal-agent, a management agreement should be executed and signed by both parties.   Items to be covered in a management agreement should include:

 

1.   A legal description of the property;

 

2.   Time period for the agreement to exist;

 

3.   A definition of the responsibilities of the manager;

 

4.   The authority of the manager;

 

5.   The reporting requirements (both frequency and detail);

 

6.   The owner's objectives in owning the property; and

 

7.   The fee for the management service.   

 

Other clauses may appear in a management agreement but these are the most common.   

 

LEASES

 

The document creating the landlord and tenant arrangement whereby the rights of exclusive possession and use for a specified time are exchanged for consideration is called a lease.   The landlord gives up the rights while the tenant or lessee receives these rights in return for consideration called rent.   The agreement generally sets forth the length of time the contract is to run, the amount to be paid by the lessee for the right to use the property, and other rights and obligations of the parties.   The landlord retains the right to receive payment for the use of the premises as well as a reversionary right to retake possession after the lease term has expired.   

 

Contractual Provisions

 

The basic essentials of contract law apply to leases or otherwise, no lease exists.   The parties must possess basic contractual ability.   They cannot be underage.   They cannot be mentally incapable by permanent disability (e.  g.  , imbecility or senility) or temporary disability (under the influence of drugs or alcohol) to rent property as a tenant or to turn over possession as a landlord.   The contract must not be in violation of law.   

 

All written leases must contain the name of the two parties involved in the lease, the landlord-lessor and the tenant-lessee.   These parties must be described in a manner sufficient to identify them.   Likewise, the property must be described accurately and sufficiently for identification purposes.   The amount of rent to be paid under lease terms should be specified.   However, a court will set a reasonable amount for the rental if no figure is given.   The lease should cover a specified period of time.   

 

Under the Statute of Frauds, leases requiring more than one year to perform must be in writing to be enforceable.   An oral lease for less than one year is legally enforceable.   However, it is good business to reduce all leases to writing to avoid misunderstandings and to provide maximum legal protection to both parties.   

 

Leasehold Estates

 

While the ownership of land itself is known as a freehold estate, the right of a tenant to occupy the land for the duration of a lease is called a leasehold estate, which is a less-than-freehold estate.   The four most important leasehold estate are:

 

1.  Estate for Years (Estate for a Stated Term).   The term, Estate for Years, is misleading because the period of time (or term) of the lease may be any fixed period, whether it is for two months, six months, one year, or two years.   The "estate for years" has a fixed beginning and a fixed end.   The estate may be terminated by agreement of the parties at any time, by the expiration date stipulated in the lease without the need for prior notice by either party.   An estate for years is not terminated by the death of the landlord or tenant.   

 

2.  Estate from Year to Year (Period to Period).   An estate from period to period is and estate which continues from year to year, or for successive fractions of a year, until terminated by proper notice.   It differs from "estate for years" in that it does not have a definite termination date.   The length of time for which the estate is renewed is dictated by the period for which the rent is paid.   If a leasehold interest is subject to renewal or termination on a year-to-year basis, it is a leasehold estate called "estate from year to year.  " Unless otherwise specified, a lease is considered a year-to-year contract.   

 

3.  Estate at Will.   Upon agreement of the parties to this type of leasehold contract, either party may terminate the lease at will with adequate notification to the other party.   The rights of the leasehold estate will continue as long as both parties are satisfied with the arrangement and its financial conditions.  There is no fixed period of duration but advance notice of termination is required of either party.   This type estate will terminate upon the death of either the landlord or tenant.   

 

4.  Estate by Sufferance.   This type of tenancy is created when the tenant continues in possession of the property (holds over) without consent of the landlord, and without right, after the tenancy expires, or when the landlord permits (suffers) the tenant to occupy the property.   The property owner may permit extended occupancy for several reasons including a current scarcity of desirable new tenants or a delay in arrangement for legal eviction of the tenant.   As reimbursement for this extended occupancy beyond the lease period, the landlord may assess the tenant additional rent at a rate in line with the previous contract rate.   Within certain limits, the landlord has the right to evict an unwelcome tenant without notice if the possession of the property is hostile to the interest of the landlord.   The nature of the estate by sufferance makes it the lowest estate in law.   

 

Use of the Property

 

In the absence of lease provision to the contrary, tenants have the implied right to use the property for any legal purpose.   If they use it for an illegal purpose, the landlord has grounds for eviction.   In practice, leases may express that the property can be used only for certain purposes or may specifically prohibit other uses.   Tenants may negotiate the provisions in the lease, for example, that prevents the landlord from leasing other parts of the same building to a competitor.   Such a provision is valid.   When tenants lease an entire building, they have the implied right to erect and maintain signs on the exterior of the building, so long as zoning codes do not prohibit such signs.   As always, lease provisions to the contrary will overrule the implied right.   

 

Obligations of Landlord

 

The landlord has certain duties and obligations under a lease contract.   In general, the residential landlord is obligated by statute to do the following:

 

1)                          Comply with the requirements of applicable building, housing, health, and safety codes affecting the health and safety of tenants.   

 

2)                          Make all repairs and do any maintenance necessary to keep the premises in a safe and habitable condition.   

 

3)                          Maintain in good working order all electrical, plumbing, sanitary, heating, ventilation, and air conditioning equipment, fixtures and appliances, supplied or required.   

 

4)                          Supply heat and running water.   

 

In addition, unless otherwise agreed to in writing, a landlord of a residential structure containing more than two dwelling units is required at all times during the tenancy, to make reasonable provision for the following:

 

1)                    The extermination of rats, mice, roaches, ants, and other such pests.   

 

2) Locks and keys.   

 

3) Clean and safe conditions of common areas.   

 

4)                    Garbage removal and outside containers for garbage disposal.   

 

5) Heat during winter, and hot and cold running water.   

 

In leasing nonresidential property, the landlord is not obligated to make repair s or to provide maintenance unless the lease contains an express or implied agreement to do so.   Further, the landlord makes no guarantee that the premises are in a "tenantable" condition or that they shall remain so.   The tenant should inspect the premises, and if alterations or repairs are needed or wanted at the landlord's expense, the tenant should see that these are done or provided for in the lease.   

 

Obligations of Tenant

 

A residential tenant under a lease contract is obligated in general to do the following:

 

1) Keep the premises safe and sanitary.   

 

2) Dispose of all garbage, trash, and other waste appropriately.   

 

3)   Use the property only in a manner consistent with the lease agreement.   

 

4)   Comply with all requirements imposed upon tenants by applicable housing, safety, and health codes.   

 

5)   Protect the landlord's property from intentional or negligent damage by persons on the premises with the tenant's permission.   

 

6) Keep all plumbing fixtures clean and sanitary.   

 

7)   Use and operate all electrical, heating, ventilating and plumbing fixtures, and appliances properly.   

 

8)   Not destroy, deface, damage, impair, or remove any part of the premises or permit any person to do so.   

 

9)   Not unreasonably disturb the neighbors or allow others to do so.   

 

The non-residential tenant's obligations are as set forth in the lease agreement.   

 

Types of Leases

 

Leases are usually subdivided according to how the amount of rental payment is derived.   The most common types of leases are described below:

 

Fixed Rental Lease

 

Sometimes called a flat lease, it stipulates a fixed rental that is to be paid over the duration of the lease.  Fixed rental leases may be further classified as gross leases or net leases.   

 

1.  A gross lease requires the landlord to pay the taxes, insurance, and all other expenses out of the fixed rental amount from the tenant.   

 

2.  Unless there are lease provisions to the contrary, tenants are under no implied obligation to pay real estate taxes, special assessments, or insurance on the leased property.   On long-term commercial leases, however, the lease may stipulate the tenant is to pay such expenses.   This type of lease is called a net lease requiring the tenant to pay a net fixed rental to the landlord in addition to some or all of the fixed and operating expenses of the leased property.   

 

Percentage Leases

 

Quite common in the retail trade business, the rental amount generally includes a base or Minimum monthly rental plus a percentage of the gross sales over and above a specified amount.   The tenant will usually demand that a maximum rental base be stipulated in the lease.   

 

Although the percentage rental is sometimes based on net income or gross profits rather than gross sales, such practice is generally not recommended because of the inability of the landlord (and sometimes the tenant) to determine either net income or gross profits.   Since the landlord's rental is extremely dependent on the tenant's business operation, the landlord should enter into such leases only after careful analysis of the tenant's credit and past performance.   Lease provisions should clearly define what is included in gross sales, when and what type of report the tenant is to submit to the landlord, and whether or not the landlord has the right to inspect or audit the tenant's books.   

 

There are several variations on these basic themes.   Among them are:

 

          Percentage Lease with Base Rent.   This is a lease in which the lessee pays a fixed minimum rent and then pays a percentage rent on gross income above and agreed-upon amount.   For instance, a retail store may pay a fixed rent of $1500 per month and a percentage of gross sales over a specified figure.   

 

          Gross Lease with Graduation.   With a payment that remains fixed for a specified period, it is either increased or decreased by agreed-upon amounts or an amount determined by changes in some index, such as the Consumer Price Index.   For instance, a lease may provide fixed payments for the first three years, with increases in the fourth year.   These increases allow the lessor to keep up with escalating costs and also earn a reasonable return on a property with increasing value.   

 

Sale-Leaseback

 

The sale-leaseback is a financing device involving just what the name implies.   An owner of real estate sells property and simultaneously agrees to lease it back from the buyer, usually on a long-term, net lease basis.   The parties to the lease are called the seller-lessee and the buyer-lessor.   

 

In some instances, a firm may purchase a site in a location of its preference, build a structure to suit its needs, and then search for an investor who is wiling to execute a sale-leaseback.   In such cases, the firm gets the location and building it wants, and the subsequent sale-leaseback frees up fixed capital the firm had tied up in real estate and enables it to use all its funds in the day-to-day operation of the business.   

 

A sale-leaseback occasionally includes an option, called sale-leaseback-buyback, for the seller-lessee to repurchase the property at the end of the lease term.   In effect, this financing device allows the seller-lessee to obtain one hundred percent financing on the building.   Such leases must be carefully drawn to avoid Internal Revenue Service scrutiny.   If the buyback price stated in the lease is a nominal value rather than fair market value at the time of sale, the Internal Revenue Service will probably rule that it was not a lease at all, but rather a long-term mortgage, and any tax benefits enjoyed during the lease term will be disallowed.   

 

The major advantages of sale-leaseback to the seller-lessee are these:

 

1.  The sale frees up fixed capital that can be used more effectively as working capital or business expansion capital for an ongoing business.   

 

2.  The sale frees the seller-lessee of management problems associated with real estate ownership.   

 

3.   The seller-lessee retains use of the property.   

 

4.  The seller-lessee can deduct the total lease payments from income when computing income taxes.   

 

5.  It enables the seller-lessee to obtain maximum financing without experiencing the many restrictive covenants that would be associated with bonds or other long-term financing devices.   

 

The buyer-lessor is usually a life insurance company, a pension fund, a church organization? or occasionally, an individual investor seeking a long-term, relatively secure investment.   The major advantages of a sale-leaseback to the buyer-lessor are these:

 

1.  The rate of return on long-term leases is generally higher than that offered on first mortgages and other long-term investments of similar risk.   

 

2.  The buyer-lessor can commit large amounts of investment funds for a long period of time, thereby avoiding the recurring problem of reinvesting in shorter-term investments.   

 

3.  The buyer-lessors have more control over the real estate they own than they would have it if they merely held the first mortgage.   

 

4.  The buyer-lessor may take advantage of financial leverage by mortgaging the property.   

 

5.  The buyer-lessor can depreciate the building portion of the investment and deduct it from taxable income.   

 

6.  The buyer-lessor benefits from any equity growth through property appreciation.   

 

Termination of Leases

 

Leases may be terminated in a variety of ways.   The most common methods are by:

 

1.  Notice.   With estate from period to period, estates at will, and estates by sufferance, the lease may be terminated upon giving proper notice.   Statutory notice is thirty days.   If the period is less than a month, the notice is equal to the period of the lease.   

 

2.  Expiration of Term.   Estates for years (estates for a stated term) are terminated on the last day of the term without need of notification.   

 

3.  Breach of Condition.   The lease usually gives the landlord the right to terminate the lease and to take possession of the leased property upon default of the tenant.   The landlord must give notice of default and allow the tenant a reasonable time to cure it.   

 

4.  Surrender and Acceptance.   This involves the surrender of the unexpired portion of the lease by the tenant and the voluntary acceptance of the lease by the landlord.   Upon surrender and acceptance, the landlord reacquires possession and relieves the tenant of future liability for rent.   This should not be confused with abandonment.   If tenants abandon leased property, they do so without permission from the landlord and thereby remain liable for rent.   

 

5.  Destruction of Property.   The tenant is relieved from the liability of paving rent if the improvements have been substantially damaged and may terminate the lease if the property is destroyed.   

 

6.  Condemnation.   When all of the leased property is taken by condemnation, the lease is usually terminated and the tenant is reimbursed for the unexpired portion of the leasehold interest.   Unless otherwise specified in the lease, the proceeds in a condemnation suit must first go to the tenants to satisfy their claims before the landlords acquire their share.   

 

7.  Merger.   A merger occurs when the tenant purchases or inherits the leased premises from the landlord.  The leased fee interest merges with the leasehold interest to form fee simple ownership, and all property rights are vested in the new owner,

 

8.  Eviction.   An eviction is the dispossession or deprivation of the tenant from all or part of the lease premises at the instigation of the landlord.   Evictions may be classified as actual eviction by law, constructive eviction, or partial eviction,

 

A.   Actual eviction by law is a statutory right of the landlord if the tenant breaches the lease provision.   It involves a judicial proceeding called an unlawful detainer action to dispossess a tenant legally.   

 

B.          Constructive eviction occurs when the leased premises become uninhabitable or untenantable for the use specified in the lease as a result of acts or omissions of the landlord that force the tenants to remove themselves.   The tenant is no longer liable for rent.   

 

C.          Partial eviction may be constructive or actual.   Partial constructive eviction occurs when the landlord, due to acts or omissions, makes a part of the leased premises untenantable.  The tenant may move out of the entire lease premises and is no longer liable for rent.   Partial actual eviction, on the other hand, occurs when the landlord actually evicts the tenant from only a part of the leased premises.   In this situation, the tenant can continue to occupy the remainder of the premises without paying rent.   Such a situation may arise when the landlord, whose business occupies a portion of the building, decides to expand and, in doing so, unlawfully evicts a tenant from an area previously occupied and leased by the tenant.   

 

9.  Foreclosure.   The landlord has the right to mortgage property that is leased.   If the mortgage is foreclosed, however, and the mortgage is senior to the lease, the lease rights of the tenant are automatically cut off.   On the other hand, if the lease antedates the mortgage, the tenant's rights are not cut off by foreclosure.  The mortgagee merely becomes the new landlord of the tenant, and both parties must adhere to the lease provision.   

 

10.   Death of Parties.   In most instances, the death of either the landlord or the tenant will not terminate a lease.   In an estate at will, however, death of either will terminate the contract.   

 

Options

 

Options are agreements to keep offers open for a stated time period.   A landlord may give a tenant an option to buy the leased real estate, or a tenant may give the landlord the option to sell.   In either situation, the option may be made a part of the lease document.   To be enforceable, an option to buy or sell real estate must be in writing and supported by consideration.   Frequently, the tenant's consideration for an option to buy is included in the periodic rental payment.   Option clauses must contain a previously agreed upon price.   Furthermore, the parties must exercise their rights in specific compliance with the terms of the option.   Normally tenants exercise the option by notifying the landlord of their intentions to buy the real estate.