Three clauses to review before you sign a lease to avoid cost increases Featured

10:17am EDT July 8, 2011
Three clauses to review before you sign a lease to avoid cost increases

So you made the big decision to open a new office or extend the term of your existing lease. You have negotiated the material business points, including rental rate, improvement allowance, etc., and the landlord has sent you its “FORM” lease to sign and memorialize the transaction.

Not so fast! While you may believe that negotiations have ended, many important clauses remain in the body of that 60-plus-page lease. They must be carefully reviewed and likely amended before you sign.

“Remember, the lease was prepared by a sophisticated real estate attorney who represents the landlord’s best interests, not yours,” says Robert Chavez, founder and CEO of Guardian Commercial Realty. “Commercial leases are typically five- to 10-year contracts and can cripple a company if not properly negotiated — so proceed with extreme caution.”

Smart Business learned more from Chavez about the important items to review before signing that lease renewal.

What are the main things a business owner should know about a lease renewal?

Understand that landlords are not pleased when tenants make lease comments and they will resist your efforts to do so. It is imperative that you remain tenacious to secure a reasonable lease. Tenants have expectations of occupying habitable premises absent and extraordinary costs. You must look carefully for clauses that shift risk from the landlord to you.

The following three examples are important, but be advised that today’s leases contain dozens of dangerous clauses. Tenants are well advised to seek the assistance of an experienced real estate professional before executing a lease.

1. Premises area. At first blush, this section appears innocuous. If the square footage is correctly stated it may appear everything is in order. However, tenants must first ensure that the square footage has been accurately measured. Astute tenants engage their own architect to verify square footage. This can be accomplished quickly and cost effectively. Misstating square footage by a small percentage can cost a medium-sized tenant upwards of $90,000 in wasted money over a five-year term. Exaggerated square footage can also increase the tenant’s pro rata share of building operating and tax expenses by many thousands of dollars over the entire term.

Second, you must make certain that the landlord cannot unilaterally increase the premises square footage unless you actually expand. Many tenants have been shocked to see their rent statements increase simply because their landlord has implemented self-serving rationale for re-measuring the space. It is imperative that tenants stipulate the verified square footage as fixed throughout the term and option period(s) before signing.

2. Real property taxes. Aside from modest annual increases, California real estate values are reassessed upon a sale or transfer of interest in the property (triggering event). Landlords pass property taxes on to their tenants in various forms over the lease term, depending on the type of lease. If a building has been owned by the same landlord for many years, it is likely to have a very low tax basis, and the tax increase due upon a triggering event can be staggering. For example, if a building was valued at $100 million in 1991, and its current fair market value is $300 million, then tenants with leases in place will likely pay an enormous increase in their pro rata share of property taxes upon consummation of the triggering event and for every year thereafter while their lease is in place.

This may even occur when a privately held property becomes publicly traded. It is baffling why a landlord who sells its building for a gigantic profit would expect to pass the tax increases on to an unsuspecting tenant. Tenants do not profit from such a sale, the landlord does. Tenants should secure what is known as Proposition 13 tax protection to avoid paying these tax increases. If the landlord will not agree, then the tenant is well advised to ascertain the taxable basis for the building along with its current fair market value to estimate what its increased occupancy costs will be upon a triggering event. Then the tenant can at least make an informed decision regarding its election to sign the lease or not.

3. Surrender agreement. This clause addresses the tenant’s responsibilities once a lease terminates and the tenant vacates. It is standard for tenants to return space subject to reasonable wear and tear. Some leases, however, impose additional burdens and costs upon a tenant when vacating. A popular AIR form lease provides an extremely broad definition of ‘utility installations’ in one section of the lease that appears harmless. The definition includes items such as power panels, floor coverings (carpet and linoleum), security systems, fire protection, cabling, HVAC equipment and plumbing in or on the premises. It does not make a distinction as to whether the landlord, tenant or even a prior tenant installed these items. Later in the lease, the same phrase, ‘utility installations,’ is used to boot-strap tenants’ responsibilities in the ‘surrender’ section.

‘Utility installations’ takes on a whole new meaning when incorporated into the surrender clause. Costs as high as $100,000 have been charged to medium-sized tenants simply because the surrender clause is so pervasive. Keep in mind that the existing tenant may be moving to a competing building after negotiations with the current landlord soured. If there is bad blood, landlords have been known to use this clause to extract many thousands of dollars from a vacating tenant. Even though it’s years away from being an issue, pay close attention to the surrender clause before signing a lease.

Robert Chavez is the founder and CEO of Guardian Commercial Realty. Reach him at Robert.Chavez@guardianusa.net or (310) 882-2060.