Landlord and Tenant Negotiations for Commercial Leases
When you are starting your small business, you may be working out of our home, which is all too common in the post-pandemic era. As your business grows, you may need a physical location either because you are a retail business, or because you need a central place for employees to gather, or possibly simply because you like working in an office. This article highlights some of the major issues that will be the subject of negotiation for a commercial lease between a landlord and a tenant.
Who has the bargaining power?
As an initial matter, each side should figure out who has the negotiating power. If you are a small business and looking to lease a small office in a large downtown office building that has few vacancies, you are likely not have much to negotiate. The landlord will simply say, “Here’s the lease and sign on the dotted line if you want to move in.” Your small business attorney may want to educate you on the effect of various lease provisions before you sign, but in the end you won’t have very much to negotiate with the landlord.
On the other hand, if you own a restaurant and are looking for a retail space in a building that has long been vacant, which is basically anywhere in any downtown area in the past couple of years, then you are going to want major concessions in rent, tenant improvements and other issues from the landlord. These issues are discussed in this article.
Rates per square footage: what constitutes a square foot
Most folks have an understanding of dollars per square foot and all of the major websites advertising lease spaces will give you a figure. That is well and good except that there are different norms for measuring the leased premises. For example, rent in an office space may be calculated on the “rentable square foot,” which include square footage of the leased premises, but also some allocation for common areas. For other spaces, there may be a question of whether you measure from the outside of the walls or from the inside.
In some parts of the country, it is typical to designate the leased premises and then say “approximately x square feet.” In other words, you are renting by the pound and if you are off on the square footage, you don’t have to go back and adjust the fixed rent for the space.
Gross versus net leases
Another major consideration in determining the lease amount is the kind of lease. In general, there are three different kinds of leases: triple net; gross; and modified gross.
A triple net lease means that the tenant pays not only for the base rent, but also real estate taxes, operating expenses and insurance. Strip mall space is a good example of space usually rented triple net. A gross lease includes in the rent the estimated real estate taxes, insurance and the landlord’s operating expenses. A warehouse lease is often rented on a gross basis.
A modified gross lease means that the tenant is responsible for the base rent and sometimes increases in operating costs, real estate taxes and base rent.
Rent concessions: are you going on holiday?
You still may not be comparing apples to apples when you are comparing spaces. In this environment, many landlords are offering rent holidays. A rent holiday simply means that the tenant does not have to pay rent for a period of time. The length of a rent holiday typically depends on the length of the lease; the longer the lease, the longer the holiday.
Lease terms and renewals
In general, the landlord will want a longer term lease and will offer more concessions for a longer-term lease. But in some cases, especially when there may be an uncertain future (the landlord plans to demolish the building) or where the tenant base is unstable (a lot of tenants moving in and out), the landlord may prefer shorter term leases.
The tenant may want to request an option to renew, especially in retail spaces where the location is critically important. If a tenant is selling its business, one key consideration will be whether the new owner can assume the lease.
Related article: Selling a Small Business: Not as Easy as you Thought
Another major concession may be whether the landlord grants the tenant any concessions for tenant improvements. A tenant improvement can be relatively minor like putting up some drywall or carpeting a space. but for other tenants, usually retail tenants such as restaurants, the tenant improvements may be extensive and expensive.
Part of the lease negotiations will be who pays for the tenant improvements, who controls the tenant improvements and what happens if the tenant improvements run over budget.
Purpose: permitted uses
The landlord may want to impose a narrow purpose on the tenant, depending on the nature of the lease. There are different kinds of leases such as office leases, industrial leases and retail leases. If the tenant is leasing a space in a mall, you can expect that the landlord will want to impose a narrow purpose as the mix of tenant uses is central to the success of the mall. On the other hand, if you are renting a storage space, the landlord may not be as concerned about what you are storing so long as it is not a hazardous product.
If you are the tenant, your purpose may be to minimize your risk. What happens if you go out of business? In general, for a new business, the landlord will require some kind of guarantee from the owners of the business or a third party against whom the landlord can proceed if the tenant defaults on the rent.
The terms of the guarantee will be a subject of negotiations. How long should the guarantee last? It could last for the entire term of the lease (good for the landlord, not the tenant) or some shorter period of time. Some tenants may be able to negotiate a maximum limit on a personal guarantee, depending on the bargaining leverage of the parties.
If you are the landlord, are you required to mitigate your risk and try to lease the premises after a tenant does a midnight move-out. Does the landlord have to try to find another tenant, or can they sit back and go after the tenant for the entire lease term rent?
In some parts of the country, tenants may be successful in negotiating a “good-guy clause,” under which so long as the tenant vacates the premises and returns them to the landlord in good condition, then the guarantee expires when the tenant moves out—usually the guarantor may still responsible for the rent before the tenant vacates. Why would a landlord agree to this provision? Because in some parts of the country it can take many months to evict a tenant, even if the tenant is many months in arrears.
For many small businesses, the lease is an important lever of success for the business. The rent will be a major part of the company’s expenses. The selection of the space and the negotiations for a lease will likely determine the success or failure of the business. We have reviewed the most important terms in a lease, but there are many others. Even if you do not have much leverage in the negotiation, you should consult with your small business lawyer to assure that you understand your responsibilities and your risk factors in entering into a lease.