Negotiating Commercial Leases & Renewals For Dummies
Knowledge is power, they say, and it's as true in commercial lease negotiation as anywhere else. Landlords deal with leases all day long — they have the knowledge. Many tenants are unskilled in what and how to negotiate leases and may be uninformed about the details of their lease, even if it's a renewal. This lack of knowledge can come back to haunt them in numerous ways. Roll up your sleeves and get informed — the decisions you make during lease negotiation can profoundly affect your bottom line. And remember: Everything is negotiable.
Questions to Ask Before Searching for the Perfect Commercial Building
If you're thinking of starting your own business, or if you're getting ready to change locations for your current business, you're probably anxious to get out the door and start looking at some properties. But rushing into a new location is one of the worst things you can do. You might get incredibly lucky and end up in the right place with the right lease terms — but you're more likely to land in an unsuitable location or sign a lease whose terms will make you miserable for the next five years.
If you're starting a new business, sit down with a pad of paper or a new document on the computer and begin thinking about the following factors that will impact where you look for commercial space:
How much can I realistically afford to pay for space? There's no point in looking at sites that are way over your budget, no matter how perfect they might be. And if you haven't started your business yet, it's difficult to project exactly how much you'll actually earn. It's better to underestimate than overestimate your earnings at this point. For retail businesses, expect to pay 10–15 percent of your projected gross sales on rent and operating expenses.
How much space do I actually need? If you're not going to be meeting customers at your location or storing inventory there, you might need little more than a broom closet with a desk and a chair. If you're selling tractors, you need a little more space, both inside and out. If you can afford it, plan to lease a little more space than you think you need now, so you don't have to move the minute your business begins to take off.
Where do I want to be? For some businesses, location is everything. If you're opening a retail shop, where you're located can make or break your business. If you're running a boiler room operation, it probably doesn't matter where you're located.
Your location is more than geographic. In a shopping center or mall, the availability of parking, the ease of getting into the complex, and your location relative to other stores are all very important factors.
Should I look at undeveloped properties? Sometimes getting in on the ground floor of a building that hasn't been built yet is a good thing; you may have more leeway in tailoring your space exactly the way you want it rather than having to work within the confines of the existing design. But it's much easier to visualize when you have something concrete to look at. And if the building's already finished, you know exactly what you're getting. And you know the building actually exists — something that might not always happen with undeveloped properties.
If you're moving an existing business to a new location, your list of questions might be slightly different. After all, this isn't your first rodeo. But even veteran renters can make mistakes, so take a few minutes and ask yourself a few questions:
Why am I moving? This might seem like a no-brainer, but writing down not only the big reason why you're moving — such as you've outgrown your space, but also all the little reasons why you'd like to move, such as a lack of an executive washroom — can help you focus on exactly what you want in your new place.
What benefits do I hope to gain by moving? Although "increasing my bottom line" is always a good answer here, there are undoubtedly others. Are you looking to shorten the commute for your workers? Draw in a higher-class clientele? Locate near businesses that will complement yours and pull in customers that will seek out your type of business?
What's my least favorite thing about my current location? If the answer is the landlord, then obviously you don't want to look at any other properties they own. If you love your location, but getting into your complex requires a left-hand turn off a busy street, which drives both you and your customers crazy, then look at properties on the other side of the road.
What's the best thing about my current location? If there are things you really like about your location, it pays to try and duplicate them in your new spot. Do you really like being on the ground floor because you're afraid of heights? Or do you love looking down at the city from the 25th floor? Is a building with restaurants nearby important, or can you and your employees brown bag it?
What kind of space configuration and basic square footage do I need? One advantage to already being in business is that you know what works and doesn't work with your current setup. Maybe you overestimated or underestimated your needs in your present building. You found out you really need a few more restrooms and a bigger kitchen area for employees. You know whether you can work in an oddly shaped space or if you really need a large open rectangle. Although space can be refitted to some degree to suit your needs, the basic shape and usable square footage is hard to change.
When do I need to move by? Coordinating the move of an existing business between two buildings is more complicated than moving into a building for the first time. Consider the impact of downtime while you move your business and the terms of your existing lease to help you figure out how much flexibility you have in your move date. If you love a certain property, but it won't have available space for six months, can you work with your current landlord to stay where you are until you can move into the new property?
Clauses to Make Sure to Get into Your Commercial Lease
When you're negotiating your commercial lease, there are a few things that should absolutely be in there. Including all of the following items in your lease is strongly recommended:
Corporate entity: If you've formed a separate corporation for your business, it is critical that this entity be identified as the "tenant" in all documents. You typically form a corporation for legal protection and accounting/tax benefits. Without your corporation as the tenant in the lease, you may lose all of these benefits and protections.
Renewal options: Although you may never truly exercise your renewal option but rather choose to negotiate each renewal term, you should have this safety net for your protection, especially if your location is critical or your business is difficult to move. It is also important to ensure that your renewal options are not personal to you as the original tenant because these renewal options may be extremely important to any potential purchaser of your business.
Assignment rights: Although almost every lease has some form of assignment rights, you must ensure that these are reasonable and allow you to sell your business and transfer the lease. Your assignment rights should permit you to transfer the lease, subject to landlord's reasonable approval, and outline the steps, including timelines to complete the transfer. You must also be cautious of existing language within this clause; in some cases, the wording allows the landlord to simply terminate your lease if you request an assignment or allows the landlord to remove renewal options or other terms for the new tenant.
Tenant inducements: Although this is a negotiable point, the vast majority of landlords are willing to and expect to provide free rent or tenant allowance to a tenant with a new lease. This isn't limited to tenants signing a new lease, but should also apply to tenants looking to renew their lease. Tenants often leave money on the table because they don't know to ask for these items or that they're common.
Signage: Visibility and exposure may be critical to a business owner. Signage is something that must be clearly defined in the lease agreement, especially pertaining to where you can have signage and what the costs are.
Parking: Parking is important to both you and your customer. Often, tenants assume that parking is something they can deal with later or that won't be an issue, but as with most things in a commercial lease, if it's not in writing, don't count on getting it.
Exclusives: Ensuring that an indirect or direct competitor doesn't move into the same shopping center can have a substantial impact on your bottom line. Not only is it important to include such language, for many tenants, the exact wording of the language can make all the difference.
Clauses to Be Apprehensive About in Your Commercial Lease
Just as it's important to include certain key terms in your lease, you must also be cautious about what terms are in the lease to begin with and how they may affect you. You may want to remove or adjust some of the following items:
Holdover: This provision indicates how much the landlord can increase your rent should you stay past any expiration date of your lease. This may never come into play for many tenants, but there may be situations in which you must remain in your space an extra couple months, and your rent potentially doubling or tripling during that time could be very costly.
Percentage rent: Some landlords require this extra rental rate for tenants, and it can cut a significant amount of money from your bottom line if you're not aware of how these numbers work. Percentage rent can be negotiated out of the lease entirely or modified to lessen the impact.
Radius restrictions: Opening up a second location? Not so fast. A landlord may have a unreasonable or large radius restriction preventing you from opening your second location as desired.
Demolition clauses: Does the landlord have the right to terminate your lease if they want to redevelop or demolish the building? This is the section you must look for to see what rights the landlord has and what compensation, if any, you would receive should the landlord demolish or redevelop the building.
Default clauses: This is the section of the lease with all the teeth. You need to understand what remedies and rights the landlord has in the event you default on the lease and determine if they're reasonable or not.
Relocation clauses: Many leases have relocation clauses that allow your landlord to move your business within the property. You need to pay close attention to the wording of this clause or it could turn out to be a costly scenario should it ever occur.
Five Lease Renewal Myths
Many tenants have preconceived notions regarding a lease renewal or how they typically work, and quite often these ideas are inaccurate or completely wrong. Some commons misconceptions include:
Exercising the option: Tenants often assume that you must exercise the renewal option in order to renew the lease. You absolutely do not have to exercise your option to renew, and in many cases you don't want to exercise your option because it limits what you can negotiate on for your renewal term.
Rents only go up: This is typically the landlord's point of view, and some option clauses indicate that your rent must go up regardless of what is happening in the market. In many cases, tenants are in line for a rent reduction, but because of how they handle the negotiation or by exercising their option, they see a rent increase instead.
Tenant allowance or free rent: Landlords often say free rent or tenant allowances are only for new tenants. But why should a proven tenant not get the same benefit as a new tenant? Tenants frequently overlook these financial incentives or are led to believe that they're not common or offered on renewals.
Additional lease provisions: A good reason not to exercise your renewal option is to address all other concerns on your lease. Whether it be parking, signage, improvements to the space, or simply adding more renewal-option clauses, your renewal is the time to deal with these issues.
False optimism: In some cases, it's not the terms of the renewal the tenant should be looking at but the renewal itself. If you haven't been profitable at your location for a number of years, perhaps it's time to consider a relocation or closing your business.