What is Lease Agreement – What Owners and Occupants Must Know
A lease is a contract where one party grants a right to use a property or land to another party in return for monetary compensation. Section 105 of the Transfer of Property Act 1882 defines that a lease agreement can be both a registered deed and an oral agreement. However, having a signed document is necessary so that both the lessor and the lessee can avoid legal complications that may arise in the future.
Read on to know the features, types and format of a lease, what is a sublease and how is a lease different from a rental agreement.
Features of a Lease
Here are the notable features of a lease financing contract:
- Contract or Agreement: There are primarily two parties signing a lease contract, known as lesser, who owns the property, and the lessee, who pays rent for the property.
- Assets: These are the properties to be leased.
- Rental Payments: These are the payments made to a lessor by a lessee in a specific interval in order to utilise the property for aforementioned purposes.
- Lease Period: This is the basic time period mentioned in the agreement before which cancellation of the agreement is not permitted.
- Terms of Lease: This is the duration during which a lease agreement and its conditions stay functional.
- Maintenance: These include rules regarding maintenance, repair, insurance payment, taxes, and other costs with respect to the asset leased.
- Termination: There are provisions laid out regarding termination of the lease terms when the lease period comes to an end.
- Ownership: During lease period, ownership of the asset is allowed to be utilised by the lessee.
- Purchase or Renewal Options: There are options given to renew the existing lease or draft a new one at the end of the basic lease period.
- Default: Lessee can be liable to receive title to the asset in return for making all future payments at once.
What Are the Types of Leases?
There can be several types of leases depending on their nature, conditions and methods. Here are the classifications based on different parameters:
Classification Based on Nature
- Operating Lease: As per the International Accounting Standards (IAS-17), an operating lease is not a financing one and is cancellable under certain conditions. Under this lease, lessee (occupant) makes interval payments to lessor (owner) to obtain access to an asset and its services. The lease period is usually five or fewer years.
- Financial Lease: A financial lease is a long-term agreement and is not cancellable at any time during the lease period. A lessee has to make regular payments to a lessor to keep using the asset and its services for a predetermined period. As per the International Accounting Standards, a lessor makes available all the risks and rewards similar to the lessee regardless of transfer of title.
Classification Based on the Method of Lease
- Leverage Lease: In a leveraged lease, a third party or a lender is involved additionally with lessor and lessee. Lender partially finances purchasing of the asset on a lease, where the lessor remains a borrower.
- Sale and Leaseback: A sale and leaseback agreement can be a little complicated, where a company sells a property that it owns and leases the same asset back from the buyer. In this way, the lessee benefits by getting cash benefits from the same property it gets to utilise.
- Direct Lease: Under a direct lease contract, a lessee gets the rights from the manufacturer directly, and the ownership of the lease remains with the manufacturer only.
Classification Based on Usage
- Commercial Lease: This type of lease is solely for commercial properties such as office buildings.
- Room Lease: For leasing a single room within a whole property
- Condominium Lease: A type of residential lease where the tenants share some building amenities
- Family Member Lease: Drafted for family members leasing property
- Lease-to-own Lease: Comes with an option to buy the property from the owner.
- Month-to-month Lease: A short-term lease agreement that renews on a monthly basis
- Hunting Lease: To use private property for hunting purposes
- Parking Lot Lease: To use a parking space for parking vehicles on a private property
- Weekly Lease: This type of lease is often used for vacation purposes
- Short-term Lease: Used for short and unusual periods
- Sublet Lease: A lease made by a lessee to rent out to another lessee known as sub-tenant
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What is the Structure for Lease Agreement in India?
A lease agreement is legal documentation that clarifies all the details, terms & conditions regarding rules and regulations which both the lessor and the lessee must follow.
A lease must be on stamp paper and notarised. It is a detailed document that lays out the following information in its structure:
- Name of the lessor, lessee or their agent (if any)
- Details regarding the property, such as an address, location, and built area
- Amount of rent and the date on which it needs to be paid
- Penalty or late charges and any grace period applicable
- Payment mode for rent
- Purpose or usage of the property and allowed activities
- Conditions regarding termination of the lease before its expiration date and also if any charges applicable for that
- Security deposit amount and the account details in which it is deposited
- Any utility provided by the lessor and any amount chargeable for that
- List of facilities and amenities available to lessee or lessee is entitled to use, such as swimming pool in a residential complex
- Various rules and regulations regarding miscellaneous things such as pets, noise, parties, etc. and also consequences for violating these rules
- Rules regarding parking, such as parking space and its availability
- Provisions regarding handling requests by a lessee regarding the repair and emergency repair
- Time period or validity of a lease agreement
- Terms regarding extension of a lease agreement
- Terms pertaining if a lessee needs to insure the property; this clause is usually available for commercial property
These are some common and important pointers that a lease structure generally includes. But, of course, there can be variations in this structure from one property to another.
How to Draft a Lease Agreement in India?
Generally, the procedure of drafting a lease agreement in India involves the following steps:
Step 1: Draft a lease agreement, including all pointers, with consent from both parties.
Step 2: The agreement has to be printed on stamp paper.
Step 3: The lessor and lessee have to sign the agreement in front of two eyewitnesses.
Step 4: Two witnesses must sign the document afterwards, attesting to the same.
Step 5: Get the document registered at the nearest Sub-Registrar’s Office and pay applicable charges.
What Are the Advantages of Leases?
Leasing offers the following advantages, which are available for both parties.
1. From the perspective of a lessor (owner):
- Regular Income: Lessor receives a regular and consistent income by keeping his property on rent for a specific period.
- High Profitability: The rate of return on the rent is much higher than the interest paid on the asset’s financing. Hence, this can be a highly profitable business.
- Tax Benefit: As the ownership remains with the lessor, they receive a tax benefit as the leased property goes through depreciation.
- Preservation of Ownership: In a finance lease, lessor transfers all risks and rewards to the lessee except the ownership.
- Possibilities of Growth: Demand for leasing has been seeing a rise as it is one of the most cost-effective forms of financing.
2. From the perspective of a lessee (occupant):
- Affordability: Lease financing is one of the most affordable housing options.
- Tax Benefit: For commercial properties, lease payments are eligible for tax deductions as business expenses. A company can avail of this tax advantage with leasing.
- Technical Support: Lessee is supposed to receive technical support regarding the property from his lessor.
- Affable to Inflation: A lease is affable to inflation as the tenant is only supposed to pay a fixed amount for a certain duration, even if the value of the property increases.
- Ownership: In certain cases, after the expiration of the lease agreement, the lessor may ask the lessee to purchase the property for a comparatively lower amount than in the market.
- Capital Goods Usage: As a business just spends a small amount as rent when it leases a property, it can utilise its fund for other purposes and business expansion.
What Are the Disadvantages of a Lease Agreement?
Lease contracts have multiple advantages, but they also have their demerits. Here are the disadvantages of a lease:
1. From the perspective of a lessor:
- Loss Considering Inflation: As there is a certain duration for the lease to expire, a lessor cannot increase the rent even if the value of the property increases due to inflation.
- Double Taxation: There is a possibility of paying double sales taxes – once when the property is purchased and again when it is leased.
- Risk of Property Damage: As the owner of the property is not transferred, there are chances that the lessee might treat the property carelessly, resulting in damages.
2. From the perspective of a lessee:
- Obligation: Finance leases are non-cancellable. Therefore, once a lessee signs a lease, he has to pay the rent for that certain period, even if he doesn’t use the property.
- Ownership: There is no guarantee that there will be a transfer of ownership at the end of the agreement unless lessor intends the same.
- Higher Cost: Lease financing results in higher expenses as lessee is responsible for lease rental and other asset ownership expenses.
- No Alteration: A lessee cannot make any modifications to the property if required.
- Penalties: If a lessee wants to terminate the lease before its expiry date, he has to pay a penalty.
- Asset Understatement: For commercial property, a lessee is not the owner of it; he cannot mention it in the balance sheet, resulting in an understatement of the lessee’s asset.
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What is a Sublease?
A sublease is a legal agreement between a tenant and a sub-tenant for renting a commercial or residential property for a certain duration.
In a sublease, the owner of a property rents out his property to a tenant who wants to vacate the premises without violating any rule of the contract and pay rent. A tenant can rent out the property to a sub-tenant under a sublease agreement. All property owners might not allow subleasing their property.
How Do Lease and Sublease Work?
Leases are legal contracts between two parties that set forth terms and conditions regarding renting out commercial or personal property. These agreements include duties and obligations for each party to maintain. For example, a residential property lease agreement typically includes the following contents:
- Duties and responsibilities of tenant and owner
- Address of property
- Required security deposit amount
- Rent amount
- Rent due date
- Consequences for violating contractual terms
- Pet Policy
- Validity of lease
- Other essential details (if any)
A sublease works by allowing a tenant to rent out a property to a sub-tenant. A subtenant addresses all property-related issues to the original tenant and not to the owner of the property. However, these laws might vary from one place to another.
What Are the Differences between a Lease and a Rental Agreement?
On the surface, a lease and rental agreement might seem similar to many. But they have significant differences. Look at the table below for their detailed comparison:
| Parameters | Lease | Rental Agreement |
| Duration | A lease agreement stays valid for a longer duration. | A rental agreement is valid for a shorter period. |
| Participants | Lessor and lessee | Landlord and tenant |
| Payment frequency | Monthly instalments | Monthly or quarterly instalments |
| Maintenance | Lessee carries the responsibility | Tenant carries the responsibility |
| Accounting standards | Lease agreements follow Accounting Standards 19. | No particular accounting standard is followed for rental agreements |
| Ownership | On expiration of agreement, lessor might ask the lessee to purchase the property or asset. | A landlord doesn’t make any such offer to a tenant upon expiry of a rental agreement. |
| Change in agreement | There can be no changes after both parties sign the agreement for that particular period. | A landlord can make changes in the agreement anytime they want. |
What Are the Important Clauses of Lease Agreement?
A lease agreement in India typically consists of the following clauses:
- Personal details of both parties
- Address of the property on lease
- Lease term or duration
- Rental amount
- Security deposit details
- Conditions regarding renovation and modification
- Rules of practice in and around property premises
- Provisions regarding repair and maintenance of property
- Notice period, renewal terms and termination clauses
- Signature of both parties and respective date
Final Word
Renting properties and apartments by developing appropriate lease agreements is a cost-effective way of utilising assets for a lessor. On the other hand, it also offers the lessee the chance to own a property temporarily while incurring limited liabilities. While there can be many types of leases, some are more common in India than others. Make sure to go through the details of a lease before signing the agreement.
FAQs
Ans: Some of the most common types of violations of lease agreements are – unauthorised pets, long-term guests, damage to property, commercial use of the residential property and due rent.
Ans: An operating lease for vehicles is an agreement between the leasing company and the lessor providing a permit to utilise its vehicle for the company and its employees. The lease term is usually for 1 to 5 years. After the expiration of the contract, the lessee returns the vehicles to the leasing company.
Ans: Registering an agreement is necessary if its validity is of 12 months and more. However, it is optional to register a deed of 11 months even though it stays legally valid.
Ans: In India, most lease agreements are for 99 years or longer duration. This is done keeping in mind the control of land transfer and its uses. This duration seems safe as it will cover the lifespan of the lessee.
Ans: There is usually a notice period between 1 and 3 months for early termination of a rent agreement which is applicable for both parties. However, the agreement should clearly mention this, considering the mutual consent of both parties.
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This article has been prepared on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this article is for general purposes only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party. The article does not warrant the completeness or accuracy of the information, and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision taken on the basis of this article.
