The AllBusiness.com Practical Guide to Office Leases

The AllBusiness.com Practical Guide to Office Leases
Table of Contents:
NEGOTIATING AN OFFICE LEASE				1
RENT				2
PERMITTED USES				3
THE TERM OF THE LEASE				3
RENT ESCALATION				3
OPERATING COSTS				4
TENANT IMPROVEMENTS AND ALTERATIONS				5
ASSIGNMENT AND SUBLETTING				6
RENEWAL OPTIONS				6
OPTION TO EXPAND				7
SECURITY DEPOSITS				7
RULES AND REGULATIONS OF THE BUILDING				8
OFFER LETTER				8
INDEX TO APPENDICES				9
	Appendix A Checklist for Office Leases			10
	Appendix B Addendum to Real Estate Lease (For the Benefit of the Tenant)			15
	Appendix C Assignment of Lease			19
	Appendix D Office Sublease			24
	Appendix E Option to Renew Real Estate Lease			51
	Appendix F Option to Expand Space Leased in a Building			53
	Appendix G Amendment to Lease			55
	Appendix H Offer to Lease Space			57
	Appendix I Option to Purchase			60
	Appendix J Consent by Lessor to Assignment of Lease			65
	Appendix K Consent by Lessor to Sublease			70

The AllBusiness.com Practical Guide to Office Leases

Overview

Most small businesses require leased space. And as your business grows, you will need to add additional space. A lease agreement constitutes a significant financial commitment for most businesses, yet many people blindly sign leases that bind their business for many years without any meaningful attempt to negotiate the terms of the lease.

In this Guide, we tell you what to look out for when signing a lease and what you should try to negotiate in a good lease. However, having an experienced real estate attorney review the lease before you sign it is always a good practice.

Negotiating an Office Lease

When you find a great space for the business and are ready to lease, the landlord typically hands you a preprinted agreement that looks (for all the world) just the way leases were meant to look. The landlord is likely to call this the standard lease, as if the perfect form of a lease agreement had been chiseled in stone eons ago.

Pay attention here: This form is undoubtedly totally one-sided in favor of the landlord. No "standard" lease exists. And regardless of whether the form looks standard or preprinted, don't be afraid to carefully review and negoti­ate the lease.

Your ability to negotiate changes to an office lease is dependent on how much leverage you have. Are other companies vying for the space? Has the space been vacant for a long time? Are you willing to pay a good rent? Let's face it: If Microsoft and General Motors are about to engage in a bidding war for the same prime space you're interested in, all of your negotiating skills mean very little.

Assuming that you do have some leverage, the following sections detail the key provisions of an office lease. Appendix A contains a comprehensive checklist of issues to consider when negotiating an office lease.

Rent

A cost analysis between buildings is essential for your business to properly estimate its future rental costs.

Any analysis of a given space's desirability typically begins with the fixed rent that the landlord quotes you. But this starting point must be evaluated in light of other factors. For example, landlords may quote a monthly lease rate of $2 per square foot, typically meaning rentable square footage. The actual usable square footage of the premises is the space that you actually can use for your business operations.

Usable square footage is less than rentable square footage because it deducts common areas such as public corridors, elevators, lobbies, and bathrooms from the overall calculation. So, to compare apples to apples, you have to know the exact usable square footage of each space you are considering.

The structure of the lease payments may also be important. For example, a start-up business without much capital may want two or three months of free rent at the beginning of the lease, with a lower rental for the first year and increasing rentals for the second and third years.

When analyzing the cost of space, you must also take into account other operating costs that the landlord may pass on to you, the tenant. Some leases require the tenant to pay for all cleaning, building security, air-conditioning, maintenance, and so on (a so-called Triple Net Lease). And some leases require the landlord to provide and pay for basic services, while the tenant pays a pro rata share of any cost increases the landlord incurs for such services over the initial base year of the lease.

Keep in mind that different buildings have different costs and landlords may charge for services in a different manner. So the types and amounts of the costs that the landlord passes on to the tenant can have a big impact on the economics of a lease.

Permitted uses

The lease typically has a section that sets forth the permitted uses of the leased space.

It's to your advantage as the tenant to make this permitted use clause as broad as possible, even if your intended purpose is initially narrow. Because your business may grow and your plans may change, you want the flexibility to use the space in any reasonable, legal manner.

Also, a narrow permitted use clause can often serve as a restriction on your ability to assign or sublet the space.

So what's the best permitted use clause? See if you can get the landlord to agree to something like the following:

Tenant is permitted to use the premises for any legal purpose or business.

If the landlord doesn't go for that, at least spell out all of your expected or potential uses.

You may also want to take a look at Appendix B—an Addendum to Real Estate Lease that benefits the tenant.

The term of the lease

The length of the lease has a significant impact on the rental rate. Landlords typically like longer term leases and are more willing to make concessions for such leases. With a long lease, the landlord enjoys the financial security of a regular rental stream over a number of years. And the landlord can avoid the hassle and expense of re-leasing the space.

From the tenant's side, a long term lease has both benefits and risks. The benefit is knowing that the premises are available at a predictable cost for the long term. The risk is that the company may outgrow the space, may need less space as its business contracts, or is locked into paying what turns out to be above-market rent if demand for rentals subsequently declines.

If you can get it, the best of all worlds is a shorter term lease with renewal options. You are usually much better off getting a 2-year lease with four 2-year renewal options rather than getting stuck in a 10-year lease.

Rent escalation

Fixed rent over longer term leases is relatively rare, because landlords often try to build in rent escalation provisions.

Sometimes, landlords insist on annual increases based upon the percentage increases in the Consumer Price Index (CPI). If you are confronted with such a request, do two things. First, try to arrange that the CPI does not kick in for at least 2 years. Second, try to get a cap on the amount of each year's increase (for example, no more than a 3 percent increase in any year). Here is a sample clause for doing that:

If you have to live with a rent escalation clause, consider a predetermined fixed amount, like

• $2,000 a month for the first year
• $2,200 a month for the second year
• $2,400 a month thereafter

Such a provision gives you more predictability in planning your business. (Note: Make sure that your business plan projections adequately reflect such increases.)

Operating costs

The starting point for determining your operating costs is identifying what services the landlord provides, what services the tenant must get directly, and who bears the cost. The following are common costs for office space:

• Heating, ventilating, and air conditioning (commonly referred to as HVAC)
• Cleaning and janitorial services
• Electricity
• Repairs
• Security

If the landlord is charging you separately for such services, try to negotiate a fixed fee or cap on the amount.

If the landlord pays for basic services but charges you for increases in the cost of rendering those services, ask how the landlord is calculating that increase. For example, some landlords may figure the base year for calculating the starting point of costs as one in which the building is not fully occupied (heat not necessarily fully on, not all lights on, and so on). In this case, your company's moving in will naturally cause cost increases. Get the landlord to count the base-year costs as if the building were fully occupied and operational.

Landlords often try to get tenants to pay for increases in property taxes on the building. Watch out for this because if the property has been held for a long time before being sold, the value of the property may be significantly higher after the sale for property tax purposes. The end result is a higher property tax that you may be stuck paying. Tell the landlord that having to pay for such an increase is not fair to you.

Landlords also try to throw in items as operating expenses that should really be capital expenses (and thus not properly chargeable to a tenant). So make sure that the definition of operating expenses that you may be liable for doesn't include capital improvements, financing charges, and other capital costs.

In addition, some landlords will charge extra for services supplied other than on "business days" or "after hours." So look at this clause carefully and try to limit charges for extra services to those that are truly extraordinary and not to be incurred on a regular basis. This can be of particular importance for a start-up business, where workers often spend nights and weekends working.

Remember, the operating costs section of your base can mean big, unexpected costs, so carefully anticipate the problems!

Tenant improvements and alterations

Most form leases provide that the tenant can't make any alterations or improvements to the premises without the landlord's consent. Those provisions are typically too restrictive and you should attempt to negotiate changes. For example, try to get the right to make non-structural changes or changes costing less than $5000 without the need to obtain the landlord's consent.

Before you can occupy the space, the premises may need some improve­ments or alterations to make it appropriate for your business needs.

Here are some key questions to answer about the initial tenant improve­ments and alterations:

• What is the scope of changes?
• What is the cost?
• How much time is needed to complete the improvements?
• What permits or approvals will be necessary?
• Will the landlord contribute to the payment for the improvements?
• Who will own the improvements once the lease is terminated?

Try to get a clause stating that you are allowed to remove any trade fixtures and alterations that you pay for, provided that you repair any damages to the premises.

If you anticipate the need to make alterations or improvements in the future, the lease should provide that you may make them with the landlord's consent, but that the consent won't be unreasonably withheld or delayed.

Also, be aware of the clause that says that at the end of the lease you have to return the premises in their original condition. Try to negotiate a clause that states the following:

Assignment and subletting

The assignment and subletting clause of the lease can prove to be a very important provision. Typically, the landlord's lease form states that the tenant may not assign or sublet the lease without the landlord's prior consent, with such consent to be granted or withheld in the landlord's sole discretion.

You should attempt to modify such a clause in several ways. The ideal change provides that an assignment or sublease requires the landlord's consent, but that the consent cannot be unreasonably withheld or delayed. (A landlord is unlikely to give you the total right to assign or sublease without some kind of approval procedure.)

If the landlord does give you a reasonableness standard on your proposed assignment or sublease, he may insist upon a recapture right. That is, the landlord may want to recapture the space for his own use or re-leasing. This condition is generally acceptable, as long as the landlord pays you any profit you expect to make on the assignment or sublease.

If an assignment or subletting comes with potential profit, then the landlord typically expects to share in that profit. Often, the split is 50-50, but make sure to recoup any expenses you incur in getting an assignee or subtenant before a profit split.

A start-up tenant should also negotiate enough flexibility in the assignment and subletting clause to allow for mergers, reorganizations, and share ownership changes.

See if you will be allowed to freely assign and sublet the lease to the company's subsidiaries and affiliates.

Be particularly leery of a clause that says a change in more than 50 percent of the company's stock ownership will be deemed to be an assignment that is prohibited without the landlord's approval. A prohibited assignment can result in the landlord terminating a favorable lease. As the company grows and new people invest in the company, this clause can be inadvertently triggered.

This Guide contains a sample Assignment of Lease (Appendix C) and a sample Office Sublease (Appendix D)

Renewal options

Because your company's future space needs are uncertain, renewal options for the lease can be quite helpful. But some landlords may be reluctant to grant...