What You Need to Know about Commercial Leases
If you are a starting a new business that requires you to either lease office space or open a physical store where you can visit with customers, chances are you will be signing a commercial lease. Before you engage in the process of selecting a viable location that meets your needs, it is a good idea to retain the services of a commercial real estate broker that specializes in representing the interests of tenants (often referred to as a “tenant rep”).
Tenant reps are typically familiar with the available properties in your geographic location and have a firm grasp on the fair market rent for varying property types. Best of all, tenant reps are paid a commission by the landlord; so, essentially you get to avail yourself of the knowledge and skill of your tenant rep without cost.
Even though, many tenant reps are knowledgeable in handling the lease negotiations with the landlord on your behalf, it is still extremely important to have a real estate attorney review and amend, if necessary, the proposed lease in order to insure that your interests are protected. On a side note, I have spoken with many tenant reps that have told me they always suggest to their clients that they retain the services of an attorney—beware of any tenant reps that advise otherwise.
This article will briefly discuss some key provisions of a commercial lease that are important for landlords and tenants to understand.
Commercial Leases: 7 Key Provisions
1 – Basic Lease Information
Many commercial leases will have a few summary pages in the beginning, which may be referred to as “Basic Lease Information”, “Lease Information” or other similar name. These pages serve as a quick reference of the key terms of the lease such as: rent amount, address of landlord and tenant, term, security deposit amount, square footage of area leased, option period, etc. It is important to understand the actual start date of the lease–some leases may refer to this date as the “Rent Commencement Date” or “Lease Commencement Date”. If the space requires either the landlord or tenant to build-out the space to fit the tenant’s business needs then the actual start date of the lease will probably be a certain defined period that is related to the completion or substantial completion of the construction to be performed.
2 – Alterations, Fixtures, Improvements
Most commercial leases will prohibit the tenant from making any alterations or improvements to the interior and exterior of the property without prior approval form the landlord. Tenants should also be aware that the landlord will deem as fixtures any items or alterations that are affixed to the property, which are surrendered upon the termination of the lease. If you are tenant, you want to insure that any trade fixtures installed remain your property and may be removed upon vacating the property. Trade fixtures are equipment that a tenant specifically installs for the operation of his/her business. Since trade fixtures can be expensive, you want the ability to take all equipment with you when your lease is up.
3 – Assignment and Subletting
Commercial leases almost always require that the landlord give prior approval before the leased space can be assigned or subletted to a third party. If you are a tenant attempting to assign or sublet your space, it is essential that you read the language of your lease very carefully – typically, the lease states that the tenant is still fully liable for all rents even if the property is assigned/subletted to another party.
4 – Condemnation
Condemnation deals with a governmental entity acquiring ownership of the property. Some leases state that if all or any portion of the property is taken by condemnation, then the lease automatically terminates. Other leases provide that the tenant may remain in the property if only a portion was taken by condemnation, and the tenant is still able to utilize the remaining space without interruption in the tenant’s normal business operations.
5 – Defaults and Remedies
This provision of the lease is extremely important. It sets forth specific conduct or actions on the part of the tenant that trigger a default under the lease. Some examples include: failure to pay rent, the filing of a mechanic’s lien against the property as a result of tenant’s failure to pay for work performed, abandonment of the property by tenant, filing a petition in bankruptcy, failure to pay all required taxes, etc. The landlord’s remedies in the event of a default are also clearly defined.
Tenants should pay special attention to a “Confession of Judgment” clause. In some states, a Confession of Judgment clause permits the landlord to go to court in the event of tenant’s default and obtain a judgment of possession to take back the property without any prior notice to tenant. This essentially speeds up the process for the landlord to regain control of the property if the tenant has defaulted under the lease.
6 – Attornment and Subordination
In this provision, the tenant agrees that the lease and all of tenant’s rights under the lease are subordinate to the rights of any mortgage, deed of trust or other security instrument constituting a mortgage upon the property. If a mortgagee (such as a bank or other lender) comes into possession of or acquires title to the property, the tenant agrees to “attorn to” or essentially recognize the mortgagee as the new landlord. Under this scenario, all terms and conditions of the lease remain in effect.
7 – Additional Rent for Taxes, Common Area Maintenance and Insurance
Most commercial leases require tenants to cover additional expenditures associated with the property, and classify these costs as “additional rent”. Tenants should pay particular attention to these expenses in calculating monthly and yearly payments owed to the landlord. It is quite common for landlords to require that a tenant pays for a portion of the real estate taxes on the property, the costs of maintaining the common areas (hallways, stairways, elevators, lobbies, bathrooms, parking lots, etc.) and the commercial liability/property coverage insurance on the building.
Article Resource: Bigger Pockets