Dear Lease Management friends:
There is much activity in the commercial lease modification space, as landlords respond to the COVID pandemic induced rental income delays. Landlords are looking to secure rental income via rental deferments as well as providing concessions, to help tenants with a palatable rental repayment schedule, while locking into future rental income in a structured lease modification agreement and repayment schedule.
As commercial landlords renegotiate lease modifications, the topic of ‘Right of First Refusal’, may come up as a mechanism to influence a lease modification signature by the tenant. Although the right of first refusal may seem at face value to be a straightforward business option for landlords, there is a hidden risk that can impact the landlord’s ability to efficiently sell a commercial property. The risk lies in the lease extension. In a recent transaction, the landlord provided a long term tenant with the right of first refusal, not understanding how this would jeopardize their ability to maximize the sales price. The risk was buried in the lease extension component of the agreement, as the existing tenant exercised a 5-year lease extension at the time the property was listed.
This shrewd negotiating tactic, dramatically reduced the landlord’s ability to maximize market value, as several buyers wanted the property for business purposes, not to manage an existing investment property. The 5-year extension actually drove these buyer prospects away, reducing the number of potential buyers for the property, and ultimately suppressing the sales price – advantage shrewd tenant, who purchased the property 15% below of the potential, un-tethered market value.
Landlords need to understand this potential challenge when building their lease modifications and protect their right to achieve the maximum market value, which the right of first (ROU) refusal does not support. It may be an incentive to entice the desired tenant, but landlords beware of the hidden risk.
The advice here is to understand the worst-case scenario, before executing a long-term lease modification and avoid right-of-first refusal, as the monetary risk far exceeds the goodwill of the rights associated.
Ken Royce * Leaseology Inc * Board of Directors
ABOUT Leaseology Inc|
Leaseology, Inc is a North America-based business advisory services firm committed to accelerated marketplace adoption of digital technology, financial management innovation, and business operations practice excellence. These core competencies apply to real estate and equipment portfolios.
