New business owners typically need to find a commercial space out of which to run their company. In today’s economy, there is no shortage of options, especially in Midwest cities hit particularly hard by the downturn (I’m looking at you Milwaukee). But, finding the space best suited for the new business is just the beginning. Once a space is found, it will be necessary to sign a lease for the space, and this is where any new business owner needs to pay close attention to what he is and is not agreeing to. Commercial leases are subject to much less government regulation than residential leases, so it’s important to have a clear understanding of the lease terms and negotiate modifications with the landlord as appropriate.
Here are 12 areas where a commercial lessee should pay particularly close attention to a lease:
The Space. It’s important to examine exactly what space is being included in the rental. Discuss hallway and restroom use as well as permitted entrances, elevators and other common areas. It’s also important to discuss whether the landlord has quoted your rental cost based on rental square footage or usable square footage. Usable square footage is always less than rentable square footage because it does not include common areas like bathrooms, hallways, lobbies and elevators. Having a clear understanding on the space which makes up the rental will help you determine whether the quoted rental price is fair and enable you to negotiate if appropriate. It also creates a clear understanding upfront on exactly what uses will be permitted.
The Lease Term. The “term” of a lease refers to its length. It sets forth when the lease begins, when it ends and whether there are any specific options for renewal. As a general rule, landlords will typically be more flexible in negotiating leases with longer lease terms, especially on rent. However, it’s important to remain mindful of the company’s needs- a longer lease means less flexibility to adapt to change as the business grows. Additionally, in the event that the market rate of rent declines, agreeing to a lengthy lease term up front may mean the company could be stuck paying above market rate for the leased premises. It’s sometimes preferable to negotiate a shorter term with a number of renewal options than to agree to an extended term- for example, a four-year lease with two three-year renewal options instead of a straight ten-year lease term.
Rent. Naturally a primary concern for any lessee, rent can be the driving decision-maker when it comes to making a determination whether to lease a space. Pay close attention to what the lease says about rent escalations or increases, as a fixed rent for the entire term of a commercial lease is not common. Be sure to understand how and when any escalations will be computed if a lease does not call for increases of a stated dollar amount. One common way for increases to be determined is by the Consumer Price Index (CPI), which fluctuates with market conditions. In the event the landlord insists on escalations determined by the CPI, then it may be possible to negotiate a cap on any amount, so, at minimum the maximum potential rent to be paid will be clear.
Assignments and Subleases. Assignment refers to a landlord or tenant’s ability to transfer the terms of the lease to a third party. For example, XYZ Corporation rents space for five years from Big Landlord. If, after two years, XYZ Corporation wants to allow ABC Corporation to rent its space for the remaining three years of the lease, the transfer of the space, along with all the terms of the lease, is called an assignment. Similar to an assignment, if XYZ Corporation only wants to let ABC Corporation rent the space for year three of the lease, this is called a sublease. Whether a commercial lease can be assigned or subleased to another tenant is a lease term that any potential lessee should pay particularly close attention to, as a clause that prohibits assignment or sublease can limit a lessee’s flexibility to respond to future market conditions. Landlords will usually be more open to permitting assignment or sublease if they have notice of any proposed transfer of the lease, they have the opportunity to approve it, and the original lessee remains liable for any unpaid rent or damage to the property by the third party.
Dispute Resolution. Pay attention to what a lease says regarding dispute resolution. Litigations costs can quickly get out of control, especially for a young company with limited resources. Mediation and arbitration present alternatives to traditional court proceedings and clauses requiring them are relatively common to see in commercial contracts and leases. Mediation involves a neutral third party that acts as a facilitator between the two parties to discuss disagreements, but he does not act as a decision-maker. Similarly, arbitration involves the use of a neutral third party; however, unlike a mediator, an arbitrator will actually make a decision regarding the disagreement which the parties can either agree to be binding or non-binding.
Items Included In the Rent Calculation. Much like a residential lease, a commercial lease can often include costs in addition to rent. Examine whether the rent price includes any maintenance costs, insurance, property taxes, etc. It’s important to have a clear picture about which costs you will be responsible for. If the lease terms aren’t clear, ask the landlord to include details about who will pay what costs and how they will be calculated.
Compliance with Laws. Commercial spaces must comply with a large number of federal, state and local laws and regulations. Typically, a landlord will be responsible for ensuring that the overall premises is complaint with laws; however, it’s important to understand the expectations with respect to the specific leased space. If the lease is silent on who is responsible for ensuring the space is complaint with applicable laws, ask the landlord to clarify the terms. For example, the Americans with Disabilities Act (ADA) requires all businesses that are open to the public or that employ more than 15 people to have premises that are accessible to disabled people. Make sure that you and your landlord are in agreement about who will pay for any needed modifications, such as adding a ramp or widening doorways to accommodate wheelchairs.
Improvements, Modifications and Fixtures. This is an issue that is easy to overlook but can have a potentially large impact on you when your lease term ends. It’s common for a lessee to need to make modifications or improvements to the leased space in order to serve its needs (new carpet, adding seating, cabinets, a reception area, etc.) Whether these improvements and modifications need the consent of the landlord should be set forth in the lease. Additionally, it’s important that the lease is clear about who owns the modifications when the lease ends. Typically, a landlord will own improvements made to the space upon the termination of the lease. However, a tenant may have the right to remove fixtures (those items that become part of the property but can be removed with relative ease and limited effect on the building itself.) Pay close attention to what the lease says regarding fixtures. It’s possible that an unsuspecting lessee could invest a lot of money in the property only to lose its right to remove things like expensive lighting upgrades or appliances when the lease ends.
Repairs. Watch out for lease clauses that require the premises to be returned to its original condition upon termination of the lease. Instead, consider negotiating with the landlord to carve out normal wear and tear to the premises, damage not caused by you or beyond the your control and any alterations which the landlord had previously approved. Additionally, pay close attention to who has the responsibility to maintain and repair plumbing, heating and air systems. It is common for leases to put that obligation on unsuspecting tenants who incorrectly assume the landlord will bear the costs of those repairs.
Termination. Any commercial tenant should make sure they understand the procedure for terminating the lease early and the requirements to terminate a lease prior to any automatic renewal taking effect. If the lease is silent as to a right to terminate, try negotiating a right to early termination along with the payment of a set sum of liquidated damages to the landlord in order to leave yourself an out. In the event that your business ends up not being as successful as anticipated, the business is sold, or market conditions simply require a change, you don’t want to be stuck relying on a court to determine damages to the landlord. It’s also important to pay close attention to notice requirements at the end of the lease term and follow them closely. For example, a lease may state that, sixty days prior to the end of the lease term, the tenant must give written notice to the landlord of its intent not to renew. If notice isn’t given sixty days in advance, the lease may call for the term to automatically renew. Be sure to keep a close eye on specific requirements in order to avoid getting stuck in an undesirable situation.
Security Deposit. Make sure it’s clear what can and cannot be deducted from the security deposit. Even though there are laws that specifically prohibit actions relating to security deposits, you should ensure that the lease specifically spells out the expectations and conditions for its return.
Signage. Take the time to make sure the lease is clear on any prohibitions relating to signage including size, location, lighting and the general appearance. You should also examine the exterior of the building and whether the type of desired signage works with the building’s structure. For example, a landlord may not be willing to permit a lessee to drill into a marble facade in order to attach a sign.
Negotiating lease terms with a commercial landlord can seem intimidating for a first time renter. But, if you know what to look for, you can ensure that the terms and fair and reasonable and expectations of both landlord and tenant are clear from the beginning.
Michael F. Brennan runs a virtual law office helping clients in Illinois, Wisconsin, and Minnesota launch new businesses. He can be reached at firstname.lastname@example.org with questions or comments, or check out his website at www.thevirtualattorney.com.
The information contained herein is intended for informational purposes only and is not legal advice, nor is it intended to create an attorney-client relationship. For specific legal advice regarding a specific legal
issue please contact me or another attorney for assistance.
By Michael Brennan
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