Leasing a retail or commercial space to start up a new business requires a significant investment of money and time. Regrettably, many new business owners speed through the leasing process and discover later the harmful lease provisions to which they had unknowingly agreed. The following are some of the important lease provisions and issues that should be identified and carefully negotiated:
- Rent Commencement Date: In leasing commercial space, the tenant often needs time to complete construction and tenant improvements from the date that the lease is signed. In most situations, a tenant should be provided a reasonable period of time (i.e. 90 to 120 days) to complete such improvements. The tenant should negotiate a reasonable term and confirm in the lease that the tenant is not obligated to pay rent during this construction period. Leases may often provide that Base Rent is abated during the construction period. This means that the tenant is still required to pay NNN expenses (i.e. tax, insurance and maintenance charges). Tenants should seek to abate all Rent, including NNN expenses, during the construction period.
- Tenant Improvements: When tenant improvements are required, a tenant improvement allowance should be requested to help pay for necessary construction or remodeling.
- Common Area Maintenance Fees: In addition to rent, a commercial tenant pays a share of the maintenance fees for the shopping center or office building. The fees are generally calculated based on the pro rata occupancy percentage of the tenant. Some points to consider are: (1) imposing a cap on the annual increase in CAM charges, (2) including a right to audit CAM charges, and (3) when calculating CAM, exclude certain charges such as landlord’s administrative overheard charges, landlord’s reserve account payments, and other unreasonable charges.
- Amortize Capital Improvement Charges: If the landlord decided to build a parking garage or replace the roof during the last year of the lease, you would be required to pay your pro-rata share of the entire expense even though your tenancy will be expiring soon. For such reasons, and also to avoid significant increases in CAM charges when capital improvements are made, the lease should state that capital improvement expenses should be amortized over the useful life of the improvement which would significantly decrease the expense payable by the tenant for such costly capital improvements.
- Gross-Up Provision: Tenants are required to pay pro-rata NNN expenses. If there is a 50% vacancy in the shopping center, each of the remaining tenant’s NNN expenses may nearly double since the same expenses would then be payable by a fewer number of tenants. A gross-up provision should be inserted stating that tenant’s pro-rata payment will be calculated as if the shopping center is 100% occupied regardless of the actual vacancy rate.
- Co-Tenancy Agreements: The success of many smaller retail tenants is dependent upon the amount of traffic generated by anchor tenants in a shopping center, such as a supermarket. With a co-tenancy agreement, you would have the right to terminate your lease or trigger a pre-negotiated reduction in your rent in the event that anchor tenant vacates the shopping center.
- Exclusivity Clause: The placement of a competing business in the same shopping center will likely decrease your sales. To protect sales revenue, obtaining an exclusivity provision would ensure that no other competing business will be permitted in your shopping center.
- Personal Guarantee: Although personal guarantees are required by most landlords, the nature and scope of the guaranty may be negotiated. For example, the guarantee may be limited to the first 5 years of a 10 year lease, or the extent of the personal guarantee may be reduced by 10% each year so as to reduce your personal exposure.
- Lease Transfer: Unreasonable limitations and restrictions to the tenant’s right to assign or sublease must be removed or minimized. It is crucial to state that the landlord will not unreasonably withhold, delay or condition its consent. Otherwise, a landlord may deny your request to assign your lease, thereby effectively restricting your ability to sell your business.
- Options to Extend Must be Transferrable: Many standard form leases state that options to extend are personal to the original tenant. This means that even if the landlord authorizes the assignment of the lease to your buyer, the option to extend the lease term does not automatically transfer to the buyer. Such a situation may significantly impede the ability to sell your business.
- Relocation: A relocation provision allows the landlord to relocate your business from the current location to some other less desirable location in the shopping center. These provisions often allow the landlord to pay nominal relocation costs to the tenant. If the landlord will not remove the relocation provision during lease negotiations, then the tenant should attempt to negotiate and identify the specific spaces in the center to where the tenant may be relocated. The tenant should also reserve the right to terminate the lease if the tenant is not satisfied with the proposed new space or the terms of the relocation.
The guidance of an experienced real estate attorney may help tenants to avoid the significant consequences of harsh provisions lurking in many leases. Since many of the above identified terms should be negotiated at the letter of intent stage, the best time to consult with an attorney is prior to finalizing the letter of intent. For tenants who are purchasing a business and therefore assuming an existing lease, it is equally important to have an attorney review the lease as the existence of certain provisions may impact the value of the business being purchased.
Kenneth W. Chung is a Managing Partner with Kring & Chung, LLP‘s Irvine, CA office. In addition to his extensive experience in handling both real estate transactions and litigation, Mr. Chung has maintained a California real estate broker’s license for over 26 years. He can be contacted at (949) 261-7700.