Are you a business owner or investor who is considering leasing commercial property? Whether you are securing your very first space to launch a business, expanding into a second, third, or more location, or investing in a commercial property, entering into a commercial lease agreement can be an exciting time for any business owner or investor.
That being said, commercial real estate leases, like all investments, carry a fair share of inherent risks. Negotiating particular conditions that secure your investment from unnecessary exposure and the unforeseen financial implications that can come along with that can go a long way in creating confidence and clarity in your investment.
Go into your commercial lease agreement with your eyes (and understanding) wide open with these 5 tips for commercial real estate lease success.
1. Negotiate the Letter of Intent
In commercial real estate, a Letter of Intent (LOI) is a preliminary version of the full commercial lease agreement that will be presented after parties have agreed to the basic terms. It lays out the primary economics and deal terms between a tenant and landlord and gives both sides an opportunity to negotiate and iron out those major points of the deal. Although it is not the final agreement, the terms of the final agreement are effectively agreed upon within the LOI. So, it’s important.
Do not negotiate your LOI on your own. Engage an experienced broker and attorney to assist in negotiating this critical component of your commercial transaction. There are so many consequential terms on the table that you need to consider and ideally, have agreed upon in your favor. Renewal options, exclusive uses, operating expense caps, HVAC caps, and much more should all be weighed and considered.
Investors or business owners that go into commercial leases without the help of a qualified broker and attorney will often learn the hard way that they could have gotten better deal terms if they had these critical players in their corner.
2. Analyze the Rent Table Chart
A rent table chart (or rent roll) is a compilation of data that shows a prospective investor or tenant all of the existing rent data on a piece of commercial real estate. It details all of the existing tenants on the property, what they pay in rent, and when their leases will expire, among other things.
The primary purpose of reviewing and understanding a rent table is to gain a clear understanding of the future income potential of the property you are considering leasing. So, once again, this is critical information that needs to be thoroughly analyzed and understood.
Have your attorney or broker run these numbers to ensure that the income potential you hope to achieve is actually possible given the current tenant landscape. Further, do not assume that the data presented is accurate. Have your attorney or agent confirm that they are, in fact, true.
3. Ask for an Operating Expense Cap
A quick way to get upside down in a commercial real estate lease is through operating expenses. Thankfully, your attorney or broker can negotiate protections for you within the lease. Always ask for an operating expense cap. This limits the maximum amount operating expenses can be increased by the landlord year over year.
Although it may seem a fairly simplistic consideration, operating expenses are a very nuanced and detailed factor in your commercial lease agreement. There is a bit of subjectivity in this area of commercial real estate. With so many variations in contract language, the risk for error or omission is high, even when dealing with an experienced and conscientious landlord.
Your attorney and broker will have the experience and knowledge needed to drill down into this part of the agreement. Typically, they will shoot for a 4-6% cap, but that can vary based on the totality of the terms involved.
4. Request a Lease Audit
This recommendation is tied to the operating expenses discussed above but adds another layer of protection that can be very valuable before entering into the lease agreement. The fact is, sometimes a landlord will refuse to include an operating expense cap in the agreement. After all, the landlord is attempting to protect their investment as well.
As discussed above, the risk of error when it comes to operating expenses is inherently high. Given that, if your potential landlord refuses to accept an operating expense cap, you want to ensure that, at the very least, the data you are getting is accurate. This eliminates the risk that you are being overcharged, which impacts your bottom line in the investment.
An auditor will perform the lease audit, taking a deep dive into the financials of the entire commercial property. In the end, the audit may reveal mistakes or misreportings that would, could, or already have cost you, as the investor, thousands of dollars or more. If mistakes are discovered, the audit gives you a data-supported opportunity to ask for a reconciliation.
5. Specify HVAC Terms
Anyone who has had the great misfortune of dealing with an HVAC system that putters out in the middle of August can relate to this important provision. HVAC problems make business operations uncomfortable or downright impossible. On top of that, the costs associated with just repairing an HVAC system can be high, much less having to contend with replacing one. For these reasons, you should always ask for an HVAC cap in your commercial lease agreement.
Typically, landlords will push off all maintenance, repair and replacement obligations for the HVAC unit that serve the premises to the tenant, and that is fine. However, you, as the tenant, do not want to get stuck with a hefty bill for a replacement of the HVAC unit when you’ve just moved in. Asking for an HVAC cap limits the amount of money that you will be responsible for per calendar lease year during the lease term (such as $1K – $1.5K), which is a valuable protective condition that you should have your attorney or broker negotiate into your commercial lease agreement.
Before you enter into a commercial real estate lease, consider these five tips carefully with the counsel of a qualified commercial real estate broker and attorney. In the end you will feel more confident and gain security and clarity in your investment.
If you need help negotiating a commercial real estate lease, NC Planning’s business planning team can help. Contact us today to set up an intro call.
