In-Place Lease

An “In-Place Lease,” or IPL for short, is an intangible asset that is recorded as part of a purchase price allocation exercise and is meant to capture the benefit of an existing lease contract to the new property owner. The value of in-place leases can be thought of best as measuring the cost avoidance of not having to secure a new lease. An existing lease for these purposes could be for a suite in an office building, for the entirety of a warehouse building, or for equipment or other non-real estate assets.

Consider the following scenario. You have just acquired an industrial building with a single tenant.  The market standard term for similar industrial leases is 5 years and at the time of your acquisition, the lease has 3 years of term remaining. You benefit from the avoidance of typical down-time and upfront costs of signing a new tenant up to the benefit associated with a 3-year term lease.

These calculations are done on a lease-by-lease basis since amortization of the resulting intangible asset is based on each lease’s remaining term. Options periods are generally not included in the calculation unless they are deemed to be materially below market.

Here are the typical components of the in-place lease calculation:

Downtime Costs

Determine what the typical market assumption would be for downtime between tenants. Specifically, how many months would it generally take to find a tenant for the space if it had been vacant when purchased? Multiply the number of months downtime by the typical market lease rate, plus expense recovery. Include typical free rent periods in this calculation to capture the true economic downtime rather than just physical downtime.  Be sure your downtime assumption isn’t greater than the actual months of lease term remaining.

Leasing Commissions

What do brokers generally charge in your market for this type of lease?  Most common is a straight percentage of the entire rental income stream over the life of the lease, but in some situations, commissions are further refined to only apply to the first few years’ term or applied as a dollar amount per square foot of the space being leased. Consult with your acquisitions team and/or any brokerage relationships you have in the market.

Legal and Marketing

We generally include a fixed assumption for legal and marketing expenses based on a typical market participant’s cost for assets of similar size and complexity.

Conclusion

In-place lease calculations are generally some of the more complex aspects of any purchase price allocation study and are highly nuanced due to the uniqueness of each lease structure. One important consideration is making exclusions for recently signed leases in which some or all of these benefits may not have been realized yet. Have the leasing commissions already been paid or are you still on the hook for those? Maybe you were instrumental in negotiating one of the leases during your inspection period and really didn’t acquire that benefit from the seller, in which case it might more accurately be recorded as a new lease outside of purchase accounting. As with everything else real estate, look to the details of the leases, the purchase and sale agreement, and the settlement statement to ensure you are accurately reflecting the nature of the transaction when assigning these intangible values.

Authored by: Scott MacComb and Tiffany Neijna