Negotiating a Commercial Lease: Top 5 Considerations
Whether you are a start-up company or an existing business experiencing growth, you may be looking to rent commercial real estate to serve as your base of operations. While the signing of a commercial lease is often a positive transaction, indicating that times are good and the future is bright, the process can be a bit daunting as commercial leases are typically “boiler plate” in nature and contain pesky “legalese” that can be dense and challenging to read. Here are five (5) things to look for when reviewing a commercial lease.
1. Reading and Understanding the Commercial Lease
As noted above, commercial leases by their nature are not “page turners,” but it is important to read and understand the lease you are about to sign. A commercial lease is a contract, and its words have meaning and implications that could affect your business in the future.
At the outset, you’ll want to make sure the basic information is correct. Be sure to check that the parties’ names are listed correctly. For instance your business entity will likely serve as the tenant of the lease. If your business is a limited liability company, your company should be listed as the tenant and designated with an “LLC” following your company’s name. Likewise, if your business has been incorporated as an S-Corp or a C-Corp, the tenant’s name should be followed by an “Inc.” on the lease.
Inevitably, the lease will contain words and terms that you may be unfamiliar with (i.e. “triple net”, “CAM”, “rent escalation” “assignability” or “core factor”, just to name a few). Most leases contain a definition section which should offer some guidance on the meaning of these terms with respect to your specific lease. Otherwise your business lawyer or commercial real estate broker should be able to clarify any questions you may have.
2. Rent, Security Deposit, and Other Fees
On a month to month basis, the biggest impact the commercial lease will have on your business is likely the rent that your company will be responsible for paying to the land lord. To that end, it is important that you carefully review the amount of rent that is being charged on both a monthly and an annual basis and check the numbers for accuracy.
The same goes for your security deposit (along with checking to see if the landlord can require it to be replenished) and your Common Area Maintenance charges (CAM). CAM is the percentage of the allocated common area maintenance your company is responsible for paying based on the percentage of the building you are renting.
You will also want to take into account how much the rent is scheduled to increase in a given period. Typically rent escalation takes place on an annual basis and is often times a one percent (1%) to three percent (3%) increase, though your mileage may vary based on geographic location of the leased premises and the strength of the commercial real estate market.
3. Landlord Responsibilities vs. Tenant Responsibilities
The lease for commercial real estate should clearly state the responsibilities of the landlord and the tenant. Many times this will largely be determined by the category of real estate you are renting (i.e. whether the building is “Class A” real estate, “Class B” real estate, or “Class C” real estate and the use (i.e. office, retail, manufacturing, or other). Depending on the class of the building and the purpose for which you are renting, services such as janitorial, lawn care, and snow removal may be included with your rent or they may be separate charges or tenant responsibilities.
The commercial lease should also indicate who is responsible (landlord or tenant) for maintenance items such as HVAC service and repair and changing of lightbulb
s in fixtures located within the leased space. It is not uncommon for the tenant to be required to maintain a service contract on the HVAC unit which heats and cools the leased premises and to change light bulbs. Other times these responsibilities fall on the landlord. In any event, there will typically be a requirement that the commercial tenant maintain appropriate insurance coverage, such as property & casualty insurance and general liability insurance, so as to protect the real estate as much as possible.
If your company is having the leased premises “up-fit” to spec or the landlord is providing “turn-key” build out of the space, you’ll want to make sure that all of the landlord’s responsibilities for the construction and up-fit of the premises are correctly specified in the commercial lease. This type of construction often occurs in newer buildings, where the landlord has financed the acquisition or construction of the building through a business banker or commercial lender. In such an instance, it is standard for the landlord (and its bank) to require that tenant agree in the lease to sign certain subordination, non-disturbance, and attornment agreements and estoppel certificates as necessary. The time period here is usually critical as the banks typically want the landlord (and thus the tenant) to execute these documents within five (5) to ten (10) days.
4. Assignability and Subletting
Many times the landlord will restrict the tenant’s ability to assign or sublet the lease without the landlord’s express written permission. This is a reasonable requirement of the landlord; after all he or she owns the building and should have a say in who will be occupying his or her commercial property.
However there may be facets of the landlord’s consent to subletting that you may be able to negotiate. For instance clarifying in the commercial lease that the landlord’s consent will not be “unreasonably withheld” is fairly standard. Another area to look for in negotiating a commercial lease is the cost of any such assignment. The lease may be structured so as to require the tenant to pay the landlord a processing fee, legal fee, administrative fee or some other fee for the landlord to consider tenant’s request to sublet. Often these fees are negotiable before the lease is signed.
5. Personal Guaranty
Wait a second! The landlord wants a “personal signature”? But the business entity is the tenant – surely the landlord must be mistaken! Right? Wrong. Landlords are in the business of collecting rent and, at the outset of entering into a commercial lease, the landlord will want to do everything possible to ensure that he, she, or it will get paid rent when due. Enter the dreaded personal guaranty.
The personal guaranty, or, “PG”, is somewhat counter-intuitive to the concept of corporate structure. Business owners and corporate attorneys go to great lengths to limit the liability of the business owner by organizing a limited liability company or incorporating an S Corporation or C Corporation. However most landlords (i.e. building owners) are corporate entities themselves. They understand the ins and outs of corporate law and so do their commercial lenders. To that end, personal guarantees are common place in commercial leases these days.
The good news is that the terms of personal guarantees are regularly negotiated. You or your legal counsel can usually have success in negotiating the scope or duration of the personal guaranty so as to minimize your personal exposure as much as possible. Such negotiation may result in a burn-off or sunset of the personal guaranty after a certain period of time or amount of rent collected by the landlord.
If you or your business is looking at entering into a commercial lease, contact us today to set up a consultation to review your terms and answer any questions you have to make sure your best interests are being put first.
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