Issues to Consider When Buying Commercial Property

The Impact Of Acquiring A Tenant

By Howard Goldman and Cameron Pease

Question:
Can a new owner of a commercial property break the lease with an existing tenant once the sale is final? We are looking into purchasing a building in Newton that is zoned commercial to use for our business. The current owner just signed a 3-year lease with the lessee that is currently occupying the building. Can we make an offer of the property contingent upon negotiating to have the current tenants vacate? Or do the current tenants have legal rights to stay through their lease term?

Answer:
It is good business practice that you are weighing these issues before making an offer to purchase a commercial property. First, it is essential that you identify whether the pre-existing tenants are commercial or residential. Massachusetts law will be applied differently to residential leases because the law regards commercial leases as business transactions between parties of comparable sophistication and bargaining power and consequently imposes fewer restrictions on the nature and terms of commercial leases than it does on residential leases. Consequently, landlords generally have few opportunities to change the terms of a residential lease after it is signed.

Assuming the property you are thinking of purchasing has a commercial tenant, you will need to weigh whether you want to become a landlord to that tenant. Under Massachusetts law, a landlord has the right to sell property while it is occupied by a tenant but a purchaser takes title to the property subject to all existing leases on the property, and must uphold the terms of the original lease. See Restatement of The Law 2d Property: Landlord and Tenant. In other words, a new owner does not have the right to cancel or otherwise amend a pre-existing lease with a tenant while the lease is still in effect. In purchasing the property, you would be acquiring the existing tenant for the remainder of the three year leasehold. Practically speaking, you would be responsible for all of the landlord requirements in the lease, and you would be subject to claims involving all breaches of the lease that occurred within the past six years (the statute of limitations on contracts in Massachusetts). You would also be subject to any options allowing the tenant to renew the lease for additional three year term(s).

Commercial leases are highly technical in nature. Prior to making an offer on the property, you should obtain a copy of the fully executed lease with the existing tenant and have a real estate attorney review it and identify any provisions that could be problematic for you as a landlord during the remainder of the tenant’s term. Your attorney should also point out to you the terms that are favorable to the landlord versus terms that are favorable to the tenant. One section that is especially important to evaluate is whether the tenant has provided a security deposit to the current landlord. While a security deposit for a commercial lease is not required under law to be kept in a separate, interest bearing escrow account, often the deposit is placed in a general operating account.

You should also evaluate whether the rent is at fair market value, and what operating expenses the landlord bears. A favorable lease for a landlord is one that is structured so that the tenant is responsible for paying a portion of or all of the common expenses and real estate taxes related to real estate ownership, in addition to base rent. Real estate related expenses associated with ownership include property taxes, insurance, and maintenance expenses, which are commonly known as the “triple net” expenses. The rent collected under a net lease may be lower than rent charged under a gross lease in which the landlord is responsible for paying all of the triple net real estate expenses.

If you proceed with the purchase, it would be prudent to have an attorney draft an estoppel certificate for the tenant to sign on the date of the closing. The estoppel certificate would provide protection against any claims of the tenant of past breaches of the lease by the landlord, which you, as the successor landlord, would be responsible by certifying that, as of the date of the document, certain things are true including, but not limited to, the following:

a) Whether the tenant’s lease is in full force and effect and has not been assigned, modified, supplemented or amended;
b) Whether all conditions under the lease to be performed by the landlord have been satisfied;
c) Whether any required contributions by the landlord to the tenant on account of the tenant’s improvements have been received by the tenant;
d) Whether there are any existing claims, defenses or offsets which the tenant has against the enforcement of the lease by the landlord;
e) Whether any rent or related payment obligation has been paid more than one month in advance; and
f) Whether any security has been deposited with the landlord.

After reviewing the existing lease with your attorney, you may choose to present the tenant with a new lease that contains more favorable lease terms, or a different amount of rent, and see if the tenant will agree to sign it. While this type of bargaining is not allowed in the context of a residential tenant, it will be allowed where the tenant is a commercial entity itself. However, after you present your offer, if the tenant does not wish to terminate or amend the lease, you will have to determine whether or not to proceed with the purchase of the property knowing you will be operating under the terms of the original lease.

If you do not want to purchase the building if the current tenant is still occupying the premises, you could also choose to make an offer to purchase the building that is contingent upon negotiating to have the current tenant vacate. Then you could approach the tenant and present them an incentive, such as a lump sum cash payment, for the early termination of their lease. If you are certain you do not want to have a tenant in the property, we would advise you find another property to purchase that is unencumbered by a tenant. Purchasing commercial real estate is complicated and costly. Trying having a tenant agree to vacate the property adds an unnecessary wrinkle to the transaction, and could cause additional expenses and significant delays.

In summary, Massachusetts law permits commercial tenants that have written leases to remain in place throughout the lease term set forth in such leases, even if ownership of the commercial property changes due to a sale or by other avenues. Therefore, a prospective buyer should conduct adequate due diligence of the pending tenancy and should make the sale contingent upon obtaining an executed estoppel letter signed by the tenant stating that the tenant has no legal claims against the landlord arising from the lease.