Leasing Strategies for New & Small Businesses
Leasing Strategies for New & Small Businesses by Jeffrey L. Cohen
Basic leasing provisions are reviewed
If you thought you didn’t have much bargaining power when negotiating a lease, this article should give you new insights into commercial leases.
Everyone who has rented a hotel room, an apartment or a car has typically been presented with a preprinted agreement requiring their signature. And most of us when presented with these long forms have, after a quick perusal or deep breath, simply signed them. Although there is some truth to the maxim that everything is negotiable, we assume that these types of documents must be signed in their original form or the business will not sell or lease its product to us.
By contrast, one of the most expensive lease transactions with the most complex documents is virtually always negotiated and amended from its original form: your business’ premises lease. Whether for retail, industrial or office space, it can and should he negotiated before you sign on the dotted line. Should you fall victim to a landlord’s declaration that it never changes its pre-printed lease form, you run the risk of someday either finding out that you were misled or wishing that you had walked away from the deal.
I have reviewed everything from 100-pages food court mega-leases to three-page off-the-shelf generic forms, and every transaction confirms that negotiation of certain items is essential to address the needs and concerns of you, the tenant.
This article will not substitute for the counsel of one’s real estate broker and attorney, but is intended to provide a brief overview of some issues which are common subjects of negotiation.
- Occupancy Date
Almost all leases will contain a lease term, and many will specify an “occupancy date.” Rent will have to be paid beginning on that date, and this could pose a problem in certain situations. If the premises are not ready on that date the tenant should not be required to pay rent. If the tenant is responsible for the build-out of the space, the landlord might balk at such a provision. If a tenant has any doubt that it or its contractor will be ready on the occupancy date, the lease should be changed. Also, free rent and other concessions should be changed so as to begin on the actual “move-in” date.
- Holdover Provisions
Most leases contain some sort of “holdover” provision, which automatically increases the rent in the space after the lease expires. The aim of such a paragraph is to encourage the tenant to either renew or move out on time, and a holdover rate of 25 percent over the old rate is more than enough to accomplish that purpose. Double and triple rent is not uncommon, and should not be consented to.
- Default Clauses
The terms in your lease specifying what will cause a default are crucial and must be clearly understood. In addition, a tenant should be entitled to notice from the landlord of any defect along with a reasonable time to cure or remedy the default or violation. Certain types of defaults, whether or not monetary in nature, may require longer cure periods. Examples of lease defaults would be the late payment of rent, not opening for business during regular mall hours, or failure to maintain liability insurance.
- Liability and Indemnity
Liability and indemnity provisions are often found in leases, and should be reviewed by the tenant’s attorney. Often these clauses require the tenant to be legally and financially responsible for almost anything that happens on or near the premises, and to reimburse the landlord for any expenses it may incur due to any such event. I have found these clauses to be generally one-sided and unfair, and suggest that blanket liability clauses be negotiated out of the lease in favor of a clause that places liability on a party for only its own negligent acts or omissions.
- Expense Pass-Throughs
Shopping center and office lease are famous for their pages of complex paragraphs which pass through to the tenant the development’s variety of operating expenses. Some of these complex clauses only pass through the annual increases. These are legitimate expenses for a tenant, provided the expenses are purely for running and maintaining the building. Trash removal, utilities and routine maintenance are good examples.
A tenant must be vigilant in its negotiation of a lease, however, to weed out any “expense” items which either enhance the value of the landlord’s property, or which are more properly the landlord’s expenses of doing business. Such items include capital improvements, new landscaping, advertising, overhead, legal fees (except to reduce property taxes), client entertainment, leasing commissions, fines and penalties, and costs associated with expanding the development. You can expect some resistance in this area, but an intelligent landlord will respect the integrity of your argument. Furthermore, be careful to ensure that the formula for determining the tenant’s portion of the total expenses is based not on the amount of the property actually leased out, but on the amount of the property actually leased out, but on the total amount of leasable space in the property. This ensures that you are not charged for a portion of the unleased space.
Subleasing or assignment will always be prohibited without the landlord’s approval. The lease should specifically state that such approval will not be withheld by the landlord in an unreasonable fashion. If the landlord has certain standards for the subtenant to meet, these should be both reasonable and in writing.
- Tenant Improvements
Depending on your needs, “tenant improvements” or the build-out of the space could be one of the most important actions of the lease. If the Landlord is paying and the budget is limited, a tenant might want to negotiate the right to select its own contractor in order to keep control over costs. Whether there are monetary allowances for specific items or just a general budget limit, the lease should state that unused dollars should be paid to the tenant. An alternative would be to apply the unused allowance to the tenant’s rent.
- Percentage Rental
“Percentage Rental” is where a percentage of sales is charged in addition to a base rental amount. This provisions is common to shopping center leases. Because this is always negotiated, different stores will, of course, be paying different rates. Before signing a lease, a tenant is, therefore, well advised to speak with other tenants about their arrangements. Once a specified level of sales is reached by tenant, it will begin paying a percentage of its sales in addition to the base rent. Accurate sales records must be kept in the event the Landlord wants to verify sales figures, and penalties are sometimes included if the tenant has under-reported sales. Never sign a lease without a clear understanding of your percentage rent obligations.
The subject of guarantees is one which can be the most important provision in many leases. Personal guarantees are typically required when the tenant is not a very large company. It is understandable why a landlord would want a guarantee, since it is not uncommon for a tenant to move out or go out of business before the lease term ends. On the other hand, an individual could be financially ruined if called upon to honor a long-term lease guarantee. Reasonable concessions by both landlord and tenant can result in guarantees that all can live with. Therefore, you should consider requesting that the guarantee be limited in time (i.e., it will expire after a certain number of months), limited to a specified dollar amount, or that it contain a dollar obligation which decreases over time. One of these options should serve to protect the landlord’s true interests while not scaring off the guarantors.
Several other provisions of your lease may require negotiation. Perhaps your lease will fail to specify who has the obligation to repair the premises or specific items. Maybe it will restrict the tenant unfairly to a specific use of the property or a specific type of business. Fixtures might automatically become the landlord’s property after the lease term, even if they are the tenant’s property and of substantial value to your business. Renewal might be automatic, or it might penalize the tenant for failure to renew before an unfairly long lead time. And perhaps the lease requires you to give up the right to a jury trial in the event a dispute results in litigation.
But, the options are numerous. If you are fortunate enough to have a broker and attorney who give you advice, along with a landlord who is reasonable and eager to lease its property, you will find that a lease is, indeed, something that can be negotiated to your satisfaction.