CONTRACTS
LEASES (LEASEHOLD)
Lesson Three
A lease is a non-freehold estate, which grants possession but not ownership of the
property. It is a form of conveyance, a contract, and a bilateral agreement. It gives the
lessee (tenant) the legal right to use and possess another’s property (leasehold interest).
The owner (landlord/lessor) possesses a reversion during the lease period in that the
rights he/she granted to the tenant will revert back to him/her at the end of the lease.
When leases are written, the parties involved usually mix an idea from one type of lease
with an idea from another until they arrive at a lease that works for their situation. No one
lease will work for all needs.
CATEGORIES OF LEASE RIGHTS
Estate for years: Any lease with a termination date that will not renew is this
type. If a tenant wants to retain possession beyond the termination date, he/she
must renegotiate a new lease that will take over when the old one dies.
Period to period (estate from year to year or periodic tenancy): This type of
lease will continue renewing until one of the parties (lessor or lessee) gives notice to
the other that they do not wish it to renew. A one year lease would renew for
another year; a five year lease would renew for another five years.
Tenancy at will: This type of lease will terminate when notice is given by either
party. Usually the parties have agreed on how much time of notice must be given.
(The death of either party terminates this lease.)
Tenancy at sufferance: A tenant has stayed improperly beyond the
termination date on the lease.
TYPES OF LEASES
Gross lease: The lessee pays a lump sum rent to the landlord, but in return the landlord
is responsible for all maintenance, insurance, taxes, and management costs. If something
needs to be repaired, the tenant simply calls the owner or management. This is a very
common lease in residential situations.
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Net lease: The lessee pays a smaller (net) rent to the landlord but is not responsible for
part or all of the maintenance. These leases can be written so that the tenant pays almost
all of the property’s expenses, including taxes and insurance.
Ground lease: A lease of land only. On a long term lease (50 to 99 years), the tenant may
actually build on the property. The improvements would belong to the tenant for the time
of the lease.
Graduated lease: A lease containing an escalator clause. The escalator clause allows
the lessor to pass down to the lessee any future increases in property expenses in the form
of higher rent. For example: If the insurance on the building rose $1,200 a year, the lessor
would increase the lessee’s rent by $100 a month to absorb that cost.
Sale and leaseback: An investment strategy where the owner of an improved property
sells it to another with the condition that it is leased right back to him. This way the new
owner gets a tax deduction (depreciation), and the former owner (lessee) gets some cash
and a deduction on his taxes as well. Usually there is a buy-back agreement in place.
Index Lease: The rent is tied to an agreed upon index. The rent rises or falls based on
that index (similar to an adjustable rate mortgage).
OPTIONS AND OBLIGATIONS
Lease Option: Lessee is given the option to purchase the property should it be placed
on the market.
Lease Purchase: Lessee is renting the property with the intention of eventually
purchasing the property. A portion of the rent payments may be used as a down payment
on the property. Should the lessee refuse to purchase the lessor would keep the deposited
funds. This is also referred to as a lease with an obligation to purchase.
Assignment: The transfer of rights in a lease to a third party. Unless released by the
lessor, the original lessee is still responsible (one lease).
Sub-lease: The transfer of partial rights to a third party in a lease (two leases). The
original tenant (lessee) is still responsible to the owner of the property.
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TERMINATION OF LEASES
Leases are terminated in most of the same ways that other contracts terminate:
Expiration of time: The lease period ended and the tenant vacated;
Mutual agreement: Just as in all other contracts, the parties agree
not to continue. This is known as “surrender and acceptance”;
Breach of contract: When either the lessor or the lessee breaks the terms
of the contract, the injured party may terminate the lease.
Death of the landlord or the tenant does not terminate the lease, nor does the sale of the
leased property to a third party. The new owner must honor the lease.
EVICTION
Actual eviction: The tenant (lessee) is removed from the property for failure to keep
the terms of the lease. This must follow a certain legal process.
Constructive eviction: This is when the lessor has violated the terms of the lease,
usually through not maintaining the property as agreed upon. This interferes with the
tenant’s right to “quiet enjoyment” of the premises and is the basis for the “constructive
eviction”. This also has to follow a legal process.
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