Leasing space for your business — whether office, retail or industrial — is an important investment for any company. While there are always many factors to consider, it is important to understand what is reasonable for your particular business in the marketplace.
In most areas it is still a tenant’s market, so it may make sense to upgrade, expand and extend leases now. In other markets, the leasing climate has started to change and landlords are able to drive harder bargains. Whatever market your company is in, there are several common leasing issues that should always be considered when negotiating a lease or lease extension.
Smart Business spoke to Sonia Lister and Spring Robinson of Jackson DeMarco Tidus Peckenpaugh about their list of the top 10 most common lease negotiation issues that business owners should address when discussing leasing needs with their landlord.
1. Letter of intent. Depending on the complexity of the lease terms, it is almost always to a tenant’s advantage to have a detailed letter of intent (LOI) as the first step in lease negotiations. The LOI should include all of the business terms of the lease. Even though the LOI is typically a non-binding document, the business terms of the deal are rarely renegotiated after the lease negotiations begin, so all essential terms should be clearly addressed in the LOI.
2. Landlord incentives. Consider asking for incentives from the landlord. A company’s ability to negotiate landlord incentives will vary depending on the vacancy rate in the market, as well as other factors such as the company’s size and financial ability. A long lease term and solid tenant commitment may motivate the landlord to offer generous concessions and incentives. Typical incentives include periods of free rent or discounted rent, landlord contributions to build-out costs or moving costs, limits on future rent increases, free parking and reduced or capped operating expenses.
3. Improvements to the premises. Evaluate which party should construct the improvements to the premises. There are three common options: a) tenant build, b) turnkey (landlord builds the improvements at its expense pursuant to a specific plan), or c) landlord build. The negotiation considerations for each of these scenarios are different and so you should be sure to discuss them carefully with an experienced tenant broker and legal counsel.
4. Condition of the premises. Make certain that the current condition of the premises is acceptable if no improvements are being made to the premises. Taking the premises ‘as is’ exposes the tenant to risk for inadequate or outdated facilities. At a minimum, the landlord should warrant that the space is up to current building, fire, safety, zoning and disability access codes and should warrant the condition of electrical, plumbing, heating and air-conditioning systems (even if only for a limited period of time).
5. Planning for catastrophic events. The lease should provide procedures in the event of any future catastrophic event (i.e. damage to the premises, condemnation, or disruption in utilities). In such events, the lease should clearly provide who is responsible for repairing or restoring the damage, whether the tenant is entitled to abatement of rent, and the right to terminate the lease if such catastrophic event is long lasting or of a significant nature.
6. Limiting the liability of lease guarantors. If a principal of your company is required to personally guarantee the tenant’s obligations under the lease, try to limit his or her potential exposure to liability. The risk to the lease guarantor can be limited by adding provisions that reduce the term of the guaranty to a certain number of months after the lease commencement date, or limit the maximum amount payable by the lease guarantor to a fixed dollar amount.
7. Consider future flexibility or allowances for company growth. Prior to entering into a lease or extending the term of an existing lease, it is important to analyze every aspect of your company’s business plan to make sure that the size of the premises is compatible with existing and future plans for your business, and that there is sufficient flexibility built into the lease in the event that plan changes. Some provisions to include to ensure future flexibility include a lease extension option, space enlargement or reduction option, early termination option and the ability to assign the lease or sublease the premises.
8. Security deposit. Depending on the market and the financial strength of your company, it may be possible to minimize the amount of the cash security deposit. If your company is and has been financially strong, the landlord may waive the security deposit altogether. Furthermore, if it makes business sense for your company, a landlord may accept a letter of credit in lieu of a cash security deposit. If, however, you are required to provide a cash security deposit, consider building into the lease a provision that would allow the security deposit to be decreased over time if the tenant has fully performed its obligations.
9. Hold-over provision. Make certain that any penalty for ‘holding-over’ or remaining in the premises after the expiration of the lease is reasonable. Furthermore, be sure to allow flexibility for negotiations with the landlord at or beyond the expiration of the term to renew the lease without payment of any hold-over penalty.
10. Notice periods and deadlines. All notice periods and deadlines for exercising or enforcing rights should be reasonable. After your company has signed the lease, it is important to periodically review the lease and to calendar all important dates so as not to forfeit or waive any rights, such as an extension option, early termination option or space reduction option.
Sonia A. Lister is a shareholder and member of JDTP’s Real Estate Practice Group. Reach her at email@example.com or (949) 851-7408. Spring M. Robinson is an associate and member of JDTP’s Real Estate Practice Group. Reach her at firstname.lastname@example.org or (949) 851-7474.