Commercial leasing markets are variously described as a “landlord market” or a “tenant market” as the strength of the relevant economy ebbs and flow. Commercial real estate leases can seem daunting, especially since they’re a long-term commitment that can cost a lot of money. But, they’re not as complicated as many think. Leading a customer or a client through the perils and potential pitfalls inherent in the leasing of commercial space is both a science and an art.
Over some time, I have realised that no two corporations will ever have the same leasing requirements and no two leasing solutions are ever identical. Structuring the lease one needs to address issues such as future business conditions and possibilities of future expansion or contraction of space needs.
It requires going beyond standard clauses to guarantee maximum flexibility to both parties involved. In commercial leasing, the negotiating process requires the bargaining skills of a diplomat, an insider’s knowledge of the real market, and the will to succeed of the most determined entrepreneur.
The Lease process starts with an in-depth analysis of the present and future space needs of the Occupier (The list of options is almost endless: to remain in the present space; to relocate; to consolidate; to renovate and expand; to achieve more favourable tax treatment in another city, state, or even country). This analysis also spans financial requirements, the corporate image sought to project and the rate of internal growth to foresee over the next decade or more.
Once we’ve located the ideal space the negotiations begin starting with the evaluation of the complexities of loss factors, landlord work letters, escalation and recapture clauses, sublet, or assignment, determining the actual cost per square foot of usable space and securing the best possible terms and conditions are few of the elements of Commercial Leasing.
While leasing decisions are certainly affected as the amount of available space and the choices available to the parties will vary in a particular economic environment. But the process itself remains largely constant. Whoever — landlord or tenant — happens to have the upper hand at the time, both parties must still consider and resolve a panoply of issues. The landlord/tenant relationship is multifaceted and long-term; the leasing process itself is complex and arduous.
The Basic Considerations of a Lease are
I. Premises.
A. 1. Establishing basic requirements
2. Comparison of premises on basis of “usable” square footage
3. Confirmation of square footage by tenant’s architect
4. Restrictions on “remeasurement” by the landlord
B. Suitability for proposed uses.
C. Availability:
1. Compare the projected delivery date with the tenant’s requirements
2. How realistic is the delivery date in light of existing tenancies or construction work?
D. Expansion Space:
1. Options vs. mandatory “takes” vs. first offers or refusals
2. Decision dates
3. Recapture, subletting restrictions
II. Parties; Credit Considerations.
A. Who is the landlord? What is the nature of ownership interest (e.g., fee simple, leasehold, condominium)? Is the landlord’s credit sufficient for material obligations, such as completion of construction or funding of buildout allowance?
B. 1. Who is the tenant? Are there related entities that need occupancy rights? If a partnership entity, such as a law firm, should there be limitations on “recourse” to partners? How will the retirement of partners be handled?
2. Security deposit
a. Form (e.g., cash or letter of credit)
b. How invested if cash
c. Access to interest if cash
III. Term.
B. Termination rights.
C. Renewal rights — compare the timing of the decision to renew against the determination of rent.
IV. Base Rent.
A. Comparison of base rent on a “usable” square footage basis.
B. Free rent periods — base rent only or escalations as well?
C. Treatment of electricity charges:
1. “Rent inclusion”
2. Direct metering or submetering
3. Treatment as rent for rent occupancy tax purposes
4. When payable (e.g., during build-out)
V. Tax and Operating Escalations.
A. Computed against a base year or base amount? Alternative formulations based on “porter’s wage” or CPI. Consider a “net lease” alternative.
B. How certain that the tax base that reflects an assessment of completed value? Consider local standards for reassessment — will the property be reassessed upon a sale or refinancing or renovation?
C. “Gross-up” provisions.
D. Any opportunity to recover if base amounts are higher than actual costs?
E. Verify tenant’s “share”.
F. Review definitions and exclusions (See Schedule C).
G. Audit and contest rights; right to refuse payments on an estimated basis; refunds.
VI. Landlord’s and Tenant’s Work; Alterations.
A. Comparison of landlord’s “contribution” to build-out costs:
1. Nature and extent of “base building” work
2. Work letter or cash contribution; availability of credit against work letter items
3. Availability of landlord “financing” of build-out costs
4. Selection of a contractor for tenant build-out
C. Other provisions:
1. Obligation and/or right to remove speciality alterations
2. Ownership of improvements for tax credit and other purposes
VII. Prior Condition of Premises.
A. Asbestos, PCB or other environmental hazards
B. “Sick building syndrome”
VIII. Compliance with Laws; Repairs.
A. Allocation of responsibility to landlord and tenant:
1. Structural vs. non-structural
2. Non-premises areas
3. Conditions as in VII above
4. Conditions arising in future
B. Compliance with Disabilities Act
C. Cap on cost
IX. Services.
A. Review of available HVAC, cleaning, elevator, electricity, water and other services and cost of same (and against tenant requirements).
B. Specification of standards in lease.
C. Ability to verify charges.
D. Capacity to supplement available services (e.g., supplemental air conditioning, extra cleaning).
X. Insurance.
A. Have an expert review the adequacy of landlord coverage and compliance with tenant requirements.
B. Mutual waiver of subrogation, endorsement and/or right to waive recovery before the loss (with a waiver in the lease).
XI. Casualty and Condemnation.
A. Does landlord restoration obligation extend to tenant build-out?
B. Are the landlord’s restoration obligations consistent with its lender’s requirements?
C. Timing of restoration decisions and outside dates for completion.
D. Rights of cancellation by landlord and tenant.
E. Build-out and move-in period for tenant after completion of landlord’s restoration work (before recommencement of rent).
XII. Assignment and Subletting.
A. Certain transfers to be permitted without consent (assignments and subleases to affiliates, mergers, transfers of stock or assets).
B. Consider the effect of other lease provisions on assignment and subletting rights (e.g., use provision, alterations, directory listings, further assignment and subletting).
C. Landlord recapture:
1. Should the tenant share in the profit
2. Should the landlord’s recapture right apply to the initial subletting
3. When should a landlord decision be required? Same timing issue with landlord consent
D. Profit-sharing:
1. Right to recover costs
2. Only obligation to pay to Landlord “as and to the extent received”
E. Remedies:
1. Can the landlord enjoin tenant breaches
2. Does the tenant have an effective remedy if the landlord improperly withholds consent
XIII. Subordination and Non-Disturbance Provisions.
A. Subordination to be conditioned on non-disturbance from landlord’s mortgagees, and ground lessors — what if existing mortgage?
B. Application to subleases.
C. Enforceability.
XIV. Defaults.
B. Defaults should not apply to the assignor after the assignment of the tenant’s interest.
C. Rights of the assignor in event of tenant/assignee defaults (notice, right to cure, right to re-assume lease).
D. Rental offsets, self-help, landlord defaults.
XV. Disputes.
A. Covenant of landlord to act reasonably.
B. Arbitration of specified disputes, such as disagreement on rental value
XVI. Other.
A. Can tenants acquire an equity interest in the building?
B. Interest and attorneys’ fees should be available to both parties.
C. Rent abatement if premises are not usable.
D. Right to record a memorandum of lease, especially where significant period before possession or where options to expand or renew.
E. Right to signage in building and elevator lobbies; right to name (or restrictions on the name) of the building (e.g., will not be named for tenant’s competitors).
F. Lease or license of roof space for communications equipment.
G. Parking and other amenities — availability and cost.
The breadth and depth of our topic make it difficult the drawing any concise or pithy conclusions. The process — one that is full of diverse issues and is time-consuming and often tedious — simply cannot be a shortcut. Only the careful management of the process by a team of decision-makers and advisors can yield the desired result, a sensible and foresightful agreement.
Negotiating a lease can be daunting, but as long as you give yourself plenty of time to negotiate the lease before you need the space and negotiate on multiple locations at once, you’ll be operating from a place of strength. You likely won’t get everything you want, but you can certainly get everything you need.
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