The time will come when every business owner will be faced with the task of acquiring space to operate, whether it be an initial startup, a move to new space after expansion, an additional location, or even a downsize of the company. Commercial real estate leases come in many shapes and sizes, but as with any sizeable transaction, every detail is likely up for negotiation. When negotiating a commercial lease, both business owners and property managers need to keep several key areas under consideration. Securing specific terms ahead of time will save mutual headache down the road.
Term and Rent
The most obvious starting point for commercial lease negotiations is the term of the lease and the rent the tenant will pay. Small businesses should negotiate one to two year lease with renewal options, rather than opting for longer-term leases, although commercial landlords will try to sweeten the pot by offering incentives. These deals may be worthwhile to more established businesses with foreseeable stability, but smaller businesses with an uncertain future and the potential for growth should look on longer lease terms with a wary eye.
Rent seems like a relatively straightforward proposition, but both sides to a commercial lease should consider rent increases over the term and in subsequent terms as a factor. Commercial landlords will want to be able to increase rent in subsequent terms should rents in the area increase or the property increases in value and desirability, but tenants will want stability when establishing a business in specific location. The wishes and concerns of both can be accomplished through negotiated rent increases/decreases included in the lease that set out the conditions for changes in rental terms so that neither side is blindsided or handcuffed when the potential for change arises. Unforeseen increases in rent can hurt the cash flow and margins of small businesses, so predictability is always a welcome factor in commercial lease negotiations.
Expenses, Maintenance and Extras
Some of the ways commercial leases vary from standard residential leases is in the division of responsibility among expenses for utilities, maintenance, repairs, insurance and other costs. This division of expenses can provide differing scenarios where tenants may become responsible for increased operating costs or other fees. There are generally four types of commercial leases that delineate the responsibilities between landlord and tenant:
- Single Net Lease, Net Lease: Under this structure, the tenant only pays utilities and property tax beyond standard rent. The landlord is responsible for maintenance costs, repairs and insurance.
- Net-Net, or Double Net, Leases: The tenant pays utilities, property taxes and insurance premiums on the building, while the landlord is responsible for maintenance and repairs.
- Triple Net Leases: The tenant pays for all costs of the building (pro-rated according to tenancy) with the general exception of structural repairs.
- Full Service Gross, Modified Gross or Modified Net Lease: Structural repairs, property taxes, property insurance, maintenance and utilities are split between the landlord and the tenant in one agreed-upon level of rent.
The most common type of lease in a multi-tenant building is the Full Service Gross lease - the base rent payment covers the tenant's share of all operating expenses of the property but stays stable, so if operating expenses increase, rent does not. This allows the tenant to predict expenses and bear no real risk of rising costs. The flip side is that the landlord is the beneficiary of any reductions in operating expenses, which would not then be passed on to the tenants.
The division of responsibility is important, and something tenants and landlords both can overlook if not careful. If a toilet overflows in a tenant's area and causes water damage in the subsequent floors, is that tenant liable for the repairs? If the parking lot needs to be cleared often during a particularly heavy winter, will the landlord cover those increased and unpredictable expenses? The terms of the lease should clearly divide categories of expenses and delineate realms of responsibility for both parties.
Most commercial leases, except for very short-term examples structures, contain annual escalation provisions that will increase the base rent regularly regardless of whether operating expenses have increased. These annual escalators serve the purpose of incentivizing landlords to sign long-term agreements with businesses that want to stay in place for a while. These provisions assure that landlords will receive rents that adjust for increased operating expenses and inflation over the term, rather than saddle landlords with decreasing margins in the long term as expenses increase and rents remain flat. These provisions, while common, can also be used as a way to increase profits dramatically, so tenants can and should carefully review these provisions and negotiate them to reasonable levels or cap these provisions to prevent significant changes to the rent over time.
Both parties, but especially tenants, should consider clauses that add flexibility to the lease. A sublease clause, for instance, provides a business an out should the company need to relocate or even wind up, while a co-tenancy clause allows a business to break a lease if a major tenant or anchor tenant in the same development closes, potentially depriving the business of secondary traffic.
An exclusivity clause prevents the landlord from renting to a direct competitor of the business in the same development, but careful wording in these instances is crucial. While the tenant would want this wording to be as broad as possible to exclude the largest amount of potential competitors, the landlord will want this provision to be drawn as narrowly as it can be to keep from ruling out too large of a potential tenant pool.
Don't Go It Alone
Commercial leases are complex, multilayered agreements that will affect both landlords and tenants for years to come, so when in doubt, these entities should call in experienced counsel to help iron out the nitty gritty of such transactions and make sure that their best interests are represented in a favorable contract.