NEGOTIATING A COMMERCIAL LEASE

The cost of renting space can be a significant business expense. A tenant can minimize that expense by doing some homework before entering lease negotiations.

COMPARATIVE ANALYSIS (SHOPPING)

Before a tenant, whether corporate or individual, enters into discussions with a potential landlord, the tenant should get to know the facts about the space in which he or she is interested (the “premises”) and the space comparable to it in a surrounding area. Specifically, the tenant should attempt to determine:

• Percentage of the building that is currently occupied

• Percentage and time any portion has been vacant

• How long current tenants have been located there

The answers to the aforementioned questions should also be determined for nearby leasable space that is comparable to the premises and located in the surrounding area with similar access.

Investigate the recent history of rent for the premises and other commercial space in the building. Determine the current rental rate, the cost of utilities for the premises, as well as the common area charges of the building and real estate taxes. This same information should be obtained regarding the comparable space in the surrounding area.

Armed with information, a tenant is now in a position to negotiate a lease. Office leases are often long, complex documents. Considerable time and money may be spent negotiating the specifics of a lease before the parties reach agreement. Most leases, however, contain certain provisions that can be anticipated and properly dealt with in the negotiation process. Set forth below is a list of those provisions and a suggested strategy for obtaining the best deal possible.

TENANT IMPROVEMENTS

A tenant is often able to negotiate a contribution by the landlord for outfitting the premises. Plans and specifications for the work to be performed that identify the specific obligations of the landlord and tenant with respect to the payment for and construction of the improvements should be attached to the lease as an exhibit. An alternative might be the landlord’s agreement to provide a period of free rent in exchange for improvements to be constructed by a tenant.

A tenant’s awareness of the availability of a work contribution usually results in some concessions, as properly constructed tenant improvements to the premises mutually benefit both parties.

DETERMINING THE COMMENCEMENT DATE

A tenant should try to establish a commencement date that will enable him or her to complete renovations and have necessary equipment in place before rent must be paid. Usually, the tenant will try to tie the rent commencement date to his or her occupancy of the premises.

If the landlord is responsible for tenant improvements, it is important to have an outside date by which the landlord is required to complete the work. If the landlord does not complete work on time, the tenant should be careful not to waive any rights he or she may have against the landlord arising from the landlord’s default.

BASE RENT

Tenants who have done their homework should know what the fair rental for the premises should be. Tenants should ensure that they are entitled to a reasonable grace period and adequate notice before the landlord has a right to charge either a late fee or penalty for delinquent payments. This is necessary because many default clauses allow the landlord to accelerate the balance of the rent payments due under the lease if the tenant is in default.

RENT ESCALATION

Leases typically call for increases in base rent in one of two ways. The first is with periodic fixed adjustments of the base rent. These adjustments are usually based on a compromise between the landlord and tenant’s opinions of what the fair rental value of the premises will be in the future. Fixed increases in base rent provide certainty to both landlord and tenant.

Many landlords desire to tie rent to increases in the Consumer Price Index (CPI). In periods of high inflation, use of the CPI to determine rent increases can result in unexpected expenses for a tenant. Consequently, a tenant should attempt to place a cap on any annual increases at as low a percentage as possible.

OPERATING COST AND TAX ESCALATIONS

Most office leases require the tenant to pay increases in building operating costs and taxes. Typically, rent adjustments do not become effective until the first anniversary of the lease. A tenant should insure that the base amounts for taxes and operating expenses are for a fully assessed and operational building. If not, these expenses may jump when the building is finally assessed for taxes and is fully occupied, as additional tenants place extra demands on building’s systems and services.

Only those costs that are directly related to the building’s operation and benefit all tenants in general should be included in operating expenses passed through to a tenant, such as:

• Associated with marketing or advertising in the building

• Incurred by the owner for a particular tenant or lease

• Capital improvements to the building should be excluded

MAINTENANCE AND REPAIR

A tenant should be guided by the principle that if the lease does not place obligation on the landlord, the tenant is responsible. Accordingly, the repair obligations should be spelled out in the lease. Generally, landlords try to limit their obligations to structural, exterior or mechanical repairs, and tenants try to limit their obligations to those repairs that are required because of the tenant’s specific actions or alterations.

A tenant should attempt to include in the lease remedies against the landlord in the event that the landlord fails to effect the required repairs. The remedy can take the form of a clause permitting the tenant to make the repairs and to deduct the cost of such repairs from rent if the landlord fails to make the repairs within a certain period of time.

DEFAULT AND REMEDIES

Many leases contain harsh default and eviction terms. Therefore, a tenant should insure that a landlord could not terminate a lease unless the tenant fails to comply with a contractual provision, receives notice of such failure and does not cure the problem in a timely fashion. A distinction should be made between monetary and non-monetary defaults, and the time periods given to cure should be reflected accordingly.

An effort should be made to negotiate the remedy clause to replace the typical punitive remedies with ones that adequately and fairly compensate the landlord but do not punish the tenant beyond loss of the premises.

ASSIGNMENT AND SUBLETTING

In the absence of a provision to the contrary, a tenant is free to assign or sublet a lease. Most landlords, however, insist on a clause to the effect that a tenant must obtain the landlord’s approval before an assignment or subletting is permitted. A tenant should insist that the landlord’s approval not be unreasonably withheld. Generally, courts have determined that a landlord cannot reasonably withhold consent if the proposed assignee or sub-lessee:

• Will be a financially responsible party

• Is a suitable tenant for a particular building space

Provided that its identity or business character conforms to the standards of the property.

• Use the premises in a legal fashion

In accordance with applicable laws and zoning requirements, and has all necessary permits to perform business.

• Will require only minimal alterations to the premises

It should be noted that a leasee’s right to assign or sublet is meaningless if the use clause in the lease is so restrictive that it would be difficult to find another tenant with a conforming use. Therefore, a tenant should attempt to make the use clause as general as possible.

OPTIONS

Renewal and expansion options give a tenant additional breathing room in both time and space over the original lease terms. As a result, the tenant should obtain as many renewal and expansion options as possible. Even if the option terms do not appear to be particularly generous, they can only be beneficial, because a tenant may always choose not to exercise an option.

CONCLUSION

To obtain the best possible deal, a tenant should understand not only his or her own rights and the leverage he or she brings into the lease, but also the compatibility of goals with the landlord’s. An attorney experienced in commercial leases will be invaluable in assisting tenants in:

• Determination of the rights of the parties

• Understanding the significance of all lease terms

• Recognizing the leverage and goals of landlord and tenant

• Evaluating the costs of a lease (with any hidden costs)

• Negotiating all the terms of a lease

The tenant who knows not only what he or she wants, but also what the landlord is looking for, will probably emerge from negotiation with a more favorable lease than the tenant who only considers his or her own goals without regard to the goals of the landlord.