Protect Yourself From a Commercial Lease Ambush
While residential leases are subject to many consumer protection regulations to protect people from unscrupulous landlords, commercial leases are the wild, wild west. The parties are presumed to have equal bargaining power, so the law doesn’t have many protections for the tenant.
A lease can be one of the largest expenses and most permanent commitments for a small business. Often the business owner is more concerned about location and the price per square foot than other issues in a lease that can significantly impact the bottom line and success of the business.
In case this is your first time at the rodeo, here are some ways to avoid an ambush:
Initial Term. Often, commercial leases are a minimum of 5 years with options to renew for additional time. Be aware that tenants are often responsible for the rent through the entire term, even if they go out of business. Having five, three-year terms gets you to a 15-year overall term, and may be less risky than three, five-year terms for a startup. Make sure you know how the rents will be increased during the term and during additional terms, and consider negotiating the increases up front.
Renewal Terms. Sometimes, it is necessary to make sure you will be able to occupy the space for a long period of time. If you are a franchise or have a business loan to help start your business, you probably want the overall term to match the term of the franchise or loan. If you are a restaurant or other business with a lot of equipment and upfitting, you will want to make sure you have the options to renew for many years. Make sure you understand how the renewal process works, and whether there is any chance the landlord has the power not to renew.
Rent. In addition to a monthly rent, most commercial leases charge additional rent for administration, maintenance, tax and insurance costs (often known as CAM). Some leases, especially for restaurants and retail, call for the tenant to pay a percentage of its revenues as well as base rent. Make sure you understand what the rent is, and how rent increases will be calculated.
Personal guaranty. A personal guaranty is a promise to personally pay the debt of your company. This means you are personally liable if the rent is not paid, even if the tenant is a limited liability company or corporation. Sometimes the landlord has the right to come after the guarantor directly without trying to collect from the tenant. Sometimes the personal guaranty can be negotiated away, but usually not if you are a new business with no credit history and no track record.
Use. Some commercial properties will grant tenants monopolies on a type of business — known as exclusive use. Make sure you know what exclusive uses are in your shopping center and make sure you don’t have overlap or plans for expansion that would overlap. Other properties might have additional restrictions, such as no alcohol sales or no business on Sundays. It is important to know this before signing a lease. Make sure the property is zoned for your use. Can you hand out flyers or have a mascot on the sidewalk? Are there required hours you have to be open?
Maintenance and repair. A commercial lease may require the landlord to maintain the roof and exterior walls — and that’s it. A commercial lease may require the tenant to have an HVAC maintenance contract and be responsible for all repairs, maintenance and replacement of the HVAC System. Tenants may be responsible for repair or replacement of the front window. Read these sections very carefully to understand what you are responsible for. Try to negotiate a cap on repair fees in a given year for big-ticket items like HVAC, electrical or plumbing repairs. Is the tenant responsible for any plumbing disaster in the leased premises, even if it was caused by a neighboring tenant? Always get the property inspected prior to signing the lease, so you’ll know what condition the property and equipment is in.
Experienced Real Estate Attorney. There are dozens of other provisions that impact your bottom line. Before you conclude you cannot afford an attorney to review the lease, multiply the initial term by the monthly total rent. Figure that you might be personally liable for that amount if the business fails or something goes wrong (such as you are 100% responsible for the roof or the HVAC failing, or if the anchor tenant closes, you have no recourse despite the dramatic drop in foot traffic). Remember that the tenant and/or the guarantor can be liable for all the rent of the term and the landlord does not have to try to re-let the space. The lease document could impact the next 5-20 years of your life.
An experienced real estate attorney may be worth her weight in gold.