With so much on the line, landlords and tenants need to make sure that their commercial leases are carefully tailored to their unique businesses and circumstances, that they’ve worked to make the terms as favorable to themselves as possible, and that they have a full understanding of their rights and obligations under the lease.
We spoke with Andrew Bennett, a commercial real estate broker and industrial specialist with Cushman Wakefield – The Lund Company…and came up with five particular areas that landlords and tenants should consider when negotiating their commercial leases.
- Early Termination/Liquidated Damages
While not addressed in leases often enough, landlords and tenants should anticipate that a tenant may want or need to exit a lease before the term is up. If a lease is silent on early termination and a tenant wants to exit early (breach), the tenant is going to be on the hook for the rent until a new tenant is found. The tenant will also be responsible to pay for the costs to locate a new tenant, such as broker fees, which can be pricy themselves. And chasing tenants that can’t pay their rent is no fun for landlords either.
Instead of leaving so much to chance, the parties can add an early termination, or liquidated damages provision. At the time of writing the lease, they can agree on a number that the tenant can choose to pay in order to get out of the lease early. The goal in determining a number is to try to anticipate what the landlord’s damages might be if the tenant were to breach sometime down the road. For example, depending on the market, it might take the hiring of a broker and six months to re-let a similar space. Accordingly, the parties could agree in the lease that the tenant can choose to pay the equivalent of six months’ rent plus broker fee as an early termination fee.
- Flexible or stringent use and subletting provisions
Just as early termination provisions can help keep the parties on good terms, so can a clear understanding of what is allowed with regard to the use and subletting of a space. Tenants should be looking for flexibility with who can be in their space and what goes on in their space. Landlords have an interest in the stability of the space. Maybe a real estate office wants to rent part of its space to a travel agent. Maybe a Taco Bell wants to start slinging pizzas and breadsticks. Allowing flexibility can help ensure the rent can get paid on time, but can also potentially affect the stature of the space itself. An office with six logos on the door may not be as impressive as the same office with one logo on the door.
- Exclusivity and tenant rights with regard to other spaces
A frozen yogurt shop probably doesn’t want an ice cream shop moving in next door. Landlords and tenants can negotiate who the landlord can or cannot rent adjacent spaces to. Although an ice cream shop is a no-go, maybe coffee is ok. Tenants can likely be pretty demanding in this regard, as the landlord just wants a signed lease, and probably isn’t very worried about what conflicts might arise down the road.
- Saying no to substitution of premises
Landlords always try to include this type of provision. An educated tenant should always strike it. A substitution of premises provision typically allows a landlord to relocate a tenant to a “substantially similar” space and only need to pay the moving costs and not much more. The provision generally does not compensate a tenant for the losses suffered from being closed for a month during the move, nor the goodwill that a business naturally generates from being in a particular location for a length of time.
- Capping Triple Nets
In the commercial real estate industry, leases are either considered to be “full service” or “triple net (NNN)”. These designations refer to who pays for costs such as utilities, building maintenance, property taxes, management fees, landscaping and snow removal. With full service leases, the landlord pays all of these costs, and bills the tenant simply for whatever rental amount was agreed upon.
With triple net leases, the costs listed above are borne by the tenant, and are collected monthly along with the rent. Tenants would be wise to insist on a cap on how much these costs can increase from year to year, with something like 4% being typical. Certain costs are outside of a landlord’s control, such as snow removal, and a wise landlord should demand that such costs not be subject to that cap.
Obviously this list is not exhaustive, and one particular term could be crucial to one business, and of no consequence to another. We work regularly with both landlords and tenants, drafting and negotiating their commercial leases. Give us a call today to help with your real estate needs!