Real Estate Lease Terms for Better Lease Abstraction

Types of Real Estate Leases

Under ASC 842, leases are classified as operating or finance leases. Here are the common types:

• Gross Lease: Often classified as an operating lease where the landlord assumes responsibility for most property expenses. Lessees record a right-of-use asset and liability for fixed payments.
• Net Lease: Lessees pay base rent plus additional costs like taxes, insurance, and maintenance. These payments are considered fixed or variable under ASC 842.
• Triple Net Lease (NNN): Similar to a net lease but shifts more costs to the tenant, requiring detailed analysis for ASC 842 classification.
• Percentage Lease: Rent based on a percentage of tenant revenue. Variable rent portions are not included in the lease liability calculation under ASC 842.
• Ground Lease: A long-term lease of land often classified as an operating lease unless ownership or control criteria are met.
• Sale-Leaseback: A transaction where a property owner sells the asset and leases it back. Under ASC 842, sale and lease criteria determine if it’s a financing arrangement.

1. Base Rent

The fixed amount due for the lease. Under ASC 842, this forms part of the lease liability calculation.
Example: A tenant pays $5,000 monthly as base rent for office space.

2. Lease Commencement Date

The date when the lease term starts. This marks the recognition of the right-of-use asset and lease liability.
Example: A lease starts on January 1, 2025, for financial reporting under ASC 842.

3. Rent Commencement Date

The date rent payments begin, often after a build-out period. ASC 842 aligns payment schedules with lease liabilities.
Example: Rent starts three months after the lease commencement date.

4. Lease Term

The period over which the tenant has control of the property. ASC 842 includes renewal or termination options if reasonably certain to be exercised.
Example: A 10-year lease with a 5-year renewal option included in calculations.

5. Operating Expenses (OPEX)

Costs for property operations, such as taxes, insurance, and maintenance. ASC 842 distinguishes these as non-lease components if separable.
Example: Tenants pay $1,500 monthly for operating expenses.

6. Maintenance Obligations

Responsibilities for maintaining the property, often borne by tenants in net leases. ASC 842 requires separating these costs if distinct from lease components.
Example: Maintenance costs of $500 monthly are excluded from lease liabilities.

7. Percentage Lease

Rent based on a percentage of tenant revenue, common in retail. Variable rent is excluded from lease liabilities under ASC 842.
Example: A tenant pays 5% of monthly sales in addition to base rent.

8. Security Deposit

A refundable payment not included in lease liability calculations.
Example: A $10,000 deposit held for a retail lease.

9. Tenant Improvement Allowance (TIA)

A landlord-provided budget for property improvements. ASC 842 considers TIA as part of lease incentives.
Example: A tenant receives a $50,000 TIA for build-out costs.

10. Sublease

Subleases are separately classified under ASC 842 as operating or finance leases.
Example: A tenant subleases a portion of office space and reports it as a finance lease.

11. Escalation Clause

Fixed escalations are included in lease liability calculations, while variable costs are not.
Example: A 3% annual rent escalation impacts liability schedules.

12. Early Termination Clause

ASC 842 considers penalties if termination is reasonably certain.
Example: Termination penalties of $25,000 are included in the lease liability.