Understanding Your Commercial Lease: What Business Owners Need to Know

Understanding Your Commercial Lease: What Business Owners Need to Know

By nature, business owners are smart, savvy professionals who can dissect even the most complex strategic plans, financial metrics, and industry data. But many business owners get overwhelmed with lease terminology. I recently had the opportunity to step above my day-to-day work and really look at a lease I was reviewing from the perspective of a business owner who is not a real estate lawyer.  I realized the document was peppered with terms and concepts that were not intuitive. So, I decided to share with you answers to the most frequently asked questions my clients have when reviewing their lease documents.

Questions Business Owners Have

Q.  What is a Proportionate Share?

A.  When a Tenant is paying for a portion of the real estate taxes, common area maintenance costs (CAM) and insurance, which is commonly called a Triple Net Lease scenario, the Tenant’s proportionate share is generally the ratio created by the square feet of the Tenant’s premises divided by the total rentable square feet in the building. It’s the tenant’s square footage divided by the total rentable square feet of the building expressed as a percentage.

Q.  I will receive a Tenant Improvement Allowance. My Leasehold Work will cost a lot more than the allowance. Shouldn’t my landlord cover the whole cost?

A.  The amount of the tenant improvement allowance is generally a function of the marketplace where your business is located, the intended use and how much local landlords are willing to provide tenants with cash up front to pay for a buildout. It’s not necessarily a function of the Landlord saying that they will build out a brand-new space for your office at no charge to the Tenant. It’s different for every tenant (national or start-up), use (dental/medical, office or a quick service drive-through) and landlord.

Q.  Is the security deposit amount negotiable?

A.  There are generally 3 ways to provide the Landlord with security for the Tenant’s performance:

    1. Guaranty
    2. Security deposit
    3. Letter of credit

And yes, the security deposit is always negotiable. Security deposits are cash up front at the beginning of the lease that sits with the Landlord (not within a separate account like residential security deposits) until the end of the lease. If everything goes well throughout the lease term and Landlord has no right to claim a portion of the security deposit, the Tenant will get a refund at the end of the lease. It’s not a very efficient way to use capital, but some Landlords may agree to limit or eliminate the personal guaranty if there is a larger security deposit. If managing the guaranty is a factor, use of capital up front for the security deposit could make sense!

Q.  Is there ever a situation where I negotiate the terms of the lease once I’ve signed it?

A.  Tenants generally have leverage with Landlords before the lease is signed and at renewals or at the end of the lease. It is best to get all of the things you want from your landlord before the lease is signed or before the lease extension notice gets sent out. After the lease gets signed, changing the lease terms requires an amendment to the lease and requesting an accommodation from the Landlord.

Q.  Do I have any control over additional rent that may be charged for my proportionate share of operating costs?

A.  In a Triple Net Lease scenario with a lease that was well negotiated, a Tenant will have mechanisms to hold the Landlord’s proverbial feet to the fire when it comes to the common area expenses. I generally negotiate hard on what is included in in a common area expense (real estate taxes, snow removal, common area utilities) and what is not a common area expense (Landlord’s capital expense of the project, Landlord’s cost of tenant incentives and Landlord’s brokerage fees). I also make sure that the Tenant has the right to review and audit the Landlord’s common area expense reconciliations if the Tenant suspects Landlord is playing games. If possible, it’s great for a Tenant to obtain a cap on the increase of controllable common area expenses, but many Landlords will agree to this type of cap.

Q.  I rented more space than I need. Can I allow a friend to use an office for her non-related business?

A.  Most commercial leases will prohibit the assignment or subletting of the space without the Landlord’s consent.

Q.  How is my share of the maintenance negotiated. For example, do I pay for cleaning the carpets and other facility-based maintenance?

A.  In a Triple Net Lease scenario, the common area expenses are meant to be passed through from the Landlord to the Tenants so that each Tenant pays their proportionate share of common expenses such as real estate taxes, maintenance to the roof or structure of the building or cleaning of carpets in the common entry way. Tenants can try to negotiate a cap on the increase of their share of the common area expenses, but many Landlords will not agree to this. Best to negotiate hard on what is and is not a common area expense and then make sure that the Tenant has a mechanism for holding the Landlord’s feet to the fire.

Q.  What alterations am I allowed to make under most lease agreements for my business?

A.  Most leases will prohibit any alterations to your space without the landlord’s consent. I generally try to get a small project or cosmetic alteration exception to this general rule so that the Tenant doesn’t need to get Landlord consent to change the color in a few rooms or otherwise do something cosmetic that does not change the structure of the space.

Q.  Can I negotiate to have the name of my business added to the building?

A.  Signage is an important factor and should be brought up early on with your broker, and any signage details agreed upon by the Landlord should be in the lease.

Q.  My lease states that I cannot install fixtures or equipment requiring utilities. Is this something that is negotiable before I sign the lease?

A.  Generally, any alteration to the space will require a Landlord’s consent, especially if your work affects common utility lines. Landlords often provide this consent, and they are generally motivated to see the Tenant open for business and operating at full capacity.

Q.  What are my insurance obligations when leasing space?

A.  Landlords generally require a list of insurance coverages. I always direct tenants to their business insurance provider for advice on the coverages requested by the Landlord and planning for delivery of the Tenant’s insurance certificates before the lease begins.

Q.  What happens if I default on my lease?

A.  A well negotiated lease will provide the Tenant with some written notice that the Tenant is in default, and then the Tenant should have an opportunity to cure the default. If Tenant cannot cure the default, then the Landlord will start the eviction process, which normally takes about 3 weeks in Minnesota. It is best to not let the lease get into a default stage, because the Tenant starts to lose control of the Tenant’s future. If a Tenant is in trouble, the Tenant should be in touch with the Landlord to work out a proactive plan to get through the troubled period.

Q.  Generally, the landlord will present the Lease Agreement to the tenant. What discretion does my lawyer have to make changes to the lease to protect my interests?

A.  It’s rare for a business to get a perfect lease where all the provisions are Tenant friendly. When the business is a smaller organization with 1 or a few locations, Landlords generally hold the upper hand and will start with a lease form that is Landlord friendly. The work of a good Tenant real estate attorney is to prioritize the most important lease terms to the Tenant and fight hard on those priority items. I focus on critical Tenant matters such as common area expenses, tenant improvement allowance and buildout procedures, the right to assign the lease in the event of a transition, any guaranty or security requested by the Landlord, allocation of maintenance costs and so on. An experienced real estate attorney also knows which provisions Landlords generally will give on without too much of a fight, so it’s a matter of pushing the Landlord as far as the Landlord will go while keeping the lease on track.

These questions come up every day in my real estate practice when I work with business clients. It is my hope that with this information, the process of leasing space for your business won’t be quite so daunting. For more information, you can contact me at 612-799-4077 or jsaunders@avisenlegal.com.

 

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