Tuesday, August 22, 2017
Landlord/Tenant Issues to Explore in Negotiation
By Bill Siegel
There are a number of issues landlords and tenants should explore when negotiating a lease which, if addressed, may avoid pitfalls in the future.
Engage the Services of a Broker and Attorney
Whether you are a landlord or tenant, it’s important to engage a broker or someone within the organization of both the tenant or and landlord, who is familiar with market data, relevant information pertaining to the respective parties, and who has the experience necessary to offer meaningful assistance during the negotiation process. (Typically, the broker’s commission will be paid by the landlord.) In addition, it’s important to engage an attorney to assist in papering the deal, and to help the broker and attorney interface with one another as they bring different skill sets to the lease negotiations.
Commercial Lease Negotiation and Terms
When the parties are, in principle, interested in entering into lease negotiations, they should enter into a letter of intent. Though the letter of intent (LOI) is usually non-binding, such an LOI will help outline the specific economic terms that will form the basis of the lease. If the parties cannot agree on a letter of intent, at least they have not wasted each other’s time in lease negotiations. The letter of intent should lay out the basic terms of the lease.
Relevant Terms of a Commercial Lease
- Rent For the most part, there are two types of rent: Full Service and Pass Through which is usually triple net, sometimes referred to as NNN. Full Service means that the landlord will pay all of the expenses, often inclusive of taxes, insurance, and utilities. Triple net, on the other hand, means that the tenant pays its proportionate share of the landlord’s taxes, insurance, and utilities. If the tenant is paying triple net, typically, the tenant will have the right to request, or the landlord will be required to provide, a statement of the landlord’s calculations setting forth the tenant’s proportionate share. The tenant will then have the right to audit the landlord’s calculations to make sure the pass through expenses are not overstated. In some instances, the parties will negotiate a percentage cap on the annual NNN increases.
- Premises The “premises” is the exact location of the space and the area being leased. Rent will be based on either Rentable Square Feet (RSF) or Usable Square Feet (USF). RSF is greater in terms of square footage than USF, as USF nets out the "core factor" – stairwells, elevator banks, bulkheads, and columns. In other words, USF is the actual space that the tenant will have available for its operations.
- Default Provisions Frequently, before a landlord has the right to take possession of the premises because of a default, the landlord will be required to give notice of default. Some leases do not contain such a notice requirement and thus, from a tenant’s standpoint, it’s important to negotiate a notice requirement. Defaults can be broken down in terms of monetary and non-monetary defaults. Typically, notice of a monetary default with an opportunity to cure will require the default to be cured with within 5 to 10 days while non-monetary defaults will typically require 30 days’ notice to cure with the understanding that the 30-day time period can be extended if good faith efforts are being made to cure the default. Also, more often than not, a landlord will limit the number of times in a calendar year in which it is required to give notice of the tenant’s default.
- Term The term of the lease, i.e. its duration, inclusive of the right to renew, should be carefully considered. The parties need to take into account whether or not the business is new or established as well as the business’s future needs. Address whether rents will increase in the future. The lease should further take into account the time necessary to build out the space as typically, the tenant will not commence paying rent until the premises is ready for occupation. If the tenant is responsible for the build out, usually, the landlord will require the space be ready by a certain time so that it can start charging rent. If the landlord is responsible for the build out, then for obvious reasons, rent will not start until the premises is ready, but in some instances if the tenant needs the space by a certain date and the premises is not ready, the landlord may have to provide alternative space and be responsible for certain moving expenses.
- Security Deposit and Guarantees Typically, the lease will require a security deposit equaling one month’s rent and in some cases, will require the tenant to pay a security deposit equal to the first and last months’ rent obligation. In some instances the tenant will be permitted to obtain a letter of credit in lieu of a security deposit. Many times, the amount of the security deposit is dependent on the creditworthiness and operating history of the tenant. Credit-worthiness and operating history of the tenant also impact whether a guaranty from the owners is required. There are instances, too, in which the guarantees can be capped or reduced proportionally to the term of the lease.
- Improvement Allowance and Base Building Often, the landlord will provide for an allowance to fund the build out of interior improvements to suit a tenant's needs. Typically, the longer the term of the lease, the larger the allowance. More often than not, the landlord will recoup this allowance through incremental increases in the rent.
- Use and Exclusive Clauses If the parties are involved in lease negotiations in a shopping center or strip mall, the tenant will want to require restrictions in the lease to prevent competition. The larger the retail space, the more complex the negotiation of such exclusivity restrictions as the landlord will require greater specificity as to the extent of the exclusivity to ensure flexibility in leasing to other tenants.
- Assignment and Subletting The right to assign and/or sublet a lease can be important, especially in negotiating longer term leases. The tenant may desire some flexibility to assign or sublet to a succeeding user of the space in the event circumstances change. Additionally, the ability to transfer (sell) a business can be severely hampered if landlord consent is required to allow a successor entity to use the space for the remainder of the term. Generally, most assignments, if allowed, require the consent of the landlord. There are instances in which a lease will have a provision preventing assignment in the event a tenant files for bankruptcy protection. The bankruptcy code, however, allows for the assignment and assumption of a lease, provided that the landlord is adequately protected.
- Renewal rights The lease should provide for a renewal election and, if possible, a set rental rate. In some instances, the lease will simply refer to market value, a reference that could do nothing more than foster future litigation. If a renewal provision exists, the lease should establish a set date for the tenant to exercise its option to renew. Typically, the deadline to exercise the option to renew will range between nine months to one year in advance of the expiration of the term. This lengthy period gives the landlord the opportunity to market the premises and it gives the tenant enough time to locate alternative space.
- Parking Space If the tenant requires parking, the parties must be in a position to agree on exclusive parking rights for customers of the tenant if parking is limited. Care must be taken to ensure compliance with local regulations.
- Expansion right The right to expand is critical for tenants that may anticipate rapid growth, and/or want flexibility over a longer term. A failure to include expansion options may adversely impact a tenant if much needed expansion space is unavailable.
- HVAC and Roof There are instances in which the tenant will be required to service the HVAC and the roof. If so, the tenant should inspect the HVAC and roof, and figure in the cost of replacement or maintenance.
- Alterations Cosmetic alterations like painting should generally not require the landlord's consent. In other cases, the landlord's consent for non-structural alterations in the premises should not be unreasonably withheld, conditioned, or delayed.
- Environmental, ADA, Code compliance A tenant should ensure that the landlord is in compliance with all existing codes and regulations, local state and federal, and if not, negotiate this factor into the lease. The landlord should be in a position to warrant that it and the building complies with all such applicable codes and regulations.
- Rent Abatement for Interruption in Use If the building is partially or totally destroyed by fire or such other cataclysmic event, the landlord will reserve the right to either terminate the lease or rebuild with rent abatement within a specific period of time. The tenant, in turn will reserve the right to terminate the lease after a period of time. In some instances, the right to terminate by either side may be based on the extent of damage to the property. It is highly recommended that the tenant procure business interruption insurance. Such insurance is often required by the landlord.
It is advisable that the tenant and the landlord seek experienced brokers and attorneys to negotiate and paper the lease negotiations. Your attorney, in particular, being knowledgeable of the terms of the lease, will be in a better position to interpret the lease especially if issues arise between the parties later.
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