COMMERCIAL REAL ESTATE LEASE CONSIDERATIONS
October 22, 2013
By James Forrest
A couple of years ago when we launched our blog, I took this opportunity to address one of the most important areas of risk management for many clients—dealing with commercial real estate leases. I thought I’d take a few minutes to offer an update to that article, with some new considerations.
Most of our client base touches real property leases in some capacity; either as landlord or as tenant. Trusted advisors, including a commercial real estate broker and corporate legal counsel, can help entrepreneurs and executives to understand commercial real estate leases from multiple transactional and contractual perspectives. When working in conjunction with a company’s commercial real estate broker, a business attorney can become an effective advocate to ensure that not only are the pricing terms are amenable to the client company, but that many other aspects to these sometimes complicated arrangements work to the benefit of the business as well from a strategic planning and risk management perspective.
The first and often most important subject to tackle is the pricing in the lease agreement. In these types of commercial arrangements, prices can look more attractive than they actually are, since several parts of the lease are up for negotiation and factor into the overall pricing. In addition to price per square foot, which is typically based on the location and the amount of square footage on offer, utilities for the space, as well as offsetting the building’s owner’s tax, common area maintenance and insurance liability can come into play. Sometimes, landlords will request a percentage of the tenant’s revenues as part of the rent calculation.
Effective counsel can ensure that the pricing package works to the lessee’s advantage as much as possible, while being fair to the lessor. It’s important to understand the mechanics of pricing at lease inception, as well as how the contract calls for rent increases to be calculated upon renewal.
Speaking of renewal, another big consideration is the term of the lease and options to re-lease the space at the end of the initial term. On one hand, we help our tenant clients ensure that they have options to renew the space with a certain rental rate locked in. This is a huge value-add if the business does well in the space and the client wants to re-up – particularly, when the rental rate is favorable compared to market rates at the end of the term. On the other hand, however, often time tenant companies without proper counsel find themselves locked into auto-renew clauses that come into force at dates three to five years in the future (when the lease paperwork has accumulated dust in some file cabinet away from diligent eyes). Tenants with proper counsel can build in required renewal notices from the landlord that give them plenty of time to consider their options before any auto-renewals take effect.
For many types of businesses, especially retailers, issues surrounding use of the property are very important in lease considerations. Use issues can include considerations that can greatly impact the health of the business over the long term, both competitive and legal in nature. For example, an upscale men’s clothier may want to negotiate with a shopping center for exclusive use within the property in its particular market.
Other use considerations can include allowable times of day for operation (staying open past six in the evening, for example) or whether the location opens for business on particular days of the week, such as compliance with company regulations or public ordinances (also known as Blue Laws) regarding Sunday operations.
As with many commercial transactions, particularly for startups and businesses in growth mode in their early years, commercial landlords may aggressively seek to secure their leases with a personal guaranty clause from each tenant. Obviously, from a risk management standpoint, it’s always the desire to eliminate personal liability in a commercial transaction, but sometimes this is unavoidable in counsel’s efforts to mete out a lease that’s optimal for the tenant. In situations that ultimately require a guarantee from the business owner, business attorneys work to get the most favorable terms possible for the tenant, and help them to understand the ramifications of the personal guaranty clause if it’s invoked in certain scenarios.
Finally, from a risk management standpoint, counsel needs to work with the client to determine the responsibilities of the parties on a variety of sticky topics. Over the course of several years, topics such as compliance with law and building codes, maintenance and repair of the premises, and other general liabilities (such as parties getting injured on the premises, what happens in the event of casualty or eminent domain) can and will become someone’s problem. Our firm endeavors to assist our clients with respect to each issue so that they are not taking on any undue responsibilities.