Negotiating a Commercial Lease

Negotiating a Commercial Lease
People that handle commercial leases frequently, know that virtually anything is up for discussion in a lease negotiation.  Good negotiators know that in a good deal, everyone wins.  If you negotiate well you won’t get everything you want, but a successful negotiation can save you thousands of dollars that can be reinvested in your business or enjoyed as profits by you and your family.

Once you have found a space that works for your business, you would put in an “Offer to Lease” to begin the process.  Be sure to put all agreements in writing.  Unless it is the final agreement, which often includes a “this is the entire agreement” clause, it is not part of the lease agreement.

These are some of the key elements that you will be negotiating.

Term of the Lease
Depending on the type of space, most commercial leases run for 5 to 20 years, with options to renew.  Lease terms are always open to negotiation. If you will be spending a great deal on renovations, you may want a longer term to protect your investment.
A shorter term could be beneficial if you are happy almost anywhere, your space does not need much preparation to be functional and you are uncertain about the neighborhood or your business success.  In this case, be sure to have renewal terms included in the lease agreement so the rent does not suddenly increase beyond your ability to pay.

Rental rates
For commercial space, the rate is most often expressed in price per square foot.  Be sure to ask how the square footage is calculated.  Does it include only net usable space or a percentage of the common area?  If the landlord does not have an accurate calculation, as sometimes happens in smaller buildings, you can have it measured yourself and come to an agreement on the square footage used in the lease agreement.

The square footage rates most often do not reflect the total cost.  Most commercial leases include additional rent on top of base rent for expenses incurred by the landlord and for which the tenant will pay indirectly.  CAM (Common Area Maintenance), TMI (Taxes, Maintenance, Insurance), CAE (Common Area Expenses), Common Costs are some of the terms used for these additional expenses.   

Be sure you understand what is included and the anticipated costs. Property taxes, insurance costs, maintenance and property management fees are some of the items typically included.  Should a shortfall or overage arise, an adjustment will be made.  Your lease can provide that the expenses are audited by the tenants for accuracy and proper billing.  

Rent free period
If the space requires major construction, ideally you should start paying rent once the unit is ready to occupy.   If you run into unexpected hurdles, at least you won’t be paying rent on top of your construction expenses.

Even if your space only requires some modifications, your landlord may be willing to offer early access or a free rent period.  It is beneficial to building owners to keep the rental rates higher to maintain the appraised value of their buildings.  

Escalation Clauses
Price index:  Landlords may want to include a clause that allows them to raise your rent in response to changes in a national indicator such as the Consumer Price Index.   If your landlord insists on this type of clause, try to get a cap on the amount of the percentage of increase per year so that you are not overwhelmed with an unexpected escalation in rent expense.

Percentage rent clause means that the tenant agrees to pay higher rent when their sales exceed a certain threshold.   If your landlord asks for this clause, negotiate that the increase doesn’t start until the target sales have been met for 12 months in a row.  That way you can avoid a large increase if your December sales are high, but the remainder of the year is much less.

Cancellation Clauses
Cancellation Clause:  If you want to protect yourself “just in case” circumstances change, you may be able to add a clause into your rental agreement that allows you to cancel the lease for cause with 30-day notice to the landlord.  Specific causes should be listed and agreed to by the landlord.  You will likely agree to pay a cancellation fee, sometimes as much as two months' rent or more, in order to protect the landlord from the short notice.

Kickout clause:  If you make less money than projected, a kickout clause allows you out of the lease after a period of time if sales do not reach expectations.  New malls looking for tenants are more likely to agree to this clause, than ones in established, sought after shopping centres.

Co-tenancy agreements:  Anchor tenants in the shopping centre can be a key motivation for your location choice.  If that tenant closes or moves away, this clause allows you to negotiate that your rent will be lowered or you can cancel the lease without penalty.

Force Majeure:  A common clause in contacts is the force majeure clause.  Should a major disaster occur (war, tornado, flood, fire, etc) and you are unable to do business for 30 days or more, you would have the right to move elsewhere without penalty.

Watch for penalty provisions such as late fees and penalties.  Often “per day” fees, these can add hundreds to your monthly rate.   If you have a good credit history, your landlord may be willing to negotiate these down or eliminate them altogether.

Landlords of commercial property can ask for a deposit in any amount.  If you are a good potential tenant with sound credit records, you will have more bargaining power.  You may be able to negotiate the deposit down to one month’s rent.  If the deposit amount is excessive, the landlord may be willing to add an amount to the monthly rent for the first 6 months or so until the deposit is fully satisfied.

Right to sublet or assign
Many landlords are willing to agree to an assignment or sublease with their consent.  Be sure that you include the clause "landlord's consent will not be unreasonably withheld", so that should you find a suitable tenant, you will be able to complete the sublease.

You will need your own insurance policy to cover the contents in your space, as well as liability which covers property damage or if someone is injured in the premises.  Your landlord may have a requirement for you to carry a higher limit of liability than your policy covers.  Be sure you include the additional cost for increasing that liability into your calculations.

Repairs and Property Improvements
Clarify who is responsible for repairs and property improvements.  If the unit has been vacant for some time, the landlord may be willing to help pay for some of the modifications.  Be sure to ask about the approval process.

It is much harder to get minor repairs done after you have moved in, so any repairs should be done before the occupancy date.  Ask about maintenance of the major systems (HVAC, RTU, electrical, sprinklers) and certification that they are in good working order on the day of occupancy. Even if the landlord repairs a major leak, it could be a major headache for you if it ruins your new computer system.

Business Exclusivity
You may want to ask for business type exclusivity. If you are opening a restaurant specializing in breakfast food, you won’t want another similar restaurant opening right next door negatively affecting on your business.

Use of Space Restrictions
You could have a lunch area or shared conference room you count on to meet clients outside of your cramped or busy unit.  Should the landlord decide to remodel that space for another tenant, you would want a provision that allows you to leave or reduce your rent to help compensate for the loss of use.
Right of First Refusal
This provision allows a current tenant a right of first refusal to rent available spaces next to their unit or upgrade to a newly available space without penalty.  It can also allow the tenant to buy the building if the landlord decides to sell.

Removal & Restoration
Many tenants are so concerned about securing the lease they don’t spend enough time thinking about the end of the lease.  Most landlords are willing to negotiate the terms of the removal and restoration clause, so make sure you review this one carefully.

Most landlords expect to keep the fixtures installed or constructed in your unit, as they should.  Fixtures become part of the unit.

If you have trade fixtures (a piece of equipment on or attached to the real estate which is used in a trade or business), they may be removed from the real estate (even if attached) at the end of the tenancy of the business.  The business tenant must compensate the owner for any damages due to removal of trade fixtures or repair such damage.

Some landlords may insist that the premises be restored or rebuilt to its base building standards.   This can mean that you will be required to rip out all of those expensive pot lights, the beautiful tile, and demolish those individual offices to bring it back to a blank slate ready to lease to another tenant.  

This can be expensive and time consuming, especially for restaurants with many improvements, so be sure to review that portion of your lease carefully.  Ask that you have the option to remove your trade fixtures and leave the premises in broom swept condition.

Use Experts
An accountant is invaluable to help you project current and future costs, as well as income projections and tax ramifications.  He or she should be consulted often, especially during your planning stages.

A good commercial Realtor can negotiate on your behalf to be sure you are getting the best deal possible on your space.  They are trained to negotiate and you can spend your time doing what you do best-- running your business.  

You should also consider consulting a lawyer to be sure your current and future legal liabilities are well understood.  Any reputable landlord should allow you time to have the contract reviewed.  If not, find another space. 

Be prepared to walk
The best piece of advice I ever had about negotiating is that the one that is willing to walk away always has the advantage.  Negotiate fairly to reach a reasonable agreement in which your interests are met and the landlord is satisfied with the agreement.  

If such an agreement is not possible, walk away from the negotiation table knowing that this was not the right location for you at this time.   By leaving respectfully, you leave the door open for future transactions.  Who knows what the future will bring!

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