About a year ago, the owner of a small law firm met a friend of his who had just bought a suburban office building. "You wouldn't happen to have some vacant space?" the lawyer asked. "Say, 1,500 square feet with a little room to expand as we grow?"
The buinding owner had just what his friend was looking for, at a rent both agreed was perfectly reasonable. "This is beautiful space for us," the lawyer announced. "You won't have to do a thing to get it ready. In fact, I'll even get one of my secretaries to type up a lease for you, free."
When the lawyer moved in, his landlord friend sent over flowers and champagne. A little later, he asked -- apologetically -- whether the lease was finished yet. "Well, with the move and everything, we're a bit behind in our paperwork," the lawyer admitted. "But it's all standard stuff."
Then the arguments began. Taxes went up, and the building owner insisted he had a right to pass the increase on to the new tenant. The lawyer installed new locks, and sent the bill to the landlord, who sent it back. The lawyer complained that the building wasn't heated at night, when he sometimes saw clients. And finally, a karate studio moved in directly over the lawyer's officer, punctuating each day with muffled shrieks and crashes.
The lawyer and his landlord friend have learned one lesson: Never take a commercial lease for granted. A lease is usually one of the largest contracts an independent business owner ever signs. A single paragraph of ambiguous language can create years of irritation and even lawsuits.
As a real estate broker who often deals with smaller offices and retail businesses, I've taken part in hundreds of bargaining sessions between building owners and prospective tenants. I find there are 10 important points to negotiate carefully before you sign the lease:
1. How long will the lease run? When I first started working as a borker, most landlords tried to pin down tenants to the longest leases they could get, to keep vacancies to a minimum. Now, however, tenants are usually the ones who want long leases, as a hedge against inflation. In almost every major city, empty space is at a premium -- and rents are rising fast. For example, the new owners of a New York City office tower just announced that they expect to see their average rents rise from $18 a square foot today to $60 a square foot within only five years.
Typically, commercial leases run anywhere from 3 to 10 years, and the term is usually negotiable with the landlord. But it's as important to pin down when the lease will begin as to determine when it will end. Unless the space you agree to occupy is already vacant and remodeled to fit your needs exactly, all kinds of last-minute problems can occur. An old tenant refuses to move out; construction isn't finished on schedule; disagreements arise about whether you can gain early access to install fixtures and make your own improvements.
Your lease should clearly spell out what happens if the space isn't ready by the move-in date, and what adjustments in rent will be made by the landlord. Be wary of a clause that allows the landlord to provide you with "alternative" space if the new premises aren't ready on time. That remedy only compounds the problems and costs of moving. If you have any doubts about whether your new space will be ready on time, give yourself some leeway in moving out of your old premises. Otherwise you may find yourself operating out of a moving van while lawyers squabble over the find print.
2. How much is the rent? Rent, unlike almost any other cost of doing business, is a fairly inflexible part of your overhead. But making cost comparisons when you're looking for rental space can be tricky.
Commercial rents are generally measured by the annual cost per square foot of the space (see "How Much Space Are You Really Renting?" below), but there are at least five common ways to calculate rent, every one of which uses square footage as the basis for comparisons.
* Gross leases, once the most common standard for office space, simply require the tenant to pay a flat monthly amount; the landlord is responsible for all the expenses of operating the building, including taxes, insurance, and repairs. (Because of rising energy costs, many landlords now charge tenants separately for heat and electricity, which used to be part of most gross rents.)
* Net leases require that tenants pay for some or all of the real estate taxes on a property, in addition to a base rent.
* Net-net leases go a step further: Besides base rent and taxes, the tenant pays for insurance on the space he occupies.
* Net-net-net, or "triple net," leases, which are usually written only for industrial properties, effectively pass on all the costs of operating the building, including repairs and maintenance.
* Percentage leases, finally, are a special type of rental arrangement that applies to retailers, especially in multipletenant malls or shopping centers. In a percentage lease, the tenant pays a fixed rate plus a percentage of gross income.
3. How much will the rent go up? Not very long ago, the costs of operating a building -- particularly real estate taxes and energy costs -- rose so slowly that an owner could catch up simply by raising his rents every time a new tenant moved in or when a lease expired and was renewed. Now, however, costs are so unpredictable that most landlords feel they need some protection in the form of escalation clauses, during the course of even a short lease.
One common type of escalation clause builds in regular step-ups in rent over the course of the lease; others pass on prorated increases in taxes, heat, maintenance, and other direct costs. Another common escalation clause automatically raises rents according to the Consumer Price Index, or some comparable index of inflation. (Since the CPI generally overstates the impact of inflation, a tenant shouldn't agree to pay more than a portion of the annual CPI increase, especially if the lease already contains escalators for taxes and direct operating costs.)
Most landlords will negotiate the key elements in the escalation clause, including the base year. If you move in halfway through the local fiscal tax year, for example, your base year for taxes could be any of three years -- the previous tax year, the present year, or even the next full year. The same holds true for heating costs and other elements of the owner's overhead. In particular, you should be careful about the base year if you move into a new building that may take a year or two to reach full capacity, since the owner won't have a stable history of operating costs to use as a reasonable base.
4. Can you sublease? Two years into a five-year lease, you discover your company is bursting at the seams and it's time to find a new home. What happens next may depend on a rather delicate negotiation with your landlord over what kind of subleasing he considers "reasonable."
At the very least, you'll have to come up with a new tenant who meets the same standards that the owner applies to other tenants. You're not off the hook if you find a massage parlor willing to take over your space in a prestigious shopping mall, or a punk-rock band that plans to use your office space for practice sessions. Moreover, if your subtenant decides to skip town, you're still responsible for paying the rent on the original lease.
Now, though, there's a new wrinkle to the traditional negotiations over subleasing privileges: the question of who keeps the profits if your new tenant pays more than you did for rent. In today's tight rental market, that situation occurs fairly often, and landlords are naturally eager to write leases that give them more control over subleasing arrangements. One tenant who merged his company with another business recently found an eviction notice in his mail. The landlord claimed that the "new" corporation had no valid lease for the premises, and would have to pay a higher rent to stay on.
5. Can you renew? Once your present lease expires, a landlord has no legal obligation to offer the same (or other) space to you. Unless you've agreed on a renewal formula and have a clause that guarantees you'll get first rights to the space when your lease expires, you'll probably end up paying the prevailing market rate to stay on.
Normally, a tenant has to give written notice exercising his option to renew his lease, or it lapses automatically. (A year's notice is typical for long-term leases, while only three or four months might be standard for shorter-term leases.) Some leases, however, are renewed automatically until you take steps to cancel them. This can be a handy arrangement for companies with several branch locations, that don't want to risk having their leases run out by accident.
6. What happens if your landlord goes broke? A few years ago, a doctor I know moved into a small, privately owned medical building and spent a fortune on renovations and built-in equipment. One morning a bank officer -- "a real shark" -- showed up and announced that the doctor's 10-year lease was void, because the bank had foreclosed on the building. The doctor could stay at twice his original rent, or move within 30 days.
The doctor could have protected himself either by making sure his lease contained a standard "recognition" or non-disturbance clause. If a landlord balks on this point, it may be that he's on shaky financial ground.
7. Who's responsible for insurance? In the rush to firm up a lease, insurance rarely gets the attention it deserves. The result is that many buildings -- especially those with multiple tenants -- are covered by a hodgepodge of overlapping and inadequate coverage. This is not only costly, it also invites disaster. In case of fire or other major disaster to the building, it may take years before the various insurance companies manage to sort out the claims and decide what was and was not covered.
Landlords in general are elxpected to carry a comprehensive policy on the building that covers liability for common areas, such as lobbies, stairways, and elevators, and provides casualty protection for the building itself. They also have the right to insist that tenants carry their own insurance to protect the landlord against claims that might arise from the conduct of their businesses (a visitor who trips on an office carpet, for example), and "contents and improvements" coverage that protects his investment in the property itself.
Making sure the policies dovetail, though, is really a job for a professional insurance agent or a lawyer with expertise in insurance. He should be able to review the building owner's policies, help close any dangerous gaps, and spot unnecessary expenses.
8. What building services do you get? Just about the only way a landlord squeezed by inflation can cut his costs is by lowering thermostats and reducing maintenance. It's a good idea, therefore, to define in writing precisely what services you're entitled to get as part of your lease. Some key points:
* Electricity is often supplied as part of the building services you get, but a landlord may reasonably set limits if you expect to install electrical machinery or extra air conditioning.
* Heating, ventilation, and air conditioning (HVAC) are also usually the landlord's responsibility. Unlike apartment buildings, though, commercial space rarely offers 24-hour HVAC service. You should attach an HVAC schedule to the lease itself, and even specify what service is to be provided on state and federal holidays. (Normal HVAC service is usually available Monday through Friday, from 8:00 a.m. to 5:00 p.m., and Saturday from 8:00 a.m. to 1:00 p.m.)
* Cleaning services can make a big difference in the appearance your company presents to the public, so you should request a specific schedule of how often the building will be cleaned, and who is responsible for such house-keeping details as cleaning your restrooms and taking out the trash.
9. Who else can move in? How would you feel if a close competitor moved in next door?Or a business that generated strange odors or loud noises?Or one that attracted unsavory people? To some degree, zoning laws protect businesses from "incompatible" uses, such as retail businesses in office buildings, or manufacturing in a retail neighborhood. But you can also negotiate stricter limits with your landlord if you feel it's necessary.
Just remember -- if you need to sublease, those strict requirements may give your landlord a reason to reject a tenant you want to turn your space over to.
10. Who pays for improvements? Modern office buildings generally provide allowances for improvements -- new partitioning, lighting, carpets, paint, etc. -- but there still remain wide variations in what individual tenants feel they need, and what individual landlords are willing to provide. No other area of a lease, in fact, is so open to negotiation and hard bargaining between landlord and tenant.
This bargaining is complicated by the high costs of even minor construction jobs. A single new electrical outlet, for example, may cost $100 to install; heavy-duty carpeting may end up running $20 a yard to lay down; carpenters, plasterers, and painters will bill their time at anywhere from $15 to $30 an hour. If a building owner is also carrying the remodeled space rent-free during construction, the cost can be substantial.
You're more likely to persuade a landlord to pay the bill for major renovation work if the changes you request will attract future tenants after you move on. Unusual partitioning and carpets and wallpaper with strange patterns or colors won't add to the value of the landlord's property -- they may even have to be removed before he can put the space back on the market.
Agreements about renovations should be put in writing, preferably with a detailed floor plan and an estimate of costs from a contractor, before the lease is signed. This document, called a "workletter," should also specify who owns any improvements. Unless you agree otherwise, anything a tenant attaches to the space he occupies -- air conditioners, light fixtures, shelving, cabinets, even his own office and manufacturing equipment -- will probably belong to the landlord. A friend of mine learned this lesson the hard way: He'd just installed a handsome new reception desk, and was dismayed to learn he'd have to leave it behind once he moved. "The worst part of it," he says, "is that I also paid for improvements other tenants got for free. That really hurts."