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Commercial Leases 101: What New Business Owners Need to Know
Starting your own business is both exciting and nerve-wracking. You are exerting a tremendous amount of energy and creativity, but there are so many details. Finding your perfect retail or office space is just as important and involved. It is exciting, but then you are handed the 40-page commercial lease. This can be eye-opening and a bit daunting.
Commercial leases are different than residential leases. Guidance from an experienced corporate attorney is helpful to navigate the process effectively. Here are a few basics.
Leases Can be Negotiated
Typically, a residential landlord will have a preprinted lease for the tenant to sign and the landlord is not expecting or encouraging any sort of negotiation. By contrast, commercial leases can be — and there is an expectation that they will be — negotiated. Commercial leases are rarely preprinted and they are drafted by attorneys experienced in business law and contract drafting.
Multi-Year Leases Typically with Automatic Extensions with Notice Provisions
Typically, a residential lease is for one year, sometimes less.
By contrast, given the need for certainty and the expectations of running a business, a commercial lease is multi-year and most often contains automatic extension provisions. As an illustration, a five-year lease will often contain an automatic renewal option — maybe for three years. In general, the tenant must exercise the option via written notice within a certain time frame. For example, the lease language might be: “Tenant must exercise its renewal option within 180 days before the lease expiration, but in no event, less than 90 days before the lease termination.” Such notice provisions must be adhered to strictly.
Rent is Often “Net” and the Lease Payment Amount Often Varies Month to Month
Most commercial leases are called “net leases” or often “triple net leases.” “Net” is being used here in the sense of “gross revenues” as opposed to “net revenues.” Unlike residential leases where the landlord makes repairs and keeps the property in good condition, a commercial lease shifts all of those responsibilities to the tenant. The commercial landlord is seeking net rents and is expecting that the tenant will pay all the expenses including the property taxes, insurance, repairs, utilities, and all other operating costs associated with running and maintaining the property. One reason commercial leases are often called “triple net” is because the monthly payments are broken out into three categories:
- Base Rent;
- Monthly 1/12th charge for property taxes and insurance; and
- Variable monthly charge for tenant’s share of operating expenses (utilities, custodial services, waste removal, grounds-keeping, etc.).
The final category is why the rent paid each month will vary slightly.
Because commercial leases are year-to-year, base rent increases are built-in and automatic. They are usually based on percentage escalators. Increases for taxes, insurance, and monthly charges will increase, too. Those increases will be based on the actual increases for the various items.
Lease Issues to Negotiate
Often commercial landlords build out your space to suit your specific needs. This is an enticement to obtain commercial tenants. You and your lawyer should negotiate as much build-out as possible. If the landlord is NOT offering any sort of build-out, then other concessions should be negotiable.
If you are expected to keep the property in good repair, then before signing a commercial lease, you must conduct due diligence with respect to the property in the same manner as if you were buying a house — that is, you need to inspect everything like plumbing, electrical, structural soundness, HVAC. If some particular system is in serious disrepair, your lawyer should require that be replaced PRIOR to you taking possession of the leasehold or that the landlord be responsible for repair and upkeep of that system.
There are many places in a commercial lease where various notices are required and, possibility time periods are set for cure. Your lawyer should negotiate long notice and cure provisions. As a new business, you may need the extra time.
Finally, here is a short, non-exhaustive list of other issues that you and your lawyer should consider and negotiate:
- Security deposit;
- Personal guaranties;
- Right of tenant with respect to and rules regarding making improvements and/or alterations;
- Trade fixtures;
- Tenant’s right of access, hours of operation, and HVAC hours of operation (if not under tenant’s control);
- Parking and storage (if separate);
- Landlord’s right of entry;
- Tenant rights regarding sale of business;
- Tenant rights regarding subletting;
- Tenant and landlord rights of assignment; and
Contact San Diego Corporate Law
If you need help with a commercial lease, seek guidance from an experienced business attorney like Michael J. Leonard, Esq., of San Diego Corporate Law. Contact Mr. Leonard by email or by calling (858) 483-9200.