Signing a commercial lease agreement is a big deal for most business owners.
Not only is the business assuming considerable financial obligations as the tenant, but it is extremely probable that the business owner will have to personally guarantee some (if not all) of these obligations. If the business owner is unable to, the implications may be disastrous.
I didn’t mean to scare you.
I just wanted to stress the importance of advance planning when it comes to reviewing and negotiating a commercial lease on behalf of a business owner. A minimum amount of planning can save you and your client countless headaches, and money, down the road. The most important time to consider future contingencies regarding a commercial lease is during the contract review and negotiation process.
This is a relatively short list of issues to consider when reviewing and negotiating a commercial lease agreement on behalf of a business owner/tenant.
1. Personal Guarantee (PG)
Most landlords will require a corporate tenant to have a personal guarantor in case the tenant cannot fulfill its obligations under the lease. I have seen people’s lives financially ruined by personally guaranteeing commercial leases.
To mitigate the risk to your client, make certain to negotiate away from signing a blanket guarantee, which means that you cover all of the obligations under the lease. If the tenant is paying $3,000/month on a 5-year lease, it’s a $180,000 minimum commitment. With CAM (see below), taxes, and additional expenses, it may be well over $200,000. In other words, it’s not something to be taken lightly. The best option is no personal guarantee.
Thereafter, attempt to negotiate to a certain dollar amount (cap) or time period. A good option is the Good Guy Clause (GGC), which has the business owner guarantee the lease obligations only until the tenant surrenders the premises to the landlord (as opposed to until the end of the lease term). So long as the tenant is not otherwise in default under the lease and gives a certain amount of notice to vacate, the guarantor is responsible only for that time period until the business vacates the premises.
A GGC is a win-win for both parties because the tenant will be off-the-hook once they surrender the premises and the landlord will avoid litigation and obtain immediate possession of the premises, thereby being able to rent it to another tenant.
2. Common Area Maintenance (CAM)
If your client is leasing a portion of a structure (e.g., office in an office building, store in a shopping center), they will be liable for an allocation of the overall operating expenses of the property (CAM), in addition to base rent. Therefore, just because the rent is $2,000/month, don’t think that the only obligation is $24,000/year. As those television infomercials say, “but wait, there’s more…”
To calculate CAM, divide the square footage of the tenant’s space by the total square footage of the property. If the tenant’s space is 3,000 square feet of a 100,000 square foot shopping center, the tenant’s pro rata share will be 3% (100,000/3). If the landlord projects that Year 1 charges are $100,000, your 3% share of the CAM payments is $3,000 for Year 1, or $250/month. That’s an additional 12% on top of your base rent, and it will increase annually.
It’s extremely important that you maintain some flexibility to sublet or assign the lease in the event of a business downturn. Of course, the landlord will want approval over who takes over the lease, their primary concern being that the rent will be paid. At a minimum, you should try to maintain the right to assign/sublease to a related entity, such as a parent, a subsidiary, or affiliate, without the need for landlord consent.
4. Use Restrictions (Exclusivity)
How’d you like to open a pizza store in a shopping center only to find another one open up in the same shopping center? This may be avoided with an exclusivity clause. Every commercial lease should include a use provision, which states the tenant’s intended use of the premises. In many retail and food service businesses, it is extremely important to be the exclusive tenant (in the shopping center) selling particular items, for example, pizza. Make certain that the exclusive use is well defined. For example, if you operate a bakery, the exclusive use shouldn’t say “operate a bakery,” but should provide that you will be the sole tenant permitted to “sell specialty cakes, cookies, pastries and other baked goods, coffee, non-alcoholic beverages and associated paper goods for on and off-premises consumption.” This broadens the usage and will prevent other tenants from selling similar products.
Did you ever notice buildings with company names on them? This doesn’t mean that these companies own the buildings. It’s likely that they are major tenants of the buildings and have negotiated signage rights. The visibility of your client’s business (office, retail, etc.) is extremely important (if they want their business to be found). If the tenant’s business is in retail, you must verify the location of the signage. This not only includes the sign above the tenant’s store, but on the pylon sign – that large sign near the entrance that lists tenant names. Shopping centers always have specific criteria regarding sign type, color, font, size and location. You will need to understand and/negotiate these matters in advance.
There are numerous other considerations, however, this list is a good springboard by which to begin negotiations of a commercial lease.
The most important thing to keep in mind is how to minimize your client’s downside risk in the event of business failure. Leasing commercial space should enhance a tenant’s business, not drag it down.
Author: Neil Greenbaum