Lease To Win | Know the 5 crucial aspects of a commercial lease agreement
To lease or buy. This tagline -- so prevalent in the housing and automobile industries -- holds true for business owners regarding commercial real estate.
Historically low interest rates have kept owners eyeing commercial opportunities. However, business owners and managers seeking to conserve capital or not interested in owning real estate owe it to their bottom lines to fully understand the complexity of commercial leases.
Many hidden costs or business-limiting factors lurk under the surface of a poorly written lease. The results can include business interruption and many thousands of dollars wasted, dealing with landlord or building issues.
Most tenants don’t have the time or expertise to thoroughly negotiate a commercial lease. While landlords and their representatives do it regularly, tenants may do it only a few times in their careers. Advantage = landlords.
Tenants commonly negotiate basic business terms in a lease agreement before passing it along to an attorney for completion. But what most people fail to understand is that a lease with acceptable legal language is not necessarily a good business deal.
Fact: Rent and operating costs are one of a company’s largest expenses. Therefore, all language should be understood and concise before you execute a contract that could bind your company for a generation.
Here are five critical aspects to consider:
Rentable Square Feet
Commercial space may be quoted as rentable square footage or rentable square feet. It sounds reasonable until you learn a “rentable square foot” can include stairwells, elevators and other common areas that can be added to the cost. In some cases — particularly office leases — it can result in a 20 to 25 percent rental increase for space that your business may not use or benefit from.
Lease Types
Two most common lease types are Triple Net and Gross. Triple net leases require tenants pay rent and utilities plus a proportionate share of common area maintenance, insurance and taxes. Meanwhile, gross leases require tenants pay rent and, in some cases, utilities. Triple nets are common for retail and industrial/flex properties, while gross leases are more common in office buildings. The challenge is to understand which expenses are passed through to the tenant and which party garners ultimate responsibility for repairs and maintenance. Ambiguous language is never good for the tenant.
Operating Expenses
Any ambiguity related to shared expenses with the landlord will likely cost a tenant money and time. If the basement floods, but language in the lease doesn’t specifically limit your liability, you may be paying for a significant portion of new drainage – complete with expensive engineering.
Utilities
As with any major expense, you must understand your options. If sub- or direct-metering electricity isn’t possible, you could be signing a lease that estimates usage and could, further, be a factor used for rent increases. For the landlord who views this as a possible profit center, you may find yourself paying for a disproportionate share of the adjoining tanning salon’s electricity for the life of your lease.
Rent Escalations
Whether tied directly to operating expenses or a public measure such as the Consumer Price Index, rent could increase quickly. You must be aware of how this calculation works. In a lease that uses an index with historical volatility, the rent could outpace all other business expenses with nothing — including the courts — to stop it.
Just about every paragraph in a commercial lease could have business operating implications. Sub-leasing, assignments, tenant improvement allowances, insurance liability, renewals, options, and rights of first refusal are all critical topics that hold significant risk and responsibility. If you don’t have adequate knowledge of these terms before you sign a lease, it’s best to find someone who does.
Michael C. Jacobs is a principal at Glickman Kovago and Company, a Worcester-based commercial real estate brokerage and property management company. Contact him at mikejacobs@glickmankovago.com.
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