A lease is a written or unwritten agreement, by which the owner of land, referred to as the landlord or lessor, transfers into another party, referred to as the tenant or lessee, the right to the exclusive possession and use of the real estate for a definite period of time.

A lease has elements of both a conveyance and a contract. It is a conveyance by the landlord to the tenant of the right to occupy the land for the specified time in the lease. It contains a contract by the tenant to pay rent to the landlord. In addition, it usually contains numerous other promises and undertakings by both landlord and tenant. The legal interest of the tenant in the land is called a leasehold estate and consists of the right to the exclusive use and occupancy of the estate.

To create a valid lease, the lessor must always retain a reversionary right to retake possession of the property after the term has expired.

Essential Elements of a Lease

There is ample diversity of opinion in the various jurisdictions as to what constitutes the essential elements of a lease. The following are the most common essential elements:

• Date of the instrument: The date in which the lease is executed and not necessarily the date of its commencement.
• Identity of the parties: The full names of the lessor and the lessee.
• Capacity to contract: The lessor and the lessee must have legal capacity to enter into a contract.
• Identification of the leased property: The leased subject property must be described with certainty although the legal description in the lease need not conform to standards necessary for other real estate instruments. However, for title insurance purposes, the lease must contain an insurable legal description in conformity with the proper local standards.
• Term of duration: A leasehold is an estate for years; it must have a date of commencement and a date of termination.
• Mutual agreement of the parties to establish a lessor-lessee relationship supported by a valid consideration: Unless otherwise provided by statute, no particular words are required in order to create a lease. The intention of the parties is the test.
• Rent: Its terms and form of payment.
• Legal objective: The subject property must be leased for a legal purpose.
• Written instrument: Sec. 5.021, Texas Property Code provides that leases for more than one year or leases which will not be fully performed within one year from the making thereof must be in writing.
• Signatures: The signature of the lessor is necessary to give effect to a lease. Nevertheless, it is the universal practice to obtain the lessee's signature because as a contract, the lease must be signed by both parties.
• Seal, Witnesses and Acknowledgment: In some jurisdictions, these are requirements in regard to either the validity of the lease or its recordation.
• Recording: Sec. 5.021, Texas Property Code, any lease exceeding more than one year must be recorded in the same manner as a deed of conveyance in order to be valid against third parties without notice. Leases must be filed for record in the county in which the lease property is located. Texas allows the recording of a memorandum of lease instead of the original lease.

Most Common Provisions Contained in Leases

• Covenants and conditions.
• Option to purchase.
• Right of first refusal.
• Extension or renewal provisions.
• Restrictions on assignments or subleases.
• Financing of improvements.
• Ownership of improvements.
• Restrictions on tenant's improvements.
• Expenses and rental adjusters.
• Repairs and maintenance.
• Warranties and restrictions.
• Insurance and condemnation.
• Use restrictions, zoning and waste.
• Default.

Classifications of Leases

The most common classifications of leases are based on any of the following:

• The type of realty involved: Office leases, ground leases, proprietary leases, residential leases, commercial leases, etc..
• The term of the lease: Short-term leases and long-term leases.
• The method of rent payment: Fixed-rental leases, graduated leases, percentage leases, gross leases, net leases, etc..

Leasehold Mortgages

A leasehold mortgage is a mortgage executed by a tenant which affects only the tenant's interest in a leasehold estate.  Leases may require the prior approval or consent by the lessor in regard to any mortgage to be executed by the tenant on the leasehold estate.

Absent contrary provisions in a lease, or by statute, both the lessor and the lessee may transfer or alienate their respective interests under a lease.

However, most leases either prohibit transfers and encumbrances on the leasehold by the lessee or they require the consent of the lessor to such transfers and encumbrances.

• Transfer by the lessor
  
  Conveyance of the land (lessor's reversion) to a purchaser during the duration of the lease.
  
  Conveyance or assignment of the lessor's right to receive rentals during the duration of the lease.
• Transfer by the lessee
  
  Assignment of the lease.
  
  Sublease.
  
  Mortgage (upon foreclosure).

Whether an instrument is an assignment or sublease does not depend upon the name given the instrument by the parties.

If the lessee transfers the entire unexpired remainder of the term created by the lease, and retains no reversionary interest, the instrument is an assignment.

If the lessee transfers less than the entire remainder of the term of the lease, and retains part of the term, however small the part may be, the instrument is a sublease.

The difference between assignment and sublease is important as it concerns liability, since an assignee becomes liable to the original lessor for rent, whereas a sublessee is liable only to the sublessor, who is the lessee under the original lease. Whether the instrument is an assignment or a sublease, the lessee in the original lease continues to be liable for the payment of rent to the original lessor.

Lease is not being insured:

Both the lease and the option to purchase must be shown as exceptions in Schedule B.

Lease is being insured but the option is not being insured:

Special care must be exercised to avoid creating the impression or implication that the option is also being insured.

In describing the leasehold estate, terms such as, “lease and option created . . . . ” or “rights of the lessee under a certain agreement . . . . ”, should never be used.

It should be remembered that any simultaneously or subsequently issued owner policy must contain a proper exception in regard to the option to purchase.

Lease is being insured and the option to purchase contained therein is also required to be insured.

Insurance of the option is accomplished exclusively by endorsement and it presents an extrahazardous risk to the Company.

Special consideration must be given in the event that the option to purchase is contained in a sale/leaseback transaction because, depending on its wording, the existence of the option may be evidence that the transaction was intended as a mortgage or security device rather than as a true sale and lease.

Any request to insure an option to purchase must be referred to the National Legal Department for approval.