Commercial Real Estate

Today on the commercial real estate market a substantially new business procedure has appeared for leasing nonresidential property in newly constructed buildings. Indeed, this new procedure allows an owner and a tenant to formalize their business relationship legally even before the official documents for the ownership title have been received. Consequently, given the sharp deficit in available premises and the backlog demand for space, this change in the law is of significant interest to many market participants.

Newly Built Facilities: The Legal Angle

The lawyers in the MIEL development company’s commercial real estate department drew up this legal procedure about a year ago, and since then it has passed practical approbation. This step was rendered necessary as a result of the increase in the level of new construction. According to our evaluations, the unmet demand for street retail premises is up to 1.5 million sqm, while the annual amount of space delivered to the market is no more than 100,000120,000sqm and the share of vacant space was 1.8% for 2006.

The average demand in Moscow for streetlevel store space exceeds supply by about twoto threefold, and the shortage over time will increase as a result of a decrease in independent construction of this format. There are a number of complications in increasing supply, for example, a year – and in some cases, two to three years – passes from the time the owner is handed the key to the premises and the ownership title is obtained. Consequently, owners must absorb financial losses for the upkeep of the space as a result of not receiving any rent payments, which, in turn, increases the period for return on investment, while profitability and total capitalization for real estate facilities drops.

Pitfalls of the Current Procedure

Today’s procedure for leasing premises in fully built buildings which have not been registered as an investor’s private property has many drawbacks. The first enforced variant is the signing of a preliminary lease agreement in accordance with article 429 of the Civil Code of the Russian Federation, binding the parties to sign the principal lease contract following state registration of the ownership title of the lessor for the premises. Both parties very often include a clause in a preliminary lease agreement on signing the principal contract within a set number of days following state registration of the ownership title of the lessor for the premises or Technical Inventory Bureau (TIB) documents. However, such a deadline poses risks for both the lessor and the tenant. In accordance with article 190 of the Civil Code of the Russian Federation, a deadline can be set to the exact calendar date, expiration date or indicated event which must occur. In this case, the deadline depends on the wishes of the parties; therefore, the deadline cannot be considered as agreed upon.

In this instance, clause 4, article 429 of the Civil Code of the Russian Federation is applied, stipulating that the principal contract must be concluded within one year from the moment the parties sign the preliminary lease agreement. When one year has expired, the liabilities stipulated in the preliminary lease contract are terminated in the event that the principal contract has not been signed or one of the parties has not sent the other party an offer to sign said contract by the deadline.

In reality, registering property the ownership title could take more than one year, thus there exists a definite risk. For example, if the lessor finds a better offer than the terms and conditions of the tenant, the lessor could cancel the preliminary agreement with the previous tenant. In turn, the lessor may not deduct indicated expenses from working costs. The second variant currently in practice is a shortterm lease contract; however, in accordance with article 608 of the Civil Code of the Russian Federation, only the property owner can sign said contract. Consequently, a contract signed prior to the registration of the property rights may be declared null and void, given said contract is not in accordance with the law. Payments effected according to said contract may be reclaimed from the lessor. Of course, the lessor could appeal to the courts, but the judge’s decision on the amount of payment for using the premises cannot be predicted ahead of time.

Furthermore, payments effected according to said shortterm agreement may be considered profit on the part of the tenant, thus substantially increasing his expenditures. Another drawback is the contract’s duration being less than one year, meaning that in eleven months, the matter of extending the contract arises, and the lessor has the right to increase the lease rate or simply refuse to extend said contract. Moreover, a tenant may be evicted in the event said contract is nullified.

Getting Real

The procedure drawn up by the assets management department at MIEL commercial real estate management and development company takes into account the limitations of the above­enumerated contracts and minimizes the risks for both parties. Indeed, the procedure simplifies the transfer and leasing of real estate in newly constructed buildings and resolves the issue of lost profits on the part of the future owner.

Here is how the procedure works, stepbystep. First and foremost, the developer’s documents are reviewed (when the facility is slated for completion and all construction and permission documentation); then the legal relationship of the developer and the investor (future owner) is reviewed; the facility title is analyzed for legality; the performance of obligations on the part of the client according to the investment contract is reviewed, etc. The client could possibly not have first ownership rights to the premises, even though the facility has not been fully constructed. Accordingly, all possible negative occurrences for both parties are clarified at the initial stage. At the next stage, the activity of the prospective tenant and his requirements for the premises are analyzed. Following this, all precontractual and contractual relations of the parties are agreed upon.

We have written the procedure so as to exclude any problems associated with the preliminary aspect of the lease contract and transfer of the premises for use by the tenant during the period prior to the registration of the ownership title. Firstly the TIB surveys the property to define exactly the subject of the contract. Additionally, we recommend attaching a copy of the floor plan to the contract with an allocation of the premises being leased. Accordingly, the risks are minimized of the contract being declared null and void owing to a lack of information describing exactly the property transferred for leasing. The specialists in the assets management department at MIEL commercial real estate management and development company analyze the timetable necessary for completely constructing a building, delivering it to the market and registering the ownership title for the building. Establishing a concise timetable precludes the possibility of the contract being declared null and void.

Consequently, the contract allows a tenant to gain access to the premises to complete finishing work and to deduct payments effected on the property from taxable assets, while the lessor can legally receive lease payments during registration of the ownership title. The drawnup legal procedure adheres to all legislative requirements. This procedure allows the owner and the tenant to realize the set business goals and to resolve principal issues on the accounting records, payment for the nonresidential premises and enough of a guarantee for both parties in the agreement prior to receiving the ownership title. The first contract as part of the new procedure was signed in February 2006, and since then the amount of space leased via this procedure is constantly increasing.