Leasing office space is an important part of a business owner’s entrepreneurial journey. Negotiating a favorable commercial lease agreement can mean the difference between excessive, unforeseen obligations and high overhead costs, and reasonable terms and costs that won’t break your budget. A landlord is usually the party to draft the first version of a commercial lease. Thus, the first version is created for the benefit of the landlord. Prospective tenants should be mindful of this fact but feel empowered to know that there is ample room to negotiate to ensure a mutually advantageous commercial lease agreement. The following are tips for entrepreneurs to consider when faced with negotiating a commercial lease agreement.
1. An Attorney in Your Corner
A tenant should consider involving a seasoned attorney to relay and represent the tenant’s terms. Even if a prospective tenant is working with a commercial real estate broker, the broker is not an attorney, and they only get paid once the lease is finalized and the tenancy is official. It is best to involve an attorney in negotiations as early as possible, and preferably prior to the Letter of Intent (“LOI”) or Term Sheet stage of the deal. Landlords and tenants alike often get their mindset on the terms initially negotiated on the front end, despite the non-binding nature of an LOI or term sheet. Terms that will be discussed are all of the below, along with the length of the lease (including renewal terms), caps on increased rent, options to renew, advanced rent (first and last month), security deposit requirements, permitted use and exclusive use, signage, among numerous other terms that may be specific to the tenant and his or her business.
2. Adequate Parking
As simple as this one may sound, many entrepreneurs find themselves in a bind if their customer base is discouraged from patronizing their business due to problems with physically getting there. Worse yet, inadequate parking ratios may mean your business cannot operate in the space as intended. Most cities have specific parking ratio requirements, and it is crucial to be aware of these requirements and determine the volume of customers a tenant may have in the building at any given time. For example, if you are the owner of a restaurant, ensure there is enough parking so that you are compliant with restaurant-related city requirements.
3. Intended Use Zoning
Prospective tenants should ensure that the building they are leasing is zoned for its intended use. For example, if the business is a bar, the entrepreneur must ensure that the building is in a “wet zone” pursuant to the relevant city code. We often negotiate on behalf of entrepreneurs to include zoning approval in the deal, i.e. the tenant will enter the lease agreement, and makes approval a condition of the lease, but requires the landlord to be the party responsible for obtaining zoning approval with the city.
4. Nearby Competitive Businesses
The proximity of a competitive business could have a positive or negative impact on the tenant’s business, depending on the industry, customer/client base, location, among others. This consideration is one that a tenant might evaluate prior to even entering the agreement in the first place, so as to not get stuck in a lease where a tenant’s business could be better-frequented elsewhere. For the same reason, tenants will often require exclusivity clauses in their lease, especially in a shopping center. Susie’s Always Sunday Brunch restaurant does not want Steve’s Sunny Side Up diner next door.
5. Build-Out and/or Improvements
Oftentimes our clients have a vision and brand for their business, and rightly expect that their physical location will conform to their brand. Negotiating build-out rights and cost allocation is integral to ensure the tenant has the power to build their space the way they see fit. The commercial lease agreement will dictate the burdens of build-out costs between the tenant and the landlord. Consider the following: how much of this build-out will benefit the tenant’s business? Conversely, how much of this build-out will create commercial value for the landlord? There should be plenty of room to negotiate such costs and benefits. The longer the lease term, the more likely the landlord is to pay for build-out costs. This is because the landlord needs to know it can recoup its build-out costs and have some profitability from the tenant.
6. The Building’s Condition
The condition of the building and related obligations of the landlord and tenant raise commonly negotiated issues. Therefore, it is important for prospective tenants to do their due diligence in inspecting whether the building’s condition is acceptable to them, especially relating to the age and condition of the roof and HVAC. We often negotiate replacement requirements for our clients. The tenant is usually responsible for maintaining everything other than the structural aspects of the building (roof, foundation, walls). Thus, if the premises is in poor condition to start, negotiating that a landlord must repair or replace certain items on the front-end could save the tenant from substantial maintenance costs down the road. Notably, a landlord may be agreeable to a replacement upfront, as insurance premiums will likely lessen based upon a newer roof and/or HVAC system.
7. Room for Growth
As a growth-focused entrepreneur, one might consider whether the building being leased provides room for expansion of the business. Tenants should consider including a right of first refusal to adjacent space, or larger spaces in the building, in the commercial lease agreement. This way, the entrepreneur may exercise the right to expand into a larger space that might become available, prior to the landlord agreeing to lease that space to a new business that comes into the market.
8. Personal Guarantees
A landlord will often require a tenant to sign a personal guarantee of the lease. Many of our clients find this fact frustrating and hope that because of their business entity, they will not be exposed to personal liability. This, however, is not always the case; particularly when a tenant’s company does not have a strong financial history and has few assets to put up as collateral. Thus, personal guarantees are often required and difficult to contract around. However, we often have success in mitigating commercial lease guarantees by negotiating for an expiration date that is sooner than the end of a lease’s full term. For example, we may insert a three-year time limit on the personal guarantee, contingent upon the tenant’s absence of default over that time span. The rationale presented to the landlord is that after a few years, the landlord has obtained some commercial value and will have recouped build-out expenses covered by the landlord.
If you are going to enter a commercial lease agreement for your business, Hunter Business Law can help you through the process and represent your best interests. To arrange a consultation, visit our contact page HERE.
This Blog was written by Hunter Business Law Attorney Stephanie Boussias.
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