Information on commercial leases and things to consider when negotiating contracts
Deciding to “move-in together” is a big step. Signing commercial leases is its own version of taking a relationship to the next level. Only in this version, it is typically accompanied by a few hundred pages of paperwork.
The standard terms of commercial leases are generally composed to favor the landlord. However, potential tenants may be able to negotiate significant improvements to the terms, as commercial leases are almost always negotiable. However, knowing what to negotiate can be complicated and may depend on numerous factors.
After a tenant-to-be decides on a suitable commercial property, the landlord and his or her representation will submit a lease form. Commercial leases are often very long and excruciatingly detailed, so it is easy to miss hidden charges or escalating fees. Before signing a commercial lease, a potential tenant may want to consider the following factors which are typically open to negotiation.
Although location in and of itself obviously isn’t a negotiable factor when signing a lease, it nonetheless affects the bargaining power of the potential tenant. The U.S. real estate market has slowly improved since the housing bubble of 2007. However, the potential tenant’s bargaining power may still heavily depend on local real estate markets and the location of the commercial space even in “a buyer’s market.”
For example, many retail and restaurant businesses rely heavily on location. A unique business space in a trendy neighborhood will create less bargaining leverage for potential tenants. Conversely, widely available rental space in a cold market may make negotiations for landlord concessions easier.
Length of the Lease
Over-committing to the term of the lease may be just as bad as not allowing enough flexibility for the long term. The term of a commercial lease can be anywhere from a few months up to 20 years. Tenants should evaluate their business’s growth potential, the nature of their industry, and if their business is location-sensitive. Shorter leases are favored by small quickly growing businesses or start-ups that are unsure if their business will succeed. Franchises may prefer a lease as long as their franchise agreement.
The length of a commercial lease may also affect management and operating fees especially if they increase annually on long-term leases. Business owners may want to consider negotiating a cap on these fees if they plan on signing a long term lease. It is usually possible to negotiate a renewal clause in short term commercial leases, but usually at a cost to the renter. The landlord might want an increase in rent for lease renewals.
Renters may be able to negotiate reduced rent for the first or last months of the term to compensate for moving costs.
Rent on commercial properties is often calculated by the year and advertised on a square foot basis cost per year. Rent may also be stated as flat rent or step-up rent which involves gradual rent increases. Business owners typically aim for a rent that is less than 10% of gross revenues. In some cases, landlords charge a base rent plus percentage of net revenues. The percentage of gross revenues can often be negotiated to begin after the tenant has hit their sales figures for several months in a row. In some cases, renters may also use an expense-participating lease in which the tenant is charged a fixed rent which includes a share of real estate taxes, insurance and certain repairs. This type of commercial lease agreement is more common in longer terms.
It is important to check how periodic rent increases are specified. In most commercial leases, rent increases are calculated according to the renter’s operating expenses, the consumer price index or a fixed percentage with a maximum cap on the increase.
It may be important to find out who is responsible for paying for heating, ventilating, air conditioning, electric lighting water, janitorial service, security, and snow removal. For employees who work late or on weekends, potential tenants may need to ensure that there is no extra charge for keeping the building’s heating or cooling system on after hours. Additionally, amenities such as kitchens, break rooms, and conference rooms may or may not come with the lease package.
A business or real estate lawyer can help business owners negotiate a commercial lease and assist in preparing and scrutinizing the documents necessary. For more information on drafting a commercial lease or commercial lease negotiations please contact Chester Hobbs at Bodie Law.