Real estate is a unique investment vehicle. Whether you are buying property for cash-flow, speculation or to expand your business, you face significant risks when investing in real estate. Part of ensuring success in the real estate market is carefully pursuing due diligence. Once, often overlooked aspect of due diligence when buying tenanted properties is reading the leases for all of your tenants. This task, while sometimes onerous, is crucial to understanding how you can use the property and potential risks. There are many reasons to read your tenants’ leases, but here are just a few that appear in the commercial:
You may be responsible for repairs
The Commercial Tenancies Act allows landlords and tenants to determine who will be responsible for repairs in the lease agreement. If you are considering a property, you need to know if you are responsible for repairs. If so, you need to thoroughly inspect the building and determine how much money you should save for upcoming maintenance issues.
Your tenants may have exclusive use clauses
Many savvy business owners insist on “exclusive use” clauses from their landlords. These clauses prevent the landlord from accepting tenants who are competitors of existing tenants’ businesses. If you are buying a property with the sole intention of being a landlord, these clauses limit the types of businesses you are allowed to rent office space to and could cost you lucrative deals. If you are buying a building because you want to use a portion of it to start or expand your own business, these clauses may prevent you from using your own real estate. Prudent buyers make a list of all exclusive use clauses so they are aware of how they can use their space.
Good tenants may leave and bad tenants may stay
Is the cashflow of your building dependent on a few anchor tenants? Does the building have difficult tenants who pay late and use a disproportionate share of utilities? If your business plan depends on certain tenants staying or leaving, you need to know when each lease expires. Commercial tenancies that are on a fixed term automatically turn into month-to-month tenancies. These tenancies can be broken with 30 days notice. However, term tenancies are much harder to break. Landlords should also be mindful of renewal clauses that allow tenants to extend their tenancies for another term.
You may not be able to raise a tenant’s rent
Many investors look for “underperforming” assets. When buying buildings, potential landlords may feel that they can increase the income a property generates. A common tactic is to raise the rents in hopes of driving out undesirable tenants and increasing revenue from the remaining tenants. However, some leases do not allow for rent increases or provide for rent increases on a schedule. Be careful to review whose rents can be raised and whose rents are locked into a schedule.
Buying a building requires a lot of due diligence. Landlords must take care to ensure the building and its tenants meet expectations. At Law365 we are ready to help you through the due diligence process to ensure your investment meets your needs and expectations. If you would like to talk to a lawyer about commercial real estate, call us at (647)-494-9599 or email us at info@law365.ca
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