Best Practices From Renewal Logistics:
How to Negotiate a Commercial Lease
Negotiate so that the Lease puts your needs front and center
So you’ve found the perfect site for your warehouse, facility, or other commercial operation. Great! But before you can make it official, you’ve got to sign the lease document. And before you sign the lease, you must review it thoroughly and negotiate for any modifications to make it more favorable to you and your business goals.
Remember, when the landlord creates the initial lease, they put their own best interests first. It is your job, as the lessee, to think of and request modifications that will place your own best interests front and center as well.
In today’s post we’re covering the most important considerations to take when reviewing and negotiating your commercial lease before signing. We’ll also touch on potential pitfalls that businesses sometimes face and how to avoid them.
As the owners of our own small business, we’ve been through the whole lease negotiation process ourselves. Now, we’re turning our life lessons into shareable knowledge. The considerations highlighted below are the things we’ve felt were most important when negotiating our lease. Read on to arm yourself with the knowledge you need to negotiate a lease that serves your needs and sets your business up for success.
What to Look For:
Factors to Consider in a Commercial Lease
Not all lease agreements are alike. Every landlord has their own way of doing things and every property is different, too. When reviewing the initial lease document provided by the landlord you’ll want to check the following:
1. Length of the Lease
Most commercial leases are long-term. Unlike residential leases that often get renewed once a year, commercial leases may ask you to commit to five or even ten years leasing the property. If you really need a shorter lease you may be able to find one for two or three years, but shorter than that is uncommon.
2. Clauses About Sub-Leasing
Since commercial leases do lock you in for so long, it is worth investigating the allowance or prohibition of subleasing the property. The worst case scenario is that you get stuck in a long-term lease that you can no longer profit from for one reason or another. At that point, you are still responsible for paying rent. If this is the case, a sublease can help you cover the cost of the property until the lease period is over and you are off the hook.
3. Rent Amount
This is already likely top of mind for you – and for good reason. The lease agreement will include the rent amount you will be expected to pay. Many lease agreements also specify expected rental increases for each subsequent year. Be sure to review this information so that you are not hit with unpleasant surprises down the line.
4. Utilities and Additional Costs
Some commercial leases place the cost of utilities, taxes, and maintenance on the landlord. These are called ‘full-service,’ or ‘gross,’ leases. However, other times the tenant is responsible for costs like utilities, partial insurance costs, some fraction of property taxes, and even some maintenance costs. (See number 4 below for additional discussion on these.) The lease should specify which, if any, of these costs will be the responsibility of the tenant and which are the responsibility of the landlord.
5. NNN and CAM
To the point above about maintenance costs, be sure to review any clauses about NNN and CAM. NNN, or Triple Net, refers to the costs of property tax, insurance, and common area maintenance. CAM is common area maintenance and is sometimes separated out from Triple Net in leases. Some landlords will cover the costs of Triple Net – including CAM – while others will place these costs on the tenant.
When it comes to CAM responsibilities, some landlords will split common areas into landlord responsibilities and tenant responsibilities. For example, roof maintenance is more often covered by landlords, while AC systems are often the responsibility of tenants.
6. Clauses About Signage
If you plan to place business signage around your facility, be sure to check that this is allowed in the lease agreement. Also, check to see if there are any restrictions on where you can and cannot place this signage.
7. Early Termination Clause
Some leases include a clause with guidelines for legally terminating a lease before the lease period is officially over. This is useful in helping you avoid getting stuck in a long-term lease. However, this clause does often include penalties and fees. While these are a pain, it is better to have the option for early termination than to illegally default on a long term lease.
Getting Down to Business:
Tips For Negotiating a Commercial Lease
Once you’ve reviewed the initial lease agreement provided by the landlord, it is in your best interest to come back with a few of your own requests. Most landlords are expecting a negotiation period where you will go back and forth until both parties can comfortably compromise on a final lease agreement.
Below we’ve compiled our top recommendations to help you successfully negotiate a commercial lease.
1. Do Your Research
Before beginning negotiation talks it is a good idea to do a bit of background research. You should research the average cost per square foot of other commercial properties in the area so you know what range of rent is typically and what rent amounts are on the high or low end.
It is also a good idea to look into the property’s history by reviewing public property records. These can tell you about any legal actions taken in the past and/or liens placed on the property.
2. Begin Negotiations Early
Depending on the number of clauses you hope to negotiate and the flexibility of the landlord, the entire negotiation process can take several months or even more! If you’re in a hurry to get your commercial operation up and running, you should begin the negotiation process as soon as possible. That said, try to avoid rushing through negotiations. Spend time working through each negotiation point and exploring compromise options.
Before you begin negotiating, decide which points are negotiable for you and which are absolute non-negotiable needs. Below your non-negotiables, you should order your other asks in terms of their importance to you.
Once negotiations begin, it will help to have your values and priorities listed out ahead of time so you don’t lose sight of your main priorities or get too distracted by small points.
4. Know Your Other Options
In any negotiations, it helps to know that you always have alternative routes to take should negotiations fail. To help you bring more leverage to negotiations, make sure that you have one or two back-up options of properties you can pursue, should this one not work out.
5. Discuss Upfitting
When negotiating the rent amount for the property, you may be able to decrease your cost per square foot by telling the landlord you do not need upfitting. Upfitting is any kind of interior modification designed to make the property more flexible or convenient for tenants.
Sometimes, upfitting is just part of the process and you can’t manage to talk your landlord out of it. If this is the case, be sure to get the most out of it by explaining your ideal vision for the space and any features you would like to be included.
6. Market Yourself Favorably to Landlords
Landlords will be more inclined to negotiate with you if they think you are likely to be a great tenant. Lay out the qualities that will make you an excellent tenant, like good credit, positive relationships with past landlords, and a solid business plan.
Don’t forget, just as you are shopping around for a property, landlords are also speaking with multiple potential tenants.
7. Use Legal Counsel
While the tips we’ve supplied here are a great starting point to prepare for commercial lease negotiation, there is just no substitute for professional legal counsel. It is highly recommended to have a lawyer review any lease agreement before you sign as they will know what to look for and be able to catch any clauses that could cause issues down the line.
Pitfalls to Avoid When Negotiating a Commercial Lease
Now that you’ve got the basics of successful negotiation tactics we’ll cover a few pitfalls to watch out for before you sign your lease. By learning about these common mistakes you will be better prepared to avoid making them yourself.
1. Hidden Costs
Landlords can sometimes get a bit too creative when calculating the rent amount for their property. Sometimes it is written in the lease that tenants are required to pay for certain types of repairs, taxes, and/or insurance. Some commercial leases even take a set percentage of the tenant’s profits! Make sure you know what you are agreeing to pay for and how much it will cost you.
2. Extra Long Lease Periods
Commercial leases tend to be in effect for much longer periods than residential leases. It is not uncommon for them to last five or ten years. Be sure to check the lease period you are signing on to. If it’s more than a couple years, do some careful projection and planning to understand what your business could look like many years down the line and whether the space will still be the right fit.
3. Ownership of Fixtures
Sometimes landlords include a clause in the lease that transfers ownership of fixtures that you purchase and install to the landlord upon your departure. This might be fine if you don’t want to deal with the hassle of uninstalling them when you leave. However, be sure to check if this is part of the agreement and keep this in mind when you eventually pay for and install any new fixtures.
4. Defaulting on a Commercial Lease
Defaulting on a commercial lease is disastrous for any business, and if the owner personally guarantees the lease, a default is just as bad on your personal credit as filing bankruptcy. Defaulting pretty much equates to 7 years of bad credit. Not only will this mean extreme difficulty for your business to receive credit (think automobile loans, lines of credit, loan or lease on an asset), but it can also affect your ability to gain customers if you’re filling out an application or an RFP and there’s a credit check involved. For that reason, you want to take all precautions necessary to make sure this does not befall you.
Be particularly cautious when signing a long-term lease. It is easier to predict revenue for your business a few years in advance but can be very difficult to project your growth over a longer period. What happens if your revenue isn’t as anticipated? Or what if you outgrow the property? Unless there is a reasonable termination clause, you will be stuck in this lease for the full term. Be sure that this is something you are prepared for so as to avoid defaulting.
5. Personal Guarantee vs Business Guarantee
Most commercial lease agreements are signed with a business guarantee. This is important because it protects you and your personal assets in the case of default. In the event that you do not pay rent, the landlord can go after your business assets in order to collect the money owed to them. However, by signing with a business guarantee your personal assets are protected and cannot be targeted by a landlord.
However, if your commercial lease comes with a personal guarantee that you are asked to sign, you risk losing your own assets like your home and car if you fail to pay rent. You can sometimes avoid signing a personal guarantee by providing documentation of P & L and balance sheets. Alternatively, you can request that the personal guarantee be voided after an initial trial period of 12 to 24 months. Most small or young businesses can’t avoid personal guarantees in the beginning though, until the business itself has sufficient credit and assets to collateralize the loan.
Best of Luck in Negotiations!
With these recommendations, mistakes to avoid, and factors to consider, we hope you feel confident in your ability to review and negotiate a commercial lease. Be aware that this process takes both time and careful thought.
If negotiating a lease is not something you can afford to focus on right now or if you are worried about the possibility of defaulting, and you’re looking to lease a space to warehouse your goods, know that there are other options available to you. For example, Renewal Logistics offers fractional warehousing. We handle the property lease and management – which includes maintenance, insurance and tax payments, and equipment purchases. You can select the amount of space in our facility that you need and pay only for that square footage each month.
Fractional warehousing is an excellent option for a business that looks ready to scale rapidly over the coming years. Rather than risk outgrowing a leased property, you can simply pay for additional space in our warehouse. On the flip side, if sales take a downturn and you need to cut costs, you can simply scale back the amount of warehouse space you use. Icing on the cake? You don’t have to build out an operations team to manage your warehousing, shipping and fulfillment operations.
Interested in learning about all of the warehousing options available to you? Give us a call or email. We are happy to talk warehousing, logistics, negotiation, business strategy, what have you. We are also passionate about supporting up-and-coming businesses and want to hear your success stories. Let’s chat!