“Few years ago, the commercial real estate market was a whole different market. It was more of a landlord’s market. Today, it’s all a tenants market,” – Andy Fried, lead consultant at Kennesaw State University Small Business Development Center.
A commercial lease is one of the most complex documents and many prospective tenants are often intimidated by the task of negotiating for one. However, things have changed a lot of late and a potential tenant today, carries a lot of leverage. It has always been true, albeit in principle, that anything on a lease can be negotiated. These days, it has become true in practice too. Negotiating for a lease puts you in a great position to get a decent deal.
Even if you have strong negotiating skills, it is not advisable to do it alone – get a skilled broker. The broker is important because he has the knowledge of what incentives the landlords in your region have been offering so as to lure tenants. However, most brokers tend to have conflicting loyalties, and that is why (in addition to the broker) you will need to get a lawyer who has specialized in commercial real estate. The lawyer knows every detail of the contract because; he is the one who has written it after all.
How to negotiate a lease
- Set the terms
The first thing on your to do list is usually negotiating the duration of the lease and the amount of rent that you will be required to pay. Generally, the rent is calculated per square foot. Normally, all leases feature a clause giving the tenant an option to renew the lease at the end of the period of lease, at either the prevailing market prices or a specified rent.
Experts usually advice small business tenants to take the lease with the shortest term possible – typically one year – but with many one-year renewal options. It is not automatic that the rent has to increase with each option to renew – you can negotiate this with the landlord. Short term leases are very advantageous as they ensure that your business will not remain tied up in a space if things don’t go as planned. It also ensures that if things go so well that you may need a bigger space for your business, you can end your lease without any hiccups. On the flip side, most landlords are unlikely to grant concessions to tenants who are unwilling to commit for a longer lease period.
The concessions are increasingly substantial for those who are willing to take longer leases. Landlords have figured out that it takes as much as one year investment to set up a new tenant. This investment is spent on broker commission and the lessee on things like renter improvement, build-out allowance, and free rent. That is why they prefer giving concessions to tenants taking longer leases.
Commercial properties are normally valued according to the rental rates per square foot in lease contracts. This is the reason why landlords prefer to hold tight on contracted monthly rates even as they offer refunds off the monthly rent. To you, a deal is a deal; its structure should matter less.
“Measure the space before you sign a lease,” advises Annette Cooper, an agent with Keegan &Coppin in Santa Rosa, California. “Spaces have sometimes been configured three or four times, and often they’re going off an old floor plan that’s not accurate.”
- Mind the extras
The extras include:
- a) Expenses – in one way or the other, the landlord will always pass on the expenses to you, the tenant. In a triple net lease, the landlord bills for insurance, taxes, and common area maintenance (CAM). The expenses are shared among renters according to the amount of space they occupy. CAM includes upkeep for shared facilities like restrooms, stairwells, lobby, parking lot, among others. Be aware of the type of expenses your landlord wants included in the bill, especially as part of CAM. Ensure that you are given the right to see the expenses budget and the actual costs incurred. Like expenses, utilities are also paid for by the renters. In shopping centers, tenants pay for their individual utility bills, while in office buildings, these bills are apportioned per square footage occupied.
By contrast, a gross lease includes everything. This type of lease typically passes on yearly increases in expenses. Either way, ensure that in the first twelve months of your tenancy, your expenses will not increase.
- b) Maintenance and repair – other than the parking lots, exterior walls, and the roof, the tenant will be responsible for other maintenance and repairs. Some landlords will require tenants to replace failing equipments such as air conditioning, ventilation, and heating systems, which may require a huge amount of money. If the building is 10 or more years old, ask for these systems to be inspected. You should also ask for an inspection of the electrical and plumbing equipment. If the inspection reveals problems, make sure you negotiate. Remember, if a tenant raises the issue, it is always flexible.
- Include an escape clause
Leases favor the landlord almost all the time. However, you can come up with clauses that will ensure a level playing field. Experts advise that you should be strategic in setting your priorities. “I try not to make whole sale changes because they are not likely to be accepted. I’m more concerned with making four or five important changes than 20 small changes,” advises, Rick Gier, a lawyer in Overland Park, Kansas.
Some of the important clauses you should think of including are:
Co-tenancy – most shopping centers depend on big anchor stores to attract traffic. So, it is a no brainer that the smaller tenant will suffer incase an anchor store closes shop. This is why you should come up with a co-tenancy clause. This clause will allow you to escape the lease, if no replacement for the anchor is in place within a specified period.
Personal guaranty release – landlords tend to always ask for a personal guaranty from the lessee. You can ask the landlord to include a clause that releases you from the guaranty after 2-3 years.
Exclusivity – this is an important clause because it guarantees the tenant that no direct competitor can move into the same building.
Sublease – this clause allows the renter to sublet some space to a complementary business. For example, a salon may sublet some space to a massage business. A sublease is very important because it allows the lessee to turn his fixed costs into variable costs.
Guaranteed selling points – it is common for landlords to sell some specific rooms as spaces that experience a huge number of monthly visitors or high occupancy rates. Make sure that you get this in writing and demand for concessions in case the landlord falls a certain percentage -say 20%- below the targets.
Be careful when dealing with brokers
Just because you recruited a broker, it doesn’t necessarily mean that he is working for you. He may be working for the landlord because it is the landlord who pays the commission after all. Research has found out that in most markets, 5-6% of the entire lease value is shared between your broker and the landlord’s listing agency. When dealing with brokers, keep the following in mind:
Pay attention to your lawyer. When you have a great real estate lawyer working for you, he will recommend reputable brokers who will offer you advice in good faith.
You can trust but always verify. Small business experts advise that when it comes to negotiations, try not to depend heavily on your broker. Most brokers want to get the contract signed without complexities, and they will do anything to get this. Make sure that your lawyer checks all the contracts before you sign them.
Don’t do it alone. Despite the preceding point, carrying out the negotiations on your own will not save you extra money. The commission that would have been shared between your broker and the listing agent will just be given to the listing agent – all of it. In addition, you could miss chances for getting concessions from the landlord.
Ensure that the broker you choose is experienced in your market. There are three major sections of commercial real estate – industrial, office, and retail. Each of the divisions has different market trends and issues. Therefore, it is good to get a broker who is experienced in the segment you are dealing with.
Keep your options open. There are some brokers who try to make you sign an exclusive tenant representation agreement. This is one agreement you should resist signing because if you do, your hands will be tied.