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Lease Audit Articles

Commercial Office Leases in the United States: Financial Risk Transfer And the Loss of Innovation

The  principal  estates  in  property  are  free-hold  (of  which,  fee  simple  is  the  most  
commonly  used  type  and  hence  practically synonymous)  and  leasehold,  each  having  
their  respective  rights  and  risks.  The  rights of  a  freehold  estate  include  the  right  to  
alter  or  sell  the  property,  to  receive  the benefit of appreciation in value, to claim tax
depreciation, and to create leasehold estates and benefit from the related rent. The risks
of  the  freehold  estate  include  the  risk  of destruction  and  damage,  of  depreciation  in  
value, and of the economic costs of owning and  operating  property.  When  the  freehold  
estate owner uses its right to create a lease-hold estate and benefit from the related rent,
the owner has also, historically, retained the related  financial  risks  of  ownership.  These  
rights  and  risks  are  theoretically  held  in balance.

Prudent corporate real estate management considers the rights and risks of the freehold
and leasehold estates as they may support or detract  from  the  competitive  advantage  of  
the  enterprise.  Enterprises  that  deliberately choose to take a leasehold estate in property
are presumptively electing to avoid the risks, and to forgo the rights, of a freehold estate.
These enterprises are demonstrating they are ‘not  in  the  real  estate  business’  and  assume  
that  holding  a  leasehold  estate  obviates  the risks of a freehold estate.
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