Negotiating Your Commercial Lease;

“An Ounce of Prevention is Worth a Pound of Cure”

by Annette Cooper (as referenced in INC. Magazine)

Over the past several weeks I’ve been approached by several business owners looking for an interpretation of their current lease document. They were trying to determine what financial exposure they have over and above what the basic lease rate requires. I thought it would be helpful for everyone involved in looking for commercial space to understand basic lease forms. We all should be aware of some specific commonly misunderstood clauses included in most lease documents. This will provide an understanding of what to look for before you sign on the dotted line. It can potentially save you money and unnecessary financial stress in the future.

Let’s start with reviewing the Standard Basic Lease Forms that are typically used in commercial leasing:

The NNN Lease document typically obligates the tenant to pay a pro-rata share of all the operating expenses over and above the initial rental rate. These expenses fall into three categories: property taxes, insurance costs, and Common Area Maintenance Expenses (CAMS). An NNN Lease document is typically used in retail leases and in retail centers, but I’ve found more and more landlords suggesting this lease form for both office and industrial products.

One of the biggest pitfalls to be aware of when obligating yourself to an NNN Lease is the exposure to a new tax assessment should the property sell while you are the tenant. Proposition 13 requires all properties sold in California to be reassessed at the new sales price. This can be significant if the property has been owned for a long time or if there is a significant increase in the price over what the current owner paid.

Another area of common ambiguity is the replacement or repair cost associated with the HVAC System (heating, ventilation, and air conditioning). For Instance, a lease clause may obligate the tenant to repair the existing unit and require the landlord to replace the unit should the entire unit fail. However, what if a compressor needs to be replaced? This can be a significant expense and could be interpreted as a tenant obligation because it’s not a “complete” replacement of the unit (much like replacing an engine in an automobile).

This lease form typically has the landlord absorbing the expenses for property taxes and insurance, but obligates the tenant to pay for Common Area Maintenance expenses and their own utilities. There are numerous hybrids associated with this lease form; Gross Lease, Modified Gross Lease, Standard Industrial Gross Lease, etc. The key here is to identify what specific expenses the tenant is actually responsible for in writing.

One commonly misunderstood lease clause is the impact of base year expenses. Many commercial leases will have a factor in the lease that allows for lease rate increases to the tenant for expense increases to the landlord over base year expenses. As a tenant, it is imperative to actually review the landlord’s budget before you sign the lease and make the necessary anticipated adjustments to your own budget. One suggestion would be to lock in your current expense exposure for a minimum of 12 months, or to request that the base year be projected to a year in advance. This is important if your lease begins in the last six months of the year. Who wants a rent increase three months after the lease begins? I’ve seen it happen and it’s important to protect yourself.

This lease form is typical of an office lease and requires the owner to absorb all the expenses of owning the building, including the utilities. As is common with the gross lease document, a full service lease will typically contain a base year expense clause. It is incumbent upon the lessee to know those base year expenses, the same as you would for the gross lease (mentioned above).

Today’s economic conditions make it a good time to be a tenant. This article is in no way meant to be completely comprehensive, but I wanted to highlight some of the issues that are commonly misunderstood in a lease agreement.

Other perks to consider when negotiating your new lease may be some rent abatement, an allowance for specific tenant improvements and a modified annual CPI adjustment. Perhaps you may find a landlord willing to give you an option to buy the property? NOW is a great time to be a tenant and NOW is a good time to ask a landlord for what you need to be successful.

As my mother often said, “The squeaky wheel gets the grease.” Don’t be afraid to ask questions and don’t hesitate to call me if I can help you with your lease requirement or a specific issue.