A key factor in the success of your business is how effectively you negotiate a commercial lease. This impacts your cash outlays over several years, your operational efficiency and, depending upon your type of enterprise, your revenue as well. Thererfore, it’s essential to take a comprehensive and methodical approach before signing a lease agreement.
Here’s how the way you negotiate a commercial lease impacts you in those three areas:
- Cash outlays: It’s not just the rent payment itself. It’s also the financial obligations you might also incur through the lease agreement, depending upon the lease type.
- Operational efficiency: If you quickly outgrow the space you rent and can’t do anything about it, your operations can become bogged down due to overcrowding, or the inability to add more staff or equipment to meet the increased demand for your products or services.
- Revenue: You might depend upon the convenience or visibility of your location to keep customers and draw in new ones. So, remember the old adage about the three most important criteria in real estate—location, location, location.
With those considerations and your business plan for the next few years, you can determine how much you can actually afford. Without some kind of multi-year rent budget in mind, you can’t make many other decisions. You don’t want to waste your time looking at places you can’t afford. And, you certainly don’t want to settle for barely adequate space without realizing you can afford more.
Assess Your Needs
Before you enter lease negotiations, make sure you take into account all the important considerations about the physical space itself. The hardest part involves making predictions. Consider, for example, local growth patterns in the community and any known big development projects (including infrastructure) in the works. Is the property you’re considering likely to be a more or less desirable location a few years from now?
Also, think about the tax and regulatory environment. Can you anticipate any changes that might make that jurisdiction become a more costly place to do business?
Once the location you like cleared that initial test, it’s time to focus on lease terms. Before you obtain a filled-in lease, it could be beneficial to ask the landlord for a blank one. That makes it easier to focus on all the variables and fine print you might overlook while going over the numbers.
What’s Covered in the Lease
Property-related costs addressed in the contract are the most basic thing to understand about a lease. For example, with a “triple net lease” – in addition to paying for the space itself – you’re responsible for the utilities, real estate taxes, insurance, routine upkeep and simple repairs. You’re on your own for everything except for major structural repairs (i.e. a collapsed roof).
With a “double net lease”, you pay for all of those items except maintenance and repairs. With a “single net lease”, you pay only for utilities and property tax. You might also find another kind of lease with a different cost-allocation formula.
None of these lease types is necessarily good or bad. When you negotiate a commercial lease, the more cost elements covered in the contract, the more exposed you are to cost increases – whether it’s in taxes, insurance or utilities. You can try to reduce that risk by negotiating limits on how much of a cost increase you’ll be obligated to absorb over the lease term. The more risk you take with these, the better the deal you’ll need to negotiate on the base rent.
Equally, or perhaps more importantly, is the length of the lease. How long are you willing to commit to staying at that location? Even if your lease allows you to sublet the property to someone else, you’re still on the hook for the rent. You’d assume the risk that whoever you sublet to will default.
Long Lease or Short?
Landlords generally prefer longer leases. It allows them to lock in a constant income for more time without trying to find a new tenant. Contrarily, the landlord might be willing to give you a better deal on the initial base rent. But, they might insist on having you responsible for the items you get in a triple net lease.
Still, what you want in regards to the length of the lease depends on the commercial real estate market environment. In a hot market, a landlord could push for a shorter term to raise the rent substantially.
Ten Lease Negotiation Tips
Here are ten more items to keep in mind when it’s time to negotiate a commercial lease:
Useable space
The number relates to space you can actually use when rent is by a per-square-foot basis. Things like elevator shafts, emergency stairwells and structural columns take up useable space. Measure the useable space and compare it to the number advertised. Minor discrepancies might be acceptable, but not big ones.
Sublease clauses
Insist upon finding another tenant to replace you to finish out the lease term if you need to move early.
Termination penalties
Perhaps you’ll want to break the lease without finding a tenant to complete the lease term. Try to keep the penalty reasonable.
Protection from competitors
If the landlord owns additional space nearby, include a provision that prevents the landlord from renting such space to a direct competitor.
Co-tenancy clause
This is the opposite of protection from competitors. If you chose to lease space adjacent to a “big box” store or a similar “anchor” tenant and you expect to draw foot traffic to your location, and that tenant leaves, you could suffer greatly. A co-tenancy clause allows you to break your lease in such a scenario.
Reasonable “cure” period
A “cure” period is the amount of time you’re given to catch up on rent if you’re behind – before incurring massive penalties or losing the lease entirely.
Certificate of occupancy
When space is used for something other than that for which the original building permit was issued, the landlord needs to obtain this document from local government. If you can’t move in until that document is obtained, protect yourself from paying rent during the time the landlord is waiting to get that certificate.
“Fixturization” period
Try to avoid paying rent during the time it takes you to modify the property so that it meets the needs of your business.
Utility costs
In the likely event that you pay the electricity, water, waste disposal and other utility bills, find out what you’re getting into. Ask to see a year’s worth of those bills from the prior tenant.
Parking rights
Does the landlord own or have access to a parking lot? If so, make sure you have enough spaces for employees and customers.
Finally, there are factors that can’t be pinpointed when you negotiate a commercial lease – whether it’s the responsiveness of the landlord when problems arise or possible issues involving neighboring tenants and their customers. For insights on those, you’ll need to do some research by talking to other tenants and spending time in the area observing its goings on.
When it comes to haggling over specific lease terms, you can get ahead by engaging a real estate attorney familiar with not only lease contract provisions, but local market conditions as well. That way, you reduce your chances of paying more than you have to. But as in any negotiation, expect to make some compromises to ensure not only that you end with an agreement, but set the tone for a positive long-term relationship with the landlord.
