Whether you’re just launching negotiations or ready to sign, you’ll want to be absolutely sure you understand your rights and obligations that are in the lease contract for your office, retail or industrial/warehouse space. Here are some common issues and tips you need to know before approving and signing a lease of commercial real estate.
Your lease contract will start with the basic business points presented as an outline or fill-in-the-blanks form.
Most leases contain a provision stating that this is the entire agreement and that:
• you have not relied upon any other representation
• there are no other outside agreements.
To make sure this is accurate, review all your proposals and notes on the transaction. Check to see that everything you have been promised is in the lease.
Legal Entities: This describes the parties involved in the transaction. Be very sure this is correct. Mistakes can be costly.
You want to maintain the protection that the business structures of your corporation or limited liability company afford.
Description: Some forms describe the premises by both the rentable and usable square footage. Others give the suite number and refer to an exhibit, an architectural drawing of the space. In this case, always ask how recently the space was measured and by whom. Using an architect should make it easy to obtain accurate area calculations.
Term: This includes:
• the commencement date
• the expiration date
• contingencies for a possible delay in possession.
If the space is vacant and in move-in condition, you likely will not have any delay in possession of the premises barring strikes, riots, natural disasters or other acts of God. The one exception is if there are certificate of occupancy (CofO) issues.
If the space is subject to construction work, you may need to anticipate delays or establish a “drop-dead date.” The “drop-dead date” is when, if the space is not delivered, you as the tenant have the right to obtain penalties from the landlord.
Frequently, a delay in possession does not extend the term of the lease, leaving you with a shorter term than anticipated. Make sure any delay automatically extends the term’s expiration in order to get the full benefit of your bargain.
Substantially Complete: This means the space is ready to occupy with only a punch-list of items to be completed or corrected. Make sure you negotiate for at least 30 days to submit your punch-list to the owner. You will certainly be too busy with other matters to do it in less time.
Insurance: Regardless of whether or not you reimburse the owner for the insurance policy, you are required to provide your own insurance. Start by sending this part of the lease contract to your insurer with any clauses that deal with
• attornment
• indemnification
• subrogation.
Review: You must review the entire contract with your legal counsel to make sure you understand what you are signing. Do not get lulled into thinking that the bulk of the lease is boilerplate. You never know what may be buried in the miscellaneous provisions.
Signature: You will be required to sign as many as four copies of the lease. Initial every page of the lease when you are signing to prevent any accidental substitution of pages later on.
You will next need to provide good funds to cover:
• the first month’s rent
• security deposits
• contribution to tenant improvements.
You also need to deliver an insurance binder from the insurer.
Building Maintenance: Make sure the provisions that set out the parties’ obligations for space maintenance and repairs accurately reflect your understanding. As a general rule, a full-service gross lease for office space, or any kind of lease covering multi-tenant property, requires the tenant to take responsibility for the interior and the owner for the exterior and common areas.
Access: Normally you will have access to your premises all the time. You can expect the electrical plugs and lights and elevators to operate. Many other services that the owner is obliged to provide will be available only during the building operating hours. These include:
• HVAC
• guard services
• building engineers.
You will be required to pay for any of these types of services if you need them to be extended beyond normal operating hours. This is a big issue for some properties and a footnote for others.
Late Charge: The late charge is used to:
• offset the cost incurred by the owner in collecting late rent
• as a preventative measure against late rent.
Most leases provide a grace period. Three-five days is typical, but you can often negotiate more days. It might be better to negotiate one or two incidents of forgiveness of late charges per year. This will probably save you more money if you forget to pay on time. Interest rate for late payment is for longer, uncured monetary defaults and is applied to those overdue amounts in addition to any late charges.
Operating Expense: Also known as the “additional rent” clause, this provision allows the property owner to pass increases of operating expenses to the tenant. Normally the pass-through begins in the second year of the lease term. The first year is called the “base,” or comparison, year. Increased expenses are compared to the base year. The difference is apportioned to all of the tenants.
Escalation: There are many expenses that can make your rental costs increase:
• Property taxes increase annually.
• Insurance costs creep up.
• Utilities and other operating expenses must be monitored and re-negotiated.
The lease contract rent is a promise to pay in future dollars. Inflation causes the future value of money to have less purchasing power. This is why commercial leases contain protective escalation clauses against income erosion.
Flat Rate Increases: Individuals who own smaller properties may not want to go through all the calculations and discussions with tenants about rent increases. Instead, they might ask for an annual flat percentage increase.
While this is easier for both parties, this kind of increase is typically based upon the entire rental payment. Expense increases are applied only to that portion of the rent that goes toward a particular expense.
Tax Increase: The owner may assure you that there is no intention of selling during your lease term. That is not enough. Taxes can increase even if the building is not sold.
The property may be transferred for estate planning reasons or by reason of death. If the owner says there is no intention of selling, then giving you a cap on tax increases should not be a problem.
Use: The use clause will appear with the basic business points. If it’s too tightly written, it can affect:
• the ability to use the space if your business model changes
• your rights to sublease or assign the lease at a later time.
Think about the ramifications of this clause with respect to your business, particularly if you are a retail or industrial tenant.
Sublet: If you outgrow the space before the lease expires, you can sublet or assign the lease. Some of the aspects of assignment and subletting are becoming more restrictive. Be sure you know your rights and obligations as well as the rights retained by the owner. The owner will always want to consent to any assignment or subletting.
Early Termination: If sublease or assignment provisions are too restrictive, you may want to negotiate an early termination of the lease to deal with outgrowing your space.
There are costs associated with the right to terminate early:
• You probably will pay several months of rent while the owner finds a substitute tenant.
• If the owner provided you substantial amounts of improvements, you should expect to repay the unamortized portion of that fee.
While early termination penalties are expensive, for some tenants this is preferable to being a sublessor with its potential liabilities.
