18 Jun Successfully Navigating a Commercial Real Estate Lease
Companies searching for real estate need to be careful about understanding and interpreting commercial real estate leases. While doing this some thoughts that should be considered are:
- How much square footage is enough or really needed?
- What is the lease rate and what does the rent include? For example some leases include trash, water or even internet service built into the price.
- What is the minimum term that the landlord wants you to sign? Many startups are cautious and only want to engage in a month to month or 6 month lease.
Before any of these questions can be asked or answered it is vital to attain the assistance of an experienced real estate broker.
Acquiring an experienced real estate broker:
Unlike residential real estate the commercial real estate market is much less standardized. A real estate broker can navigate you thru actually finding the properties as well as navigate you thru items with certain issues like zoning. It is important to get a broker who handles specifically the tenant side of leases. Also when you take into effect that the landlord is usually the one who pays the broker’s commission there really is no reason for not working with a broker.
Here are some other things to keep in mind when working with a commercial real estate broker. Commercial real estate brokers are paid a percentage of the lease amount so they have an incentive to lease you the most expensive space possible. Generally the less in cost of a lease the less attention you can expect from a broker. With this in mind you may want to work with a commercial real estate attorney who can help you navigate the lease and point out potential issues. They may also assist you in finding a competent tenant real estate broker.
Navigating the lease:
In most cases the first copy of the lease that you will receive will be completely written in favor of the landlord. They do this in the hope that you will just sign the lease without paying much attention to the details. You must realize that many commercial leases are not standardized and many of the clauses in the lease can be negotiated so that they are fair to both the tenant and landlord. In most commercial real estate markets real estate is quoted by the year or month and on a per square foot basis. Keep in mind though that the square footage that you will need for your office space and the square footage that you are charged for are often different.
Types of Leases:
The first type of lease is known as a percentage lease. This type of lease is common with retail spaces. You pay a base rent plus a percentage of sales if the total amount of sales goes over a certain dollar amount.
The next type of lease is known as the net lease. In addition of the price per square foot you also pay for some or all of the other expenses for running the property. In a double net lease this would include taxes and insurance. In a triple net lease this would include taxes, insurance and maintenance. These are also sometimes referred to as common area maintenance or “can” fees. You should be clear on all costs in addition to the square footage rental cost and negotiate caps on how much they can be increased.
The next type of lease is the gross lease. With a gross lease all fees are accounted for in the per square foot price quote.
Things to Negotiate in a Lease:
The length of the lease:
The best case scenario for you as a tenant is a short term lease with multiple options to renew when the lease is up. This way if you go out of business or outgrow your space you are not stuck with the lease. You also avoid losing the space if it continues to serve your needs well. However generally longer term leases are more favorable to the landlord so the longer the lease the better negotiating position you are in for other parts of the contract.
How rent increases are handled:
Landlords will try to work into the lease an annual increase in the rent based on the consumer price index or some other measure. These are also called escalations and should be fully understood before entering into any lease.
Find out who is responsible for what expenses. Unlike residential leases where the landlord is responsible for the maintenance of the property with commercial real estate this is not always the case so make sure the lease clarifies who is responsible for what expenses. If you want to make alterations to the space then you want to make sure it’s outlined in the lease what alterations you’re allowed to make. With long term leases it’s not uncommon for the landlord to cover the cost of building out the space. Also keep in mind that if you are not going to use the space until it is built out you do not want to be paying full rent during that time.
If your business needs a sign for customers then make sure you know what is allowed and what isn’t.
Whenever possible you want to have the ability to sublease your space. This offers some protection if you are no longer able to pay the rent or if you’ve expanded to the point where you need a much larger space.
Exit Plan Clause:
This is necessary if you may break your lease before the lease is over. Whenever possible you want to negotiate early termination fees like a two or three month penalty.
If you sell your business then you’re going to need to assign the lease to a new owner. Some leases will not allow this.
If your business depends on the foot traffic that another nearby business brings into an area then you should consider adding a co-tenancy clause which allows you to break your lease if that anchor tenant leaves.
Before you Sign the Lease:
Remember that the landlord rents space out as their profession. He has a lawyer creating the lease for his benefit and his use. As a possible tenant you have every right to question what is in there. The terms should reflect the business terms that you discussed with that landlord as well as some other business like items which should be reviewed not only by yourself but also by an attorney. Many times potential renters are turned off of the process after reading a lease that is given to them. However they should keep in mind that this document was written by/for a landlord for his benefit.
Another issue that could come up is what if there are delays in getting permits and licenses to open? Also, how can you protect yourself from paying rent for long periods while the business has not yet opened? In the case where you are responsible for the construction there is usually a hard date that you need to meet. So before you sign the lease you want to find out how long the city or town that you will operate in takes in the permitting process. This is something that your local broker can tell you beforehand. Say the time for permits and licenses will take 3 weeks. You want to make sure that you discuss this period of time with the landlord before signing the lease to get them to agree to not charge rent during this time period. In addition if there will be delays in opening the business due to some other reason(s) this can be discussed with the landlord to see if they are flexible with the point at which rent starts.
Renewing the Lease:
The subject of renewing the lease can be discussed with the landlord at any time. For example say you are in a 5 years lease and you have been in the property for 18 months you have every right to discuss that lease with them. Typically when your lease is about to expire you are going to have a notification anywhere between 6 months to 1 year before your lease expires that states that you must contact the landlord in order to use the option for renewal. If you miss that date you are still able to negotiate with the landlord to stay. The only thing that you miss out on is the existing set of rules that are already written in the lease about time periods to renew so this part will have to be renegotiated. A lot of the times in your lease it will refer to something called ‘Fair Market Value’. This is what is considered the fair price not only for the base rent but also for the concessions or any of the improvement dollars that the landlord would be responsible for. It’s typically determined not just from what the landlord says but also from comparable deals in the market that have been done recently. If however you disagree with this number you can always call your real estate broker that you had when you signed that original lease and say that you wanted to renew with the option that you have in the lease but that the landlord is being difficult. Because say for example, your landlord thinks the space is worth $5000 a month and you think it is only worth $3000 a month. Ask the broker to find the last couple of deals that were done in the area to support your cost.
To exercise your option to renew you must notify the landlord at that 6 month or 12 month point before lease end in writing of your intention to do so. This is the drop dead date. If you don’t have an option but need to stay in the property there is no guarantee that the landlord will enter into an agreement with you. At that point you must have the ability to negotiate the ability to renew. The danger of not having an option is that if your business is a very successful one and you have no other place to move so the landlord has you at your mercy at lease end.
Once the option to renew has been negotiated the landlord will issue a lease amendment. A lease amendment is usually only a couple of pages in length. It will inherit all of the other terms that were in the master lease and it’s going to change very slightly the term of the dates that you will be allowed to lease that space as well as some of the business items that shows what you’re paying in rent.
Terminating a Lease:
A lot of times people want the flexibility to get out of a long term contract. Especially nowadays when a tenant is asked to sign up for 10 years a lot of them don’t know what they’re going to be doing in 12 months. So they want the flexibility to terminate. You can put in the original lease a termination clause that will allow you to terminate the lease at a certain point in time. Landlords dislike termination options. The reason for that is, if you sign a ten year lease the landlord is going to book your lease revenue as income. For example they can say that I have “John Smith” as a ten year tenant in my building who has good credit and use this fact to get money out of the building via a bank. As a tenant you have a right to terminate a lease but it is your responsibility to notify the landlord in writing within the proper timeframe of doing so to avoid conflicts. There is the possibility that after notifying the landlord that you plan on terminating that they will penalize you with a fine usually in the amount of a month or two of rent.