You’re in an enviable position if you’re a retail or industrial business in the Seattle Metropolitan area—at least when it comes to your occupancy costs. Commercial space exceeds demand in the local market and property owners are inclined to be accommodating.
On the other hand, if you’re a biotech company, you’ll find that office and lab space in Seattle is in very short supply. The cost of leasing space here is increasing and your ability to negotiate favorable terms is more limited. But that doesn’t mean you can’t gain important protections or concessions through negotiations.
The more you know about commercial leasing—and the more thorough your due diligence—the more likely you are to ultimately sign a lease that suits your needs, regardless of the market conditions.
Start by Reading the Lease Document
You’ve completed your research and identified a suitable property for your business based on such factors as size and location, general affordability, appearance, layout, proximity to transportation, zoning, visibility, prestige, parking, traffic and foot-traffic patterns, safety, and handicapped access.
Now you’re ready to negotiate terms with the property owner.
Start by reading the details of the landlord’s standard lease document and consider hiring a real estate attorney to review it before you sign. Your real estate attorney can also play a role in the negotiation process.
Important elements of your negotiation include the following:
Understand the True, Long-Term Cost of the Lease
A property’s base rent—i.e., the amount you’ll pay for the actual square footage—is only one component of the cost of the lease. To ensure that the lease meets your budget targets, it’s vital to understand the nature and scope of other costs you’ll be expected to bear and to ensure they’re clearly stated in the lease document. For example, when and under what circumstances can your landlord increase your rent?
Depending on the terms of the lease, you may be responsible for paying any of a number of ongoing expenses in addition to the base rent, such as taxes, legal fees, insurance, utilities, security, repairs and maintenance, and possibly even the cost of an on- or off-site leasing office. Do you have your own meter to govern utility costs, or are you charged based on a percentage of the total costs for the entire property? If the HVAC system breaks down, are you responsible for repairs? Who pays the plumber if a pipe breaks, or the roofer if you have a leak? And are you responsible for your own security services or are you expected to make a contribution towards systems or personnel contracted by your landlord?
Under the terms of your lease, you may also be responsible for various fees, including CAM (Common Area Maintenance) fees-sometimes also referred to as load factor fees. CAM fees are levied for the direct and indirect costs of maintaining shared spaces, such as elevators, parking lots, public restrooms, lobbies and hallways, and landscaped grounds. CAM and load factor fees can include fixed costs, variable costs, or both. As there is no standard definition for CAM fees, their composition can vary significantly from one lessor and one lease to another. Make sure you understand what you’re paying for in CAM fees—including the base year to be used in the calculation and the base-year CAM amounts—and that they’re clearly documented in the lease.
For all of these add-on costs, it’s important to know how often and on what basis you’ll be charged. If they’re variable costs, how are they determined and is there a maximum percentage or dollar amount governing increases?
Establish the Term and Renewal Options
The optimal duration for your lease depends on a number of business and economic factors: How fast is your business likely to grow and, if that growth translates into the need for additional space, can the property accommodate you? Is it possible you’ll downsize or move certain of your operations? Are there reasons to believe you’ll need to relocate the entire business? How available or competitive in your preferred location is this type of space? Are real estate costs expected to increase or decrease in the near future and the longer term?
You’ll generally negotiate an initial term for the lease, plus a renewal option(s). It’s also valuable to establish a bail-out provision and a time frame for negotiating an additional term.
If the initial term of your lease is relatively short, your renewal options assume increased importance. Under what circumstances, for how long, and at what cost are you able to renew your lease?
If you have a longer initial term, the bail-out provision comes into play. What is the cost to you if it becomes necessary to terminate the lease before the current term expires? What notifications must you make, and when—and what other procedures are mandated to avoid default? And what happens if you do default?
Because of the inherent complexity of relocating a business—and the amount of time it takes to plan for and implement a move—it’s important to ensure that you have the option to negotiate with your lessor well in advance of the expiration of your lease. The closer your lease is to expiring, the less flexibility you’ll have in the negotiations, assuming you don’t want to move the business.
Consider the Value of Additional Clauses
Can you sublet any or all of your space to another business? If you anticipate the need to expand your space in the future, the ability to sublet might allow you to lease more space than you need for current operations, and then sublease the excess for a shorter period. Alternatively, if you think you might downsize or move some portion of your operations, the ability to sublet provides you with important flexibility.
At some point, you may find it advantageous to change the structure of your business. For example, from a sole proprietorship to a partnership, or from a partnership to an S corporation or a C corporation. If so, you’ll want the ability to assign the lease to your new entity.
Tenant Improvements and Build-Outs
If you’ll need to make significant changes to the property to suit your requirements, who pays for build-outs and tenant improvements? For a longer-term lease, will your landlord provide an improvement allowance or perhaps even take responsibility for implementing the construction projects?
Is the proximity of another, larger business an important factor in your decision to lease the space? If you’re planning to lease a retail storefront, for example, you may have selected your location based on the existence of what is referred to as an anchor tenant. What if the anchor tenant leaves and is not replaced with another business of similar stature?
Can one or more of your competitors lease space on the same property or in the same development? It may well be that proximity to competitors is a good thing—for example, if you’re moving your retail furniture store to the city’s “furniture district.” But if you don’t want a competitor to land nearby, you may be able to include a provision in the lease that grants you exclusivity.
A permitted use clause is the lessor’s representation that there are no covenants or zoning restrictions to prevent your use of the property as intended for your business.
Committing to a lease is a critical strategic, legal and financial decision for a business. It follows that access to the expertise and advice of professionals who have no financial or other interest in the transaction, such as attorneys and accountants, can make all the difference. If you have questions or concerns, give us a call.