Commercial Leases -- A Tenant's Perspective
All too often, commercial tenants sign leases without an understanding of its basic terms, let alone the ramifications of provisions buried deep in a lease’s boilerplate. The smart tenant negotiates more than just rent – he or she knows what he or she is signing and the implications of each and every clause.
There are four general categories of commercial leases: gross, modified gross, triple net and absolute net. In a gross lease, the tenant does not reimburse the landlord for any of its expenses, including those associated with common area maintenance (“CAM”). With a modified gross lease, the tenant will typically pay base rent together with some amount of the landlord’s costs of operation over and above a stated amount.
The majority of leases, however, are so-called triple net or absolute net. With a triple net lease, the tenant must reimburse the landlord for CAM, real estate taxes and the landlord’s insurance. In other instances, leases described as triple net may include other “pass through” costs which a tenant is asked to pay (utilities, for example). The most extreme is the absolute net lease which requires the tenant to absorb all costs of operating and maintaining the property. These leases are generally used when the tenant is the sole and 100% occupant of the property.
Commercial leases terms run the gamut from 5 to 20 years, generally with fixed escalations in base rent. Depending on the property and the landlord, lease terms and base rent may be negotiable. Remember, everything is negotiable and if you never ask, you won’t know.
CAM, pass-throughs, and other charges reimbursable under the lease are the primary source of tension in the modern commercial landlord/tenant relationship. The tenant wants the certainty of knowing what his rent and charges are going to be on a monthly and yearly basis. The landlord wants protection from unexpected rises in taxes or the costs of providing services to the property. The key: read your lease and know every charge you will be faced with once your tenancy begins.
Another key aspect of any commercial lease is the services that will be provided by landlord and tenant’s reimbursement of those expenses. Make sure you know what’s not being provided, because otherwise it’s going to be an out of pocket expense. Further, unless the lease is gross, the landlord should identify the components that constitute the costs of operating the "common area" for which it seeks reimbursement. CAM definitions vary from lease to lease based on landlord preference, the type of property, and the negotiations of the parties. The wise tenant should negotiate the items to be included in CAM, the items that will not be included in CAM, and an annual cap or limit on expenses that landlord may attempt to pass through to tenant.
Make sure you understand exactly what you are leasing. For example, with retail space a lease will usually be based on “rentable square feet” which is typically larger than usable square feet. Resolve discrepancies prior to executing a lease or you might be faced with paying unforeseen costs since most expenses are based on rentable square feet as opposed to usable square feet.
Many landlords offer tenants a "build out allowance" as an inducement to lease the premises. A landlord's payment of the allowance, however, is tied to specific conditions in the lease. For example, if the tenant abandons the premises prior to the end of the lease term, the tenant may have to repay the build out allowance, along with landlord's other damages. Tenants should make sure they understand when and under what circumstances the build out allowance will be paid.
A tenant should also understand what constitutes default and the consequences of any event of default. There are two kinds of defaults – economic and non-economic. Economic default provisions deal with failure to pay sums due under the lease. Non-economic default provisions typically refer to other provisions in the lease - use of the property, hours of operation, or failure to provide services required by tenant under the lease. It is essential that the tenant have a full understanding of (1) what constitutes an event of default; (2) tenant's right to cure, if any; and (3) landlord's remedies for tenant's default.
Subletting is another important aspect of commercial leases. If a tenant sells his or her business or merges into another, lease provisions regarding subletting become very important. Many leases provide that the tenant may assign or sublet the premises with the consent of the landlord, which consent "shall not be unreasonably withheld". Obviously, the more flexibility the tenant has in its assignment and subletting provisions, the more flexibility the tenant will have in the conduct and prospective sale of its business.
Assuming your business is run as an entity (corporation, LLC, etc), Landlords will typically want the individual owners to guaranty the tenant’s obligations. If required, the guarantors need to understand the ramifications of such a guaranty. For example, if the company goes out of business after year one of a five year lease, the guarantors will be responsible for making lease payments until the landlord can rent the space again. Consider asking for a cap on the amount of guaranty. You don’t get if you don’t ask.
Additional points for a tenant to consider:
• If you are the tenant in a multiple tenant building, consider asking for a clause that prohibits your landlord from leasing to another tenant that might compete with you.
• Address what signage is permitted. Consider having a diagram and examples.
• Make sure you will have adequate access to parking spots for you and your customers.
• Understand use requirements – some leases require tenants to be open 7 days a week.
Most commercial leases will also address the parties’ responsibility for accidents and personal injury, casualty, damage to the building, and eminent domain. A tenant should review these provisions thoroughly with counsel to see if they meet the tenant's risk expectations.
There is no one “standard” form of commercial lease. The terms and provisions are, in general, only limited by the parties’ creativity and negotiating skills. As with any other contract, know what you are signing and remember that the only promises that count are those that are put in writing. The consequences of signing a “bad lease” can be devastating.
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