As we make our way into a new year, and the economy continues to improve, I find myself preparing and reviewing more and more commercial leases.
There is always an adversarial relationship to some extent between the tenant and landlord. Generally speaking, the owner wants market rent, which increases over time while the tenant wants the cheapest rent possible, which is fixed over time. The owner desires to recapture all costs incurred in the ownership of commercial real estate including, but not limited to, taxes, insurance, common area expenses, and repairs. That is why so many landlords desire to find tenants willing to pay on a triple net basis. The tenant clearly has the opposite interest, and prefers only to pay rent without any obligation to pay for repairs, other than to its own space.
Often times the tenant and landlord will agree on what is known as an “expense stop,” where the landlord’s expenses top out based on given calendar year, e.g., 2017, or the first year of the lease term. Any expense over the expense stop period are passed on a pro rata basis to the tenant. That way, the owner can set her rent at a level sufficient to pay the expected historic expenses while still making a profit, and the tenant is only responsible for any unanticipated increase, such as taxes and insurance.
Another major issue owners and tenants must negotiate is a personal guarantee. Especially in a brand-new lease, most landlords will insist on some type of guaranty from one or more of the principals of the tenant. The guarantor may be able to negotiate a “burn off” provision whereby the guarantee only applies to the initial term, or even more beneficial to the tenant, agree to a guaranty that is reduced by one month for every month of rent paid. For example, in a five-year lease (60 months) every single month in which rent is paid timely reduces the amount of remaining term guaranteed by the tenant by one month. Therefore, by the 30th month, the personal guarantee has “burned off” and the tenant has the sole obligation to pay the remaining term of the lease and the individual guarantor has no further obligation.
Tenant fit-up allowances are another major issue which must be negotiated. The owner will either pay for the fit-up (and naturally “bake” them into the rental) or allow the tenant to perform their own fit-up. However, when the tenant is performing the fit-up work, it is important for the owner to protect themselves from the contractors working on their property. The best practice is to ask the tenant to obtain lien waivers from the contractors in advance so that in the event that th tenant fails to pay for the work, liens will only attach to the leasehold interest and not to the owner’s property. Of course, it is not surprising that many contractors will be reluctant to agree to do so on substantial fit-up work. To the contrary, Contractors who wish to protect themselves from the risk of non-payment may instead seek the owner’s consent as well as the tenant prior to commencing work, thus avoiding the argument altogether.
There are many other issues important to tenants including the right to signage, the right to sublet or assign the lease, parking rights, use of common areas, and especially in shopping centers, the right to exclusivity, e.g., ‘no other pizza restaurant will be allowed in the shopping center during the term of the tenants lease.’
Finally, it is imperative for both parties to calendar critical dates under a lease. Usually, the lease either automatically renews or automatically terminates 3 to 6 months before the end of existing term. Options to renew (or terminate) must be exercised timely, and both parties must ensure that they have accurately calendared these deadlines. Always remember that leases, like most written contracts, will be enforced according to their terms by a court. Thus, failure to read the lease and to comply with the terms will result in an adverse decision in the event of a dispute. Our attorneys at Kinkead & Stilz have several decades of combined experience in drafting and negotiating commercial leases for prospective landlords and tenants in Kentucky. We would be happy to help you with any of your commercial real estate needs today.