Real Estate Reporter, October 2006

Lessee Beware: What to Know Before You Negotiate a Lease

by Joan Velazquez

Finding the right business locations, at the right price and the right terms, is an important challenge for your family-owned business. Landlords typically will be represented by experienced brokers and legal counsel, and will present their prospective tenant with a detailed and landlord-favored lease form. While market conditions often determine how flexible a landlord may be in negotiating, your prospects of reaching the best available terms depend on your advance understanding of the likely key issues. You should seek the advice of an attorney experienced in negotiating leases before commencing negotiations with the landlord. Among the issues you should discuss with your attorney are:

• Lease Term. The initial length of your Lease is straightforward, but there are significant issues involving the starting point of your term. For example, you may need time to transition from your present location, and tenant improvements may be needed to accommodate your needs. Under such circumstances, you should bargain for a suitable period of time between the lease signing and the commencement of monthly rental charges. Also, if the space is not available on your move-in date, whether because the existing tenant has not vacated or because improvements are not finished, are you required to wait an extended period of time or can you terminate the Lease and find other space?
• Rent. Although your initial base rent will be clearly stated, there are significant related issues. For instance, most commercial leases contain provisions adjusting the rent throughout the lease term, raising important issues concerning (a) what economic index will be applied to adjust the rental rate, (b) will there be any limit to the increases, and (c) is the adjustment only upward, with no decrease if the applicable index goes down? Also, if you are late in a monthly rent payment, is there any grace period before a late fee is imposed, or before the landlord can declare you in default?
• Renewal Options. Factors such as the importance of this location to your business and the difficulty of moving to another location may make renewal options very important to you. What option(s) would you like, and what is realistic to expect? How far in advance will you have to elect to renew? How will the rental amount for the renewal term be determined, and will you have to decide whether to renew before that new rent has been determined? You also should be aware of more subtle issues often lurking in the landlord’s lease form, such as (a) does a prior, but now cured, default void your renewal rights (it should not), and (b) if you assign your Lease, do the renewal rights pass to the assignee (this will be important to your prospective assignees)?
• Space. Is your rental amount based on “useable space” or on “rentable space”? Do you have any option to expand into additional space as your business grows? If so, is that in the form of right of first refusal for additional space as it becomes vacant, or will other tenants be moved so that you can have contiguous space? Can you be moved if another tenant needs to expand and, if so, (a) will the landlord reimburse you for relocation expenses, (b) is the other space desirable for your business, and (c) what impact will this interruption have on your business?
• Common Area Maintenance and Other Costs. In addition to your base rent, a commercial lease will assess a variety of other charges to you, such as: common area maintenance expenses, utility charges, maintenance and repair of heating and air conditioning systems, and general expenses of building operations. Among the particular terms to search for in the Lease are (a) will you be charged only for your fair portion of these expenses, (b) will you be charged for the landlord’s environmental issues, (c) is there any cap limiting your exposure on expenses, (d) what capital expenses are likely to be passed through to you, and (e) if the landlord sells the building, will your proportion of property tax be increased based on a new property valuation? Also, (i) what services (parking, air conditioning, etc.) will be available during evenings, weekends and holidays, (ii) what parking spaces will be available to your employees and customers, and (iii) what charges will you pay for these items?
• Tenant Improvements. What improvements are necessary to bring the premises in line with your needs, and what will the landlord contribute to the cost of these improvements. How much time will you have to complete these improvements before your rent commences? Will the landlord charge a supervisory fee for this work, and are you free to use a contractor of your choice (or only the landlord’s contractor)? These provisions can be critical to your front-end economics and are often the subject of hard bargaining.
• Repairs and Modifications. What obligations does the Lease impose on you for repairs? For example, do these include work within the walls and the building core, or only to the exposed surfaces of your premises? Can you make changes without the landlord’s consent and what, if any, fees must you pay if you remodel or upgrade? Must you remove your improvements at the end of the lease term, which can be quite costly particularly with necessary patching and repairs? Alternatively, what equipment and fixtures should you have the right to move to your new location? If changes in law require facility modifications (for example, handicap facilities or safety requirements), who pays for these?
• Damage or Destruction. If the building is damaged (for example by fire or earthquake) and your space is limited or unusable, can you terminate and move? What will your insurance coverage pay for, and what will your landlord’s insurance pay for (remember, you are paying for the landlord’s insurance under your triple net lease)? Careful examination of the lease terms, and the relationship of the specific insurance coverages, are critical to protecting your interests.
• Assignment or Sublease. If you sell your business, or your changing needs require a move, what approval rights will the landlord have to assignment of your Lease? Will you remain liable for the rest of the term, even after an assignment? If you bring additional owners (including family members) into the business, is that a “change of control” requiring the landlord’s consent? If you assign or sublease to a third party for a higher rent, does that increase go to the landlord even if it results from your improvements to the space?