What does "Embedded lease" mean in real estate?

Definition

An embedded lease is a lease-like arrangement hidden inside a larger contract that isn’t expressly labeled as a lease but meets lease-accounting criteria (for example, under ASC 842). It gives a party the right to control the use of a specific identified asset for a defined period in exchange for consideration, even though the contract’s primary purpose may be services, licensing, or another deliverable.

Key criteria

Identified asset — the asset is explicitly specified (serial number, street address) or implicitly identified (delivery to a specific location, dedicated unit).
Right to control use — the user can obtain substantially all economic benefits from the asset and can direct how and for what purpose the asset is used.
Defined time period — control is granted for a measurable term or renewal period.
Consideration — payments or other benefits are exchanged for the use of the asset.

Common real-world examples

Contract Type	Embedded Lease Example	Why it qualifies
Service contract	Office space included in a facility-management agreement	Contract supplies services plus control over a specific office or suite — use of the space meets lease criteria.
Software license	Use of specialized hardware bundled with software	The hardware is an identified asset and the licensee controls its use to run the software.
Franchise agreement	Use of delivery vehicles provided by franchisor	Vehicles are identified and the franchisee controls their use for a defined period.
Distribution agreement	Dedicated storage space in a logistics provider’s warehouse	Specific warehouse space is allocated and controlled by the customer.
Contract manufacturing	Use of a dedicated production line or equipment	Lessee directs production timing, uses identified equipment — meets control and identification tests.
Data hosting	Dedicated server hosting where the client controls the server	Client has exclusive use and control of a specific server for a term.

Why it matters

Embedded leases must often be recognized on the balance sheet under modern lease-accounting rules (e.g., ASC 842). Failing to identify them can lead to misstated lease liabilities, understatement of assets, noncompliance with accounting standards, and inaccurate financial ratios.

How to identify an embedded lease — quick checklist

Does the contract refer to or deliver a specific asset or location?
Can the customer obtain substantially all economic benefits from that asset?
Can the customer direct how and for what purpose the asset is used?
Is the term of use determinable (fixed term, renewal options, usable-for period)?
Is payment or other consideration tied to the use of that asset?

If you answer “yes” to these questions, the arrangement likely contains an embedded lease and should be evaluated under your lease-accounting policy.

Practical steps for lessees and accountants

Review all service, licensing, distribution, franchise, and outsourcing contracts for identified assets and control provisions.
Document facts and circumstances that show control (who benefits, who directs use, maintenance responsibilities).
Work with legal to confirm whether the asset is dedicated or specified in a way that meets identification tests.
Apply your lease-accounting standard to determine recognition, measurement, and disclosure requirements.

Related term

Bottom line

Embedded leases are common in real-estate-related and service contracts. They occur whenever a contract gives control over a specific asset for a period in exchange for consideration, even if the document’s headline purpose is not leasing. Identifying embedded leases ensures correct accounting, more transparent financial statements, and better risk management.