10 Top Things to Pay Attention to in Commercial Real Estate Leases

If an entrepreneur is not going to conduct business from his or her place of living, most likely a decision will have to be made about leasing an office, store, or storage space. The landlord/tenant relationship is multifaceted and a long-term one. Accordingly, the leasing process can be complex and arduous. A commercial real estate lease is a long document, bringing together numerous rights and obligations of the parties in an attempt to govern their long-term relationships and to foresee various situations that may emerge in the future. U.S. law strictly enforces contractual agreements between parties. Therefore, it is essential to have a lease agreement in place that covers in detail even the most remote circumstances. Full discussion of the lease review process would require several volumes, but below, I will briefly review some of the most significant points in lease negotiations.

 

Premises: This is the area the rent price is based on. What are you paying for? For total square footage or usable square footage? Usable square footage excludes such common areas as elevators, stairways, halls, and the like. Landlords often market space as available square feet, including allocation of various common areas within the available premises. Thus, rentable and usable measurements may be different.

 

Are the premises suitable for intended use? When determining if the premises are suitable for intended use, consideration should be given not only to present, but also to tenant’s possible future needs (possibility of establishment of a different business on the same premises, optional expansion, rent price on additional expanded space, etc.).

 

Term: Beyond the obvious need to address the duration of the tenancy, the parties should discuss the possibilities of lease extension and/or termination and the date of the lease commencement. The tenant will want the lease to commence once the business can be feasibly conducted; if the building is under construction and the lease commences immediately, the tenant may be stuck with useless space.

 

Base Rent: The base rental price may be net or gross rental. Gross rental means the tenant will be paying a pro rata portion of all operating expenses and real estate taxes, in addition to the net rent. Various other charges may be included in the rent (utility charges are common example). In some cases, it may be cheaper for the tenant to obtain these services independently rather than through the landlord. The more extra components are included in the rent, the more difficult it is for the tenant to verify costs and make sure that no third party is making a profit on services or products provided. The object of direct service agreements is to eliminate a middleman.

 

Landlord’s and Tenant’s Work. Alterations and Repairs: The responsibility for present and future alterations and repairs should be allocated between the parties in advance. If the need arises to change the design or add new features to the space, to what extent the tenant is permitted to do so? Which alterations will be done at the tenant’s expense and which at the landlord’s? What decisions can the tenant make without the landlord’s approval? To whom will the removable improvements of the space will belong after the lease is terminated? Also, during the period of tenancy, who is responsible for various necessary repairs?

 

Overall Condition of the Premises, Compliance with Laws, Insurance: Latent or hidden conditions may exist that are not obvious upon a walkthrough of the premises, and they may disturb the tenant’s work on the premises. Environmental hazards are one example. Thus, the tenant should require the landlord to submit the results of the most recent examination of the premises and ensure that any hazardous conditions that may emerge in the future will be properly addressed. Also, it should be described in detail in the lease agreement what party will be held responsible for legal compliance costs, such as satisfaction of fire safety requirements, emergency lighting, the Americans with Disability Act, etc. The tenant should also ask to review the landlord’s insurance policy in order to determine whether the space and the tenant’s products will be adequately covered by it in various situations; if the landlord’s insurance is not adequate, the tenant should obtain independent insurance. The tenant should also determine whether or not the landlord has sufficient coverage to pay for restoration of the premises in case of unforeseen circumstances, like a fire or flood.

 

Services: What services are included in the lease, if any? What does the tenant require? Does the tenant have flexibility in choosing services and providers? Does the landlord guarantee that the tenant will have these services continuously throughout the lease term? For example, what electrical voltage is necessary for the tenant’s operations? Does the tenant require elevators, a separate phone line, cleaning services, air-conditioning and heating after business hours, parking, and building access during off hours? All of these things and more should be considered. 

 

Assignment and Subletting: The parties should negotiate whether the tenant has a right to assign or sublet the space in whole or in part and whether he will need to obtain an additional approval from the landlord for each proposed sublease agreement.

 

Subordination and Non-Disturbance Provisions: The present landlord’s interest in the premises may change in the future. Thus, the tenant should make a concerted effort to ensure that a change in building ownership will not affect the tenancy. The landlord may want to be able to sell the building free and clear from others’ rights in order to attract more buyers. The parties must reach a compromise on this issue.

 

Personal Guarantees and Credit Consideration: Very often, the parties to the lease agreement are business entities rather than individuals. In such case, if one party defaults on its contractual obligations the damages of the injured party are limited by the amount of business assets and available insurance. Absent more, the tenant or the landlord may be left only with a claim against whatever capital the company has. Thus, the parties should consider one another’s creditworthiness and, in case the business does not have enough capital or there is a risk of its diminishment, personal guarantees of its owners may be useful.

 

Defaults and Disputes: The parties should negotiate in advance the remedies that will be utilized in case of default. For example, the tenant may want the landlord to provide a period to cure default before filing a complaint with the court. As the landlord/tenant relationship is a long-term one, the parties should recognize the need for efficient and cost-effective dispute resolution mechanisms. A protracted litigation is detrimental to both parties and can be substituted by simpler, quicker methods of resolutions, such as arbitration, mediation, and other alternative dispute resolution procedures.

 

The process of lease negotiation may be lengthy and tedious, but only a carefully drafted, detail-oriented agreement can yield desired results and protect from unexpected surprises.

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