When it comes to one of your business's top expense items, your commercial real estate lease, tenants must have all the facts when making these long-term and often inflexible commitments. Without proper guidance and counsel, your business could miss opportunities to properly negotiate critical lease provisions, creating significant financial exposure and organizational risk.
As a tenant representation-only brokerage firm, we commonly see landlord-friendly lease provisions inserted into leases that put tenants at risk. As such, the following are 10 lease risk factors that you, as a tenant, should be aware of.
The asking rate is typically the first thing that tenants focus on in lease negotiations, but there is more to rent than meets the eye. Not only do you need to ensure that your rental rate is comparable to similar properties in that market, but you must also take market projections into account. For example, to a non-commercial real estate expert, today's market seems strong. What you don't realize is that the commercial real estate industry, historically, tends to lag behind the general economy by 12 to 18 months after a recessionary period. Tenants who take this into account approach today's market with caution, and look for short-term leases as they wait for the pending downturn. At that point, they are likely to find opportunities at a significantly lower rate than today's current market.
2. Rental Abatement
Most tenants do not get sufficient free rent in their agreements. In today's market, it is not uncommon to see one month of free rent per year of the lease. Additionally, in a down market, landlords are willing to offer even more free rent to secure your commitment to their building for years to come. Not securing sufficient free rent can cost you hundreds of thousands to millions of dollars.
3. Termination Options
Remember when I mentioned that commercial real estate can be one of the most inflexible agreements you enter into? That's usually because of the length of lease agreements and the amount of capital that is tied up within a lease obligation. A termination option provides flexibility which allows your business to exit a space that is no longer serving you because you need to:
- Close a location.
- Find a space that better suits your needs because of changes in the market or business.
- Expand and the current landlord cannot offer that opportunity.
No one can predict the future, so having termination options creates some peace of mind in the long term.
4. Operating Expenses.
A lease structured as net, net, net (or NNN) means that the landlord passes the property taxes, building insurance, and common area maintenance (CAM) charges onto the tenants, based on their pro-rata share. Far too often, landlords create unfair revenue streams for themselves by passing through unnecessary or inflated expenses to tenants. As a rule of thumb, always look to negotiate a cap on annual operating expense escalations in the 3 to 4 percent range.
5. Assignment and Subletting
For a tenant to sublease their space, they must first get approval by the landlord. Depending on how your lease is written, the landlord can often take their time to provide approval. Such delays can force your company into an expensive state of limbo, making it difficult for a prospective subtenant who may be juggling move-out dates from another space. While tenants will likely always have to get landlord's approval before subleasing a space, you can negotiate a timeline for approval up front to prepare for this.
6. Tenant Improvement Allowances
When signing a new lease, a tenant improvement (TI) allowance is one of the most common concessions that landlords offer. TI dollars can be used for anything from new carpets and paint, to a full unique build-out. The problem is that these TI dollars are often insufficient for the desired build-out and are usually structured so that if you don't use them by a certain date, you lose them entirely. We recommend that you get multiple bids on what it will cost to do what you want to the space before you sign the lease, to ensure you are not stuck with an unexpected bill. It's also a good idea to negotiate in the lease that you have the right to fully roll over any unused amount into free rent.
7. Landlord Versus Tenant Responsibilities
Some leases are very poorly structured, so the tenant is responsible for expensive equipment failures, major building repairs, or structural issues. In these scenarios, tenants have significant cost exposure. Negotiating these clauses favorably is critical to ensuring that you are not stuck with a significant bill at the end of your lease. At Keyser, we have seen this happen to varying degrees, sometimes costing tenants millions in unexpected costs at the end of a lease agreement. That's a great parting gift, right?!
Juggling move-in and move-out dates can be challenging, especially if construction is involved. Let's say your construction completion date has been delayed by 30 days and so you need to stay in your current space a month longer. When businesses stay longer than the lease expiration, they are charged a holdover fee which, depending upon the lease, can sometimes amount to 200 to 300 percent of your current rent. Most tenants have no idea these clauses exist until they matter. A well-negotiated holdover period should be part of every lease in case the need arises. Our recommendation is to negotiate up front the flexibility to stay in that space for up to 90 additional days at the agreed-upon rate with no penalty, and then a minimal increase after that.
9. Relocation Rights
Did you know that with relocation rights, which are often hidden deep within 100-page lease agreements, the landlord can relocate your business however they see fit? Landlords insert this clause to allow them to relocate tenants from one suite or building into another for their own objectives, usually to attract or retain other tenants. Interrupting business to relocate is costly and highly disruptive, and we recommend striking this clause entirely.
10. No or Poor SNDA Language
Leases typically have what's called a subordination, non-disturbance, and atonement (SNDA) agreement. If a new owner purchases your leased property, without well-negotiated SNDA language, they may have the right to strike your agreement, evict you, or negotiate a new agreement despite the terms of your old agreement. With strong SNDA language, you're guaranteed non-disturbance if the building ownership changes--meaning that your new landlord will need to wait until your lease expires to negotiate any new terms.
Having a well-negotiated lease is critical to you as a tenant, and can not only give you peace of mind, but can protect your interests, create flexibility, and save you money.
Jonathan Keyser is the founder and thought leader behind Keyser, one of the largest independent commercial real estate firms in the country--exclusively representing occupiers of office, industrial, healthcare, retail, and municipal space.