Commercial Tenants: Get the Best Lease You Can
Leases for commercial space are commonly long, full of legalese, and no fun to read. As a future tenant, you may be tempted to decide that it’s all boilerplate, and just sign it without reviewing it in detail. If you do this, you may not be getting the deal you negotiated, and the lease may give the landlord rights in the future that could result in you losing your space, options to renew, and paying more than you thought. Despite what the landlord tells you, there is no “standard lease form” for commercial property.
If the lease is for more than a few thousand square feet, has a term in excess of five years, involves considerable construction and renovation, or if you are contributing to the cost of the construction, you should certainly retain a lawyer to negotiate the lease. Whether you are reviewing the lease on your own or with counsel, you should consider the following issues:
Definition of the Space. Check the plan of the premises that is commonly attached as an exhibit to the lease to make sure you are getting the property you expect, and that the space is sufficient. Most office buildings measure space according to the standards of the Building Owners and Managers Association, or “BOMA.” They allow landlord to include a portion of the common areas in the leasable space of the tenant, which result in your paying for up to 20% more space than you actually use. This makes a big difference in the cost of each square foot of usable space, and something you need to take in to account when comparing a lease of space measured according to BOMA, and lease that uses the actual square footage of the space. Does the landlord have the right to move you within the building if he wants to lease the space to someone else? If so, how much notice are you entitled to, and does the landlord have to pay for the expenses of moving and other incidental costs, such as changing letterhead or business cards?
Rent. What are the grace periods for payment of rent? Short and infrequent grace periods, such a two five day grace periods during the term of the lease, are common for payment of rent. Grace periods for other defaults should be at least thirty days after written notice by the landlord. This is important if you have an option to extend or a right of first refusal on other space that is terminated if you are in default under the lease.
Options to Extend: Options to extend the term of the lease are valuable for the tenant. If a lease term is concluding and there is no option to extend, the landlord has substantial bargaining power since he knows the tenant will have to go through the expense and difficulty of moving if there is no agreement on a renewal. Issues you need to consider:
- Leases commonly require that a tenant exercise an option to extend the term of the lease within a certain time, usually sixty to ninety days before the conclusion of the current term. These provisions are generally interpreted strictly by the courts. Make sure you diary the date by which you must exercise the option.
- Some leases provide that tenant loses the option if there was ever a default under the lease, even if the default has been cured. Insist on a provision that
- You can exercise the option so long as there is no outstanding default under the lease at the time of exercise of the option.
Rent Escalations. Leases with options to renew or leases for terms in excess of five years commonly have provisions for increased rent due. It is preferable to have the rent increased according to the actual increase in expense of operating the building, rather than to an index such as the consumer price index.
Build Out. It is common in a new lease that the landlord will agree to make some renovations to the space, or will build new space. If so, a work letter should be an exhibit to the lease, precisely stating what the landlord is obligated to do.
- The more build out you request, the longer the term the landlord will require so he can amortize the cost of the renovation. If he is building new walls and doors, expect to sign a five year lease. If he is doing some painting and replacing some carpet, you can probably get a three year lease. If you are starting a new business, a shorter lease term is critical: if you really succeed, you will need more space; and if you decide to close up shop, you do not want a long-term rent obligation to continue. If you are willing to take space totally “as-is” that has been vacant for a substantial time, you may be able to get a lease as short as a year.
- If the space is in a building under construction, make sure you have a right to get out of the lease if possession is not delivered by a certain date so you are not hung out to dry if construction is delayed. Also, the obligation to pay rent should not commence until a certificate of occupancy is issued.
Expense Pass-Throughs. You can expect that an office in regular office building will be on a triple net basis, the shorthand for which is “NNN.” That means that the landlord’s expense for common area maintenance or “CAM” (snow shoveling, cleaning etc.), liability insurance and real estate taxes will be passed through to the tenant. Issues to consider in these provisions:
- Has the landlord represented what the first year pass through will be? Is it on a base year basis, where you just pay for increases in expenses from the first year of the lease, or do you pay an additional common area charge from the beginning?
- Does the list of items included in CAM exclude all capital items? Roof repair is okay, but replacement of the roof, or the HVAC systems, is not.
- Do you have the right to audit the landlord’s records to determine if the CAM calculations are correct? Is there a limitation on the time after you get a statement of common charges to contest it? A 30 to 60 day objection period is too short. Ask for six months.
- You should carefully check the pass-through statement you get each year. They are frequently wrong, either including unauthorized expenses or getting the percentage wrong?
- Is the percentage you are being charged equal to your actual percentage of space in the building?
- Is the landlord allowed to charge a management fee, or are pass-throughs limited to payments to third parties? Is there any limit on the percentage of the other expense that can be charged for the management fee?
Insurance. Many leases require that the tenant carry liability and fire insurance. Send the insurance provisions to your insurance agent to you know how much it will cost you. The lease may also provide that the tenant has to indemnify the landlord for damage to the building. Make sure the indemnity obligation is limited to harm caused by the tenant within the leased premises. Show an indemnity provision to your insurance agent as well to make sure you are covered for any liability.
Subletting. The right to sublet the premises is important if you need to get out of lease for any reason. The lease should allow subletting the space for any use permitted by applicable zoning or the other leases of the premises, but could exclude retail, sex-related businesses, etc. The landlord may insist on the right to approve a subtenant, but the lease should provide that such consent will not be unreasonably withheld. Landlords, in arguing against such a provision, frequently claim that they have to make sure a subtenant is financially responsible. Tenants who sublease space are generally still liable under the lease, so this is not a valid reason to resist such a provision.