Lease Terms Worth Knowing

I'm often asked by dealers and more often by general managers whether their particular related party-lease terms are “fair.”

I will not get into the definition of fair, because it varies greatly depending on whether I am talking with the tenant (often the general manager) or the landlord (often the dealer).

There are wide variations in the terms of leases that must be negotiated between the tenant and the landlord. However the following is a summary description of the basic terms of many of the related party leases that I have seen.

General: Substantially all of the leases are “triple-net,” meaning the tenant (dealership) is obligated to pay, in addition to the rent, all operating expenses of the property, including, but not limited to, real-estate taxes, any other government charges, insurance, utilities, repairs and maintenance.

In addition, the leases generally require the tenants to pay for additions, repairs, renovations and improvements to the properties undertaken by the tenant.

Rent: During the initial lease term and any extensions, tenants pay annual base rent in monthly installments. In the old days, monthly rents were typically a fixed percentage of the fair market value (FMV) of the property or the monthly debt service plus a cushion.

Probably more typical today in a related party lease are rates from 9% to 11% of the FMV at the beginning of the lease.

These leases typically provide for upward periodic adjustments in base rent. That's usually based on a change in a consumer price index (CPI) which may be subject to fixed minimum and maximum rent escalators during the initial lease term and any extension periods. The rental payments typically reset based on FMV during certain renewal periods.

Term and Termination: The leases generally are for initial terms of 10 to 20 years. Leases typically have options to renew upon generally the same terms and conditions for one or more additional periods of five to 10 years each, exercisable at the option of the tenant.

Indemnification: Generally, a tenant will be asked to indemnify the landlord from liabilities, costs and expenses from 1) use, condition, operation or occupancy of the property; 2) breach, violation or nonperformance of the lease or any law; 3) injury or damage to the person, property or business of the tenant or any customer of the tenant; and 4) violation of environmental laws or regulations.

Insurance: A typical lease provides that the tenant will maintain insurance on the properties of the type and in the amounts that are usual and customary, including commercial general liability, fire and extended loss insurance provided by reputable companies, with commercially reasonable exclusions, deductibles and limits.

Damage to or condemnation of a property: Leases generally provide that, if a material portion of a property is condemned, the lease may be terminated and any condemnation award would belong to the landlord.

Assignment: Leases generally provide that the tenants may not, without prior written consent of the landlord (which under certain circumstances may not be unreasonably withheld) or upon compliance with conditions set forth in the lease agreement, assign or otherwise transfer any lease in whole or in part except to a related person.

Events of Default: If there is an event of default under a lease, the landlord may terminate the lease, evict the tenant, retain possession of the property and/or lease the property to others. An event of default typically includes failure to pay rent; failure to comply with the provisions of the lease; certain events relating to bankruptcy or insolvency of the tenant; or failure to maintain a current franchise agreement.

Dealers and general managers, do the right thing and agree on “fair” lease terms that reflect the fair market value of the real estate and the ability of the dealership to support it.

Don E. Ray is a CPA and a senior vice president at AutoStar. He can be reached at 901-907-0134.

Questions or comments about this column?
Send us an e-mail at [email protected].