Navigating Lease Acquisitions Successfully: A 10-Step Guide to Effective Due Diligence for Buyers

Acquiring a new group of stores or restaurants can be an exciting and lucrative business venture. However, it is crucial to pay close attention to the leases for each property during the due diligence process, as they can impact the outcomes of the acquisition.

Imagine buying a chain of 50 restaurants only to find out that twenty percent of the leases have expired or the option notice dates have passed. Worse yet, the landlord already signed new leases for some of the spaces. The considerable investment you just made may provide significantly less income as a result of not completing your due diligence. This is a situation no buyer wants to find themselves in.

This guide will discuss what a potential acquirer should look for in commercial leases prior to making an acquisition.

Why Due Diligence Matters in Lease Acquisitions

Due diligence is a process that allows buyers to assess the financial, legal, operational, and market aspects of a commercial lease acquisition. It is a crucial step in minimizing risks, ensuring the terms are favorable, and making informed decisions about the potential investment.  Why does performing due diligence matter?

Financial Assessment: To assess whether the lease terms are favorable and fit within your budget

Risk Mitigation: Helps buyers identify and mitigate risks associated with the property and lease, so you can make informed decisions about whether to proceed with the acquisition and how to address any issues that may arise.

Understanding Lease Terms and Conditions: To ensure they align with their business goals and objectives.

Ensuring Legal and Regulatory Compliance: To ensure that the property and leases comply with all applicable laws, regulations, and zoning ordinances.

Market Analysis: To determine whether the lease terms are competitive and whether there are better options available in the area.

Negotiation Leverage: If issues or discrepancies are identified, buyers can use this information to request amendments to the lease terms or negotiate a lower purchase price.

10 Steps for Success During Lease Acquisition

Consult with a Real Estate Attorney

If you work in commercial real estate or are involved in an acquisition, it's crucial to consult with experienced professionals such as real estate attorneys, brokers, and other industry experts to ensure that you are well-informed and able to make the best decisions for your specific situation.

Complete Lease Abstraction

Every lease contains information about the lease term, amount of rent, and other operating expenses the tenant is responsible for paying. As the first step in reviewing the leases during a potential acquisition, you should complete a lease abstraction for each location you are considering acquiring. This process can be outsourced to a company like Leasecake, and will identify all important dates, clauses and dollars so you have a clear picture of what you’re committing to.

Confirm Key Lease Dates

One of the first things a potential acquirer should do when reviewing commercial leases is to confirm the key lease dates to ensure the lease is still active. These dates include the commencement date, expiration date, and renewal options notice dates. Understanding these dates is essential for planning the transition and future operations of the acquired business.

In addition, the acquirer should check whether the lease terms align with the intended duration of the acquisition, and that it is long enough to see a return on investment. If a lease is set to expire soon after the acquisition, it may be necessary to have the seller negotiate an extension or find an alternate location, which can be time-consuming and costly. Alternatively, the extension of the lease could be completed via the assignment document. This can, however, result in delays to the acquisition closing date, due to complications that arise when negotiating lease terms.

Request Estoppels

One proven way to ensure that you have documentation of the lease term dates and that the lease is still indeed active and in effect is to request the seller complete estoppels with all of the landlords. An estoppel certificate can be used to confirm lease details, such as critical dates, renewal options, and any outstanding balances. When reviewing estoppels, it is a good idea to look for any conflicting info that may be present in the lease files.

Review Financial Terms

In addition to the lease dates, buyers need to thoroughly evaluate the financial aspects of the lease, including rental rates, escalations, security deposits, and any additional costs such as common area maintenance fees, property taxes, or utilities.

Compile a Comprehensive Set of Lease Documents with No Gaps

Another important aspect to consider is the completeness of lease documentation. A comprehensive set of lease documents should include the original lease agreement, any amendments or addendums, and any related documentation such as estoppel certificates, subleases, or guarantees.

Gaps in documentation can lead to misunderstandings or disputes between the landlord and the new tenant (the acquirer) and may result in unexpected liabilities or obligations. It may also be very difficult to obtain all the respective lease files after an acquisition has closed. Therefore, it is essential to ensure that all documentation is complete and accurate before proceeding with the acquisition.

If there are gaps, the acquirer should request the missing documents from the seller or landlord as part of the due diligence process. For example, if you have a lease and the Fifth Amendment,  but nothing else, you need to find amendments 1-4 before you proceed. Otherwise you have no idea what exactly is included in those missing documents.

Review Assignment Provisions

During an acquisition, the existing tenant's lease is often assigned to the new tenant (the acquirer). It is crucial to understand the consequences of this assignment, as it may affect important lease provisions. For example, the assignment of the lease may void renewal options or exclusive use protections, which can significantly impact the long-term viability of the business.

To avoid any surprises, you should thoroughly review the lease assignment provisions and consult with a real estate attorney to understand the implications. This language is often complex and may require an attorney review.

Understand Your Renewal Options 

Renewal options are an essential aspect of commercial leases, as they provide the tenant with the opportunity to extend the lease term beyond the initial expiration date. When acquiring a chain of retail stores or restaurants, it is crucial to understand if there are any future renewal options in the leases and whether the rents for these options are defined.

Having renewal options with defined rents provides the acquirer with more predictability and control over future occupancy costs. In contrast, leases without renewal options or with uncertain future rents may expose the business to significant rent increases or force the acquirer to search for alternative locations upon lease expiration. To mitigate such risks, the acquirer should prioritize leases with favorable renewal options and clearly defined rents.

One area in particular to review during your due diligence is whether any lease provisions are affected by the assignment. If necessary, the acquirer may need to negotiate with the landlord to ensure that essential lease provisions are preserved during the assignment process.It is common to potentially forfeit any future renewal options if the terms of potential assignments are not followed correctly.

Consider Other Terms or Conditions That Make It Difficult to Operate Out of the Space

Lastly, the potential acquirer should carefully review the lease terms and conditions to identify any provisions that could make it difficult to operate out of the space. Some examples include restrictive use clauses, which limit the types of businesses that can operate in the premises, or competitive clauses that prevent the tenant from opening a similar business within a specified radius of the leased property.

Additionally, the acquirer should be aware of any significant maintenance or repair obligations, as these can result in substantial expenses and disrupt operations. If the lease includes onerous terms or conditions that could negatively impact the acquired business, it may be necessary to renegotiate these provisions with the landlord or consider alternative locations. It is always recommended to visit the site and inspect the property in advance of the acquisition. Do not be afraid to ask for copies of HVAC maintenance reports, as unexpected HVAC expenses can be a very unpleasant expense.

Thoroughly Understand Each Individual Deal in the Acquisition Package

Acquisition bundles come in all shapes and sizes. Thoroughly understand each deal in your acquisition package so that, if necessary, you can sort out and eliminate any specific deal that does not make financial sense or has you taking more risk than you are willing to consider. For example, if you discover during the lease abstraction process that certain lease deals absolutely do not align with your future vision, then it is a good time for you to negotiate some of those transactions out thereby reducing the purchase price as well.

Simplifying the Process of Due Diligence

A thorough examination of commercial leases is necessary during the due diligence process of a potential acquisition. At a minimum, acquirers should review key lease dates, confirm comprehensive documentation, assess lease assignment consequences, evaluate future renewal options, and scrutinize restrictive terms. Meticulously addressing these factors can help acquirers more confidently navigate the acquisition process and mitigate risks.

Reviewing all the key dates, dollars and documents involved in a lease acquisition can seem daunting, expensive and time consuming. But there is an easier way.

Leasecake is the leading lease and location management platform, with a team of real estate experts with an average of 16 years of experience each. We offer quick and affordable lease abstraction for all of your leases, whether you already own the property or are preparing to potentially acquire them.  If you would like help with lease abstraction as part of your due diligence process, visit us at leasecake.com to learn more.

Looking for more tips and best practices? Download our guide, “Due Diligence During Lease Acquisitions: A Guide for Buyers”  to streamline your due diligence process and find more resources here.

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