The Art of Abstracting – Prop 13 Provisions & Improperly Identified Ground Leases

Lease abstracts are an integral part of the commercial real estate (CRE) cycle. Developing and maintaining the integrity of lease data on a timely basis is essential to providing a solid foundation for due diligence purposes, property ownership/investment and management. If the provisions in a lease are not abstracted accurately, there can be significant negative consequences for all parties involved in the CRE cycle; however, fast, accurate lease abstracting is not always readily available. Mining through numerous pages of complex lease documents and deciphering legal terms into a digestible summary is an art form which requires lease abstract specialists and demands hundreds of man-hours – something most lenders, owners/investors and managers either do not have or cannot afford.

The level of detail and number of provisions needed in an abstract can vary depending on the end-user. For example, clients on the due diligence side generally need an accurate and concise snapshot of just the financial provisions of a lease, whereas owners/investors and managers may need more detailed information in addition to the financial terms to properly manage and administer their lease portfolio. In order to receive quick and accurate lease abstracts, all parties in the CRE cycle should look for an abstracting partner that utilizes CRE subject matter specialists with legal expertise, have vast abstracting knowledge and robust data management and integration capabilities.

Issues
While lenders, owners/investors and managers may have different abstracting needs, the financial terms of a lease are at the core of every real estate transaction. Below are some of the most important elements to keep in mind to abstract accurately regardless of the ultimate end-user:

  • Prop 13 provisions vary from state to state: Proposition 13 (Prop 13) is a provision that governs whether the landlord is able to pass through the cost of any increase in real estate taxes on the property due to a change in ownership. It is extremely important for an abstractor to capture if the landlord is unable to pass through this cost, as this will decrease the landlord’s total recovery from the tenant. It is not unusual for a lease to prohibit the pass-through of increased property taxes, or alternatively, to limit the frequency of such pass-throughs during the term of a lease. While many CRE professionals are familiar with Prop 13 as a key provision to capture in California leases, the challenge lies in being aware that leases in other states may contain similar language, but it might not be easily identifiable as the Prop 13 language. CRE Lease specialists are aware of these provisions and can decipher very quickly whether these increased costs can be passed along to the landlord. Not accurately capturing Prop 13 provisions can lead to the same issues for lenders, owner/investors and managers as outlined above regarding reimbursements.
  • Improperly identified ground leases could introduce risk: A true ground lease on a property can be difficult to identify, as at times the lease forms will include “ground lease” language when referring to a build-to-suit lease. A build-to-suit lease resembles a ground lease because it identifies the land as the interest actually being leased. One of the key elements of which to be aware is who has ownership of the improvements – the building – during the term of the lease. In a ground lease, the tenant typically owns the building until the end of the lease term when ownership reverts back to the landlord. In a build-to-suit contract, the landlord retains ownership of the land and the development.A ground lease can have specific advantages and disadvantages for a landlord and tenant, which may affect a lender’s decision to proceed with lending on the property; thus properly identifying a ground lease is a crucial aspect to underwriting a property. In a ground lease scenario, the interests of the fee owner must often be subordinated to the ground lease in order for the ground lessee (tenant) to secure leasehold financing. A loan that is secured by a property, and which is subject to a ground lease, is often seen to have more risk than one that is secured by a fee simple interest. As such, the existence of a ground lease can greatly affect the underwriting of a property and must be properly identified by the abstractor.Similar to lenders’ concerns regarding ground leases, owners and investors need to be cautious about the ability to sell or refinance a ground leased property. For property managers, the reimbursement structure under a ground lease can differ greatly from other regular space leases at the property. An inexperienced abstractor may not understand the unusual structure and thus may not capture accurately.

There are many nuanced elements of which a lender, property owner/investor or manager needs to be aware when entering into a real estate deal or managing a property. With the increasing amount of data tied to lease contracts, it is ideal to have a combination of legal and real estate expertise for lease abstracting. Firms should be looking for the real estate subject matter experts with legal expertise who can provide accurate and timely lease abstracts they can trust to lean on during the transaction process.

About Situs Lease Abstracting Offering
As a leading provider of commercial real estate advisory services and innovative solutions to the global financial services industry, Situs is uniquely positioned to provide the accurate and timely lease abstracts for owners/investors, property managers and lenders. We understand how a property operates and what the key issues are when managing, leasing or selling a property. Our extensive work in the real estate market provides with us subject matter expertise needed to understand how a lease will impact the performance of a property.

Situs does not abstract in a vacuum. As a real estate advisory company, we have a deep understanding of property leases and the impact abstract information has on due diligence, ownership and management, and therefore, we are able to capture the data in a way that is useful.

In addition to capturing the data from the leases, Situs creates an issues list highlighting any discrepancies a client might have in their rent roll as compared to the leases. Situs produces abstracts in a template that allows the extracted data to be seamlessly integrated into clients’ operating systems.

We are a real estate company with an experienced team dedicated to providing lease abstracting services – our experts have a thorough understanding of a lease from a real estate perspective and how potential issues in the document can impact the performance of a property.

For more information, contact:

Zenobia Tambuvala
+1 713 328 4411
zenobia.tambuvala@situs.com

Cheryl Clark, Esq.
+1 713 328 4493
cheryl.clark@situs.com