Heads of Agreement (HoA) vs. Agreement for Lease (AfL)

LINK is able to include future rental incomes from proposed commercial-industrial tenants of vacant
investment property being acquired or under construction. This future rental income and the terms
and conditions that govern it are typically identified within a Pre-Lease Agreement.

Pre-lease agreements are made between an intending landlord (lessor) and an intending tenant (lessee)
prior to the commencement of a commercial construction project or a future purchase.

For construction projects, prudent developers will seek to secure pre-lease agreements with
creditworthy tenants prior to project commencement; often a condition precedent to finance.

Financiers view pre-lease agreements favorably as they indicate a reduction of post-completion market
risk by providing more certainty of income to service a proposed post-completion investment facility to
facilitate holding of the completed property for investment purposes.

For construct-and-retain projects, LINK structures project finance in two-stages; the initial project
finance, then to automatically switch to term investment facility upon activation of leases which provide
income for monthly servicing.

This type of facility has been promoted by LINK since the late 1990s / early 2000s and are most suited
to shopping centre projects and other commercial and industrial property projects where the developer
intends to hold part or all of the completed project within its investment portfolio.

The usual alternative to the LINK approach is a construction facility without a takeout which leaves the
developer scrambling, at or close to completion at a stressful stage, to find a quick refinance.

A noteworthy example of this 2-stage funding was the construct-and-retain funding that LINK
structured for a federal government pre-committed commercial property in Orange, regional NSW.

However, this type of funding is not restricted to commercial property development, recently LINK
structured a similar facility for a 5-storey, 23-unit development in one of Sydney’s medical precincts.

It is usual for a minimum level of pre-leasing to be a set condition for financing, typically to cover a
minimum of 50% of on-going interest. Higher pre-lease income is a strong indicator of the mitigation
of market risk and thus usually results in more favourable credit terms.

In Pre-Lease Agreements, the intending tenant commits to a set rental rate, lease term length, rental
reviews, contributions to outgoings, and other terms.

A developer may dangle a ‘carrot-on-a-stick’ by offering rent-free periods and other incentives, such as
a contribution to fit-out, to secure pre-committed tenants and rental income.

Pre-lease income may create developer’s equity by virtue of increasing the value of the land and/or the
end value of the completed project, thus reducing or removing altogether the requirement for the
developer to put hand-in-pocket to contribute cash or other property security.

Overall, pre-leasing helps demonstrate market acceptance of the proposed project, reduces vacancy
risk, and improves the viability of a project for financing purposes, hence, pre-lease agreements are
considered a key factor in credit underwriting.

Pre-Lease Agreements may be in the form of certain types of documents, including a Heads-of
Agreement (HoA) or an Agreement for Lease (AfL).

Both these documents are acceptable for the purpose of analysing a post-construction take-out or an
acquisition finance proposal involving a pre-committed tenant. Each type of document, however, has
its specific strengths and weaknesses, the differences between them may typically be identified as:

Heads of Agreement (HoA)
A HoA is a preliminary, non-binding agreement that outlines the main commercial terms agreed upon
by both parties, but does not constitute a final offer or contract.

It demonstrates the intent to lease, and at what terms, prior to drafting a full contract.

Agreement for Lease (AfL)
An AfL constitutes a legally binding contract that constitutes a formal offer-and-acceptance between a
lessor and a lessee.

It lays out all material terms in detail such as rent, length of lease, conditions, etc. An AFL commits
the parties to the lease, pending the drafting of or execution of a final contract which is usually
contingent upon certain conditions such as Occupation Certificate, obtaining of a DA for change of use,
or availability of the premises by a certain date.

Key Differences
▪ An HoA is non-binding, whereas an AfL is a binding contractual offer.
▪ An HoA contains high-level terms, an AfL details all terms of the lease.
▪ An HoA comes before an AfL in the typical lease negotiation timeline.
▪ Parties can withdraw after an HoA; an AfL requires specific terms for termination.
▪ An AfL provides the basis for preparing the final lease agreement. An HoA may not.
▪ In essence, an HoA signals intent to lease whereas the AfL binds the parties to the lease terms
prior to execution of the final contract. The parties would usually and should proceed from an
HoA to AfL before executing the completed lease contract.

Pre-lease income may be credited toward equity requirements for the project instead of requiring out
of-pocket equity or pre-sales, ie; Pre-Lease Agreements count towards pre-sales requirements.

To conclude, pre-leasing helps demonstrate demand for a proposed product to be constructed, reduces
vacancy risk, and improves the viability of a project, especially in the consideration of a project financier
which would consider pre-leases a key factor in underwriting a proposed project.

Contact LINK today to discuss financing options that may assist you to maximise the return on your
property investment or construction project.

Disclaimer

The information in this article is of a general nature and is not intended to address the circumstances of any particular individual  or entity. Although we endeavour to provide accurate and timely information, we do not guarantee that the information in this  article is accurate at the date it is received or that it will continue to be accurate in the future.