Commercial Leases: Ten Tips for Clients
The failure or success of your business may depend on the terms of your commercial lease. Before you sign on the dotted line, carefully examine every term of the lease agreement. Make sure that the lease is drafted to accurately reflect the business terms of your rental arrangement, provide a reasonable allocation of costs, risks and liabilities, and address the particular requirements of your business.
To that end, pay close attention to the following ten areas:
1. Lease term. Understand the length of the lease, including when it begins, ends and whether there are renewal options. If you’re starting a new business, you probably don’t want to tie yourself to a five or ten year lease. A short term lease with renewal options generally is preferable.
2. Rent. Understand the price per square foot, but focus on the bottom line. The price per square foot may be misleading, since it may include unusable space. Sometimes a more expensive bottom line is actually a better deal, because the space is more efficient for your business needs.
3. Gross, net, or percentage lease. Understand that the total cost of the lease will be determined, in large part, by the type of lease. In a gross lease the tenant pays a flat monthly amount, and the landlord pays all expenses normally associated with ownership, such as utilities, repairs, insurance, and (sometimes) taxes (“Other Expenses”). In a net lease the tenant pays base rent and all or part of the Other Expenses. In a percentage lease the tenant pays base rent, all or part of the Other Expenses, and a percentage of the tenant’s gross revenue (tied, of course, to the leased premises).
4. Common area maintenance (“CAM”) charges. CAM charges relate to common areas which several tenants share, such as lobbies, parking areas, security, etc. Verifying your percentage of the CAM charges and excluding inappropriate charges can help control these costs. Your share of the CAM charges will likely be lower if it’s based on the total square footage of the building rather than on the leased square footage.
5. Tenant Improvement (“TI”) allowances. Consider whether your business requires improvements, modifications or fixtures added to the existing space. Understand who will pay for the TIs and who will own them after the lease ends.
6. Pass through expenses. Consider whether the lease subjects you to an annual increase in operating expenses, or “pass-throughs.” Some leases call for a four or five percent annual increase to protect the landlord against inflation, while others overcharge tenants by mandating a ten to fifteen percent annual increase. Require the landlord to provide a detailed list of expenses, prepared by an independent, accounting firm, to support increases, and make sure you have the right to audit the landlord’s books.
7. Signage. Consider not only whether signs are permitted under the lease, but also understand how many are permitted, where they are to be located, when they may be displayed, how large they are permitted to be, and whether the signage provisions in your lease are comparable to similarly-situated tenants.
8. Subleases and allowable uses. Understand whether you’re allowed to sublease or assign the lease to another business. Generally a sublease is prohibited absent the landlord’s consent, unless, in certain cases, to an affiliate. Also consider whether you are allowed to change the type of work you can do on the leased premises, since your business may change or expand during the life of the lease.
9. Exclusivity and nondisturbance. If you are planning to be the only business to perform a certain service or sell a certain product on the property, the lease should prevent the landlord from leasing space to a competitor. Also make sure that you cannot be forced to relocate generally or, further, move or sign a new lease if the property is sold or undergoes foreclosure.
10. Repair and termination. Understand who will maintain and repair the leased premises, including the heating and air conditioning systems, and whether you can make the repairs, after notice to the landlord, and deduct the cost of the repairs from the rent. Also understand if and how the lease may be terminated, including notice requirements, penalties for early termination, and how disputes are to be handled.
Leases can often be one of your most important contracts. Pay close attention to the entire lease agreement, as it is usually drafted in favor of the landlord. Even in a tight market, it’s possible to strike a bargain if you know what to look for in the agreement and how to negotiate key provisions.
* This column is not to be considered legal advice or a legal opinion on specific facts or circumstances. The contents are intended for informational purposes only. If you need legal advice or a legal opinion, please consult with your attorney.
Originally appeared in Business Connect magazine, June 1, 2007.