Are you looking to renew or enter into a new lease for commercial space for your business. Before talking to the landlord, you should have a good idea of what is expected from you and what you can expect from them. Commercial leases are contracts, enforceable by and against both parties in court or via alternative dispute resolution. Unlike residential leases, there are few limiting regulations on what can and cannot be in a commercial lease. Here are some of the important lease terms, many of which are all negotiable with the landlord.
- Length of the lease
- Pricing
- Tenant Responsibilities (utilities, taxes, insurance)
- Common Area and Maintenance cost allocations
- Lease Guaranty Requirements (security deposit or personal guaranty)
- Miscellaneous provisions
Length of the Lease: Most landlords like longer terms for their leases, say a minimum of 5 years. You can negotiate shorter terms – 2-3 years with options for renewals – depending on the landlord and the building. Note that the length of term often corresponds with square foot pricing for the same; a longer term will usually result in lower pricing per square foot. Often you will want to have a renewal option that extends the life of the lease at the end of a term. For example – the end of your 5-year lease term is coming up and the lease allows you to notify the landlord that you want to renew for another 5 years. The landlord will usually require this renewal term to have pricing that reflects the then-current market rate for similar space. You should review early termination provisions which often require the tenant to pay early termination fees or remain responsible for the rent for the remaining term.
Pricing: When leasing commercial space, you should look at comparable rates for similar spaces in similar buildings and locations. If you are looking for a small retail space, then investigate the rents for similar locations. The same goes for office space. Note that office buildings rental rates are also governed by location (downtown versus the suburbs) and “quality” of the building itself. Is the building a high-rise, modern or not, amenities for tenants or not (like a gym in the building, parking, etc.). These will all dictate the price per square foot for rent. In the lease, there will often be annual base rent price increases over the term of the lease. These should be reviewed and negotiated with the landlord. Are the rate increases reasonable? Generally, the landlord will increase the rent each year based on a formula which should be explained to you. Is the rent increase based on the consumer price index, on inflation, on a bank rate, or what? With the current high inflation rates, note that your rent rate may increase significantly each year.
The security deposit should be part of your pricing review. Does the landlord require 1-2 months of deposit? If the landlord requires a personal guarantee, the guarantee can sometimes be avoided by negotiating a larger security deposit – say 6 months.
There can be negotiations about what is called tenant improvements or tenant buildout. Will the landlord pay for or reimburse the tenant for repainting, new carpet or flooring, or other improvements that increase the value of the property? Sometimes a tenant can negotiate for 2-4 months of free rent, so the tenant has funds to improve the space themselves.
Common Area Maintenance (CAM) Charges: These are extra charges allocated to the tenant, above the base rental rate, and are payable monthly. When a lease is brand new, the landlord will estimate the cost for CAM, per square foot and then add that cost as a separate charge on the monthly rent. At the end of the year and each year thereafter, the landlord will audit the actual charges incurred and will credit the tenant’s account if overcharged or invoice the tenant if undercharged. CAM charges are spelled out in the lease and generally include trash, snow removal, landscape maintenance, building maintenance (such as elevators, lobby areas, etc.), parking lot maintenance, etc. .The tenant is responsible for a percentage of those charges, based on the square footage rented by the tenant versus the entire building’s square footage. You should ask the landlord to give you a breakdown of the CAM charges for the prior two years and ask the landlord if there any expected renovations scheduled in the next year or so, such as getting a new roof.
Tenant Responsibilities: Generally, there are two types of commercial leases that describe the responsibilities of the tenant.
NNN Lease – This is called a triple net lease and it means the tenant is responsible for ALL costs to the space they have rented except the roof and exterior walls. Tenant responsibilities include repair and maintenance of HVAC, plumbing, electrical, trash removal, janitorial services, windows (interior and exterior), etc. The landlord will only be responsible for repairs and maintenance to the roof and exterior walls. Adequate insurance coverage will be required by the landlord where the tenant covers fire, theft and other damage to their personal property, as well as general liability insurance. The lease will have lengthy clauses providing insurance coverage. Generally, triple net leases are found in retail space, such as strip malls and shopping centers, but also sometimes in very small office buildings.
Regular Lease – These leases are usually in large commercial office buildings. The landlord is responsible for plumbing, HVAC, electrical, janitorial service, elevator maintenance, etc. which are all included in the calculations for CAM charges as explained above. The tenant, through CAM charges, will share in the maintenance expenses, including for anything outside the actual leased space – hallways, elevators, exterior windows, parking facilities, trash removal, landscape maintenance, landlord insurance costs. Note that CAM charges should NOT include the landlord’s personal property taxes or real estate taxes. The tenant will remain responsible for insurance coverage and any personal property taxes owed to local governments.
Lease Guaranty: A personal or corporate guaranty may be required by the landlord. The guaranty is used by the landlord if the tenant defaults on the payment of rent or any other provision of the lease. If the tenant is a small business, the landlord will probably require a personal guaranty by the owners of the business, or at least one of the owners of the business. If the tenant is a larger business, or if the tenant is a company that is owned by another company, the landlord may a corporate guaranty from the parent company.
Guarantees can be a burden on a tenant as they inhibit a tenant’s ability to obtain financing. Banks like to be in “first” priority position when extending a loan. Sometimes the landlord will allow the lease to be subordinate to a tenant’s bank loan, but that is unusual. There are a few ways to try to avoid the requirement of a guaranty. One is to offer a higher security deposit – say value of 4-6 months’ rent in total. The landlord could also be asked to drop the guaranty after two years of on-time rent payments and no defaults under the lease. A third option is to ask the landlord if the tenant can pay a higher rent. Example – 1K square foot lease at $21/sq ft is $1750/month in rent. Another $1/sq ft takes it to $1833. $2/sq ft takes it to $1966. Over 5 years that’s about $12K in extra revenue for the landlord. Crunch the numbers and see if this is an affordable option and if the landlord will accept it in lieu of a personal or corporate guaranty.
Miscellaneous Provisions: Commercial leases will also have provisions for
- Subleasing – if the tenant wants to sublease part of their space to a third party, the landlord will usually require their approval and require the third party to provide sufficient financial information to enable the landlord to be comfortable with the sublease. Note that the tenant will remain responsible for the entire space if the subtenant defaults.
- Assignment/Assumption – If the tenant needs to get out of the lease completely for any reason (they have sold their business, going out of business, etc), they can find a third party to “take over” the lease where the third party steps into the shoes of the tenant for the remainder of the term of the lease. Again, the landlord will require financial and other information to be provided before approval is made for an assignment. It is advisable to have language in any assignment clauses that releases the current tenant from any continued obligation to the landlord, but some landlords will not permit that language.
- Alternative Disputes Resolution – Many commercial leases will have clauses that provide the steps for resolving disputes prior to going to court. These provisions should be reviewed carefully.
- Boilerplate sections include clauses about notice to each party, choice of law or venue, how the lease may be amended, etc.
Commercial leases can be long and complicated and are usually written in favor of landlords, so you are urged to contact your business attorney to help you negotiate a new or renewing lease for your business.
