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Most real estate savvy folks are familiar with the phrase “caveat emptor” or “buyer beware,” as applied to real estate transactions. Buyers are routinely advised to scrutinize their purchases through property inspections, review of zoning, permitting and code compliance of the property in addition to obtaining title insurance. However, when leasing property, tenants typically focus on the terms of the lease agreement often without adequate consideration of risks associated with the landlord’s title to the property. This risk has increased in the past several years given the increased frequency of title transfers of distressed properties through foreclosures, deeds in lieu of foreclosure and other types of distressed property workouts. Tenants are well advised to protect their interests in the event the landlord is not holding clear title to the property. This is particularly important for longer term leases, leases where the tenant is investing in substantial tenant improvements to the property and leases with the option to purchase the property.

What Happens to My Lease in the Event of Mortgage Foreclosure?

Tenants often presume that: (i) the landlord is the lawful owner of the property, (ii) the landlord’s agent executing a lease agreement has lawful authority to do so, (iii) there are no covenants or restrictions affecting their intended use of the property, and/or (iv) there is good legal access to the property. Also, tenants often do not consider what may happen to their lease in the event of foreclosure of a mortgage the landlord may have on the property. Failure to confirm and address such issues may result in significant losses that are not recoverable due to the invalidity of the lease or the condition of the landlord’s title. In the worst case scenario where a tenant is forced to move as a result of legal issues associated with the lease, here are some potential consequences:

  • the tenant may lose the value of leasehold improvements made to the leased property;
  • the tenant may lose the value of any design and permitting expenses related to the existing location;
  • the tenant may incur significant relocation expenses;
  • the tenant may lose locational goodwill which can be of crucial importance to a tenant’s business; and
  • the tenant may lose the value of favorable lease terms if current market rates have increased.

Bottom line:  Perform Due Diligence

A title search of the leasehold property and subsequent leasehold title insurance provides knowledge of matters affecting the title that are pertinent to the leasehold investment and insures against a wide range of damages that could be suffered due to invalidity of the lease and/or due to the condition of the landlord’s title to the underlying property. Let the tenant beware!