Guide to Office Leases

Signing an office lease is a major step for anyone starting a business. It is a commitment to a location in which to do business.  It is typically among the first milestones.

Prior to signing a lease it is imperative that you understand, and agree with, all of the key terms. Reading a lease can be difficult and intimidating. A lease is typically slanted in favor of the landlord, so it is important to determine which terms you can accept and which you need to negotiate. It is advantageous to have an attorney look over the lease with you to help evaluate all of the terms and clarify any unfamiliar wording.

Key Lease Terms

The first and most critical terms are typically the amount of rent you will pay and the length of the lease. Depending on the situation, they may be open for negotiation, particularly the length of the term.

Leases will often have rent escalation clauses. You should carefully review such clauses and match them with the projected cash flow of your business.

A shorter-term lease allows you the flexibility to pack up and leave sooner if you are not pleased with the location. A long-term lease can give you long term stability and keep rent increases down, but may tie you to a location that may not be profitable or one, which your business may outgrow. There are generally ways to break any lease, but it’s not your intent going into such an agreement to seek ways to get out.

Among the other key terms you will want to focus on when evaluating a lease include:

• What type of lease are you signing? (Various lease types are discussed below.)
• What charges, taxes or fees are or are not included in the rent?
• Which improvements, modifications or repairs are you responsible for and which ones are your landlord responsible for?
• Exactly what are the physical boundaries included in the lease? (Are you paying for any common areas such as hallways, stairways or a shared loading dock?)
• Can the space be assigned or sublet to another party?
• How much is the security deposit (if there is one) and what are the conditions for its return?
• How can the lease be terminated early and what penalties will you have to pay?
• Specifically, what business activities can the premises be used for? Not used for?
• How are disputes resolved, should they arise between lessor and lessee?

Since there is no such thing as a “standard lease” it may be possible to negotiate the terms, depending on your position.  If the space you are looking to rent is highly sought out by other businesses, your bargaining power will diminish greatly. Depending on how valuable the space is to your needs (such as a prime location) you will need to determine whether or not you can accept the terms of the lease with few or minimal changes.

If you have some leverage in negotiating the terms of the lease, look at several areas in which you can work a better deal. Most often the initial amount of rent will be the most difficult to negotiate. Therefore, you may look at other terms such as:

• Rent Escalations: If the landlord insists on rent escalations, try to negotiate that there is no escalation for the first two years and then agree upon a ceiling for increases after that. Such provisions may allow you to sign a longer-term lease.  If the landlord has had trouble renting the space, he or she may also want to sign you for a longer term provided there are rent escalations.
• Repairs & Services: If the rental price is set, you may be able to make some agreement on repairs and services that will be provided by the landlord, such as a paint job.
• Returning the Premises to Their Original Condition: Typically most construction and alterations need to be approved by the landlord. Many businesses improve upon the structure of the original location by adding additional wiring for computers and additional telephone lines as well as enhancing the capacity for other technology. You may be able to negotiate that such upgrades can remain and that you do not have to return the premises to their original condition.  In addition, you may be able to use the fact that your technological improvements will increase the value of the property as a bargaining chip.

Before negotiating terms of a lease, make a list of terms that would benefit your business. For example, if you are opening a jewelry store in a mall, the lease should stipulate that no other, or only one other jewelry store, can open in the mall during the term of your lease. If you are expecting to generate walk-in business, you will need terms that allow you to put up necessary signage.

Whatever type of business you are opening, there are specific needs that will have to be discussed prior to signing a lease. In addition, make sure that zoning ordinances do not prohibit you from opening up the type of business you chose to run.

As is the case with any negotiation, the side with the greater need will have less bargaining power. A building owner or landlord who has had an empty storefront or office space for an extended period of time will be more agreeable to your terms including options. He or she may have a greater need to rent the space.

Options

When you negotiate your lease there are several options you can have included. The most common is the option to renew.  Since landlords will want to raise the rent at the end of the initial agreed period, this will need to be addressed in advance. If you can get an option to renew at a predetermined fixed price, as opposed to renewing at the fair market price, you will likely save money when the initial term of the lease ends, especially if office rents have escalated.

A short lease with one or more options to renew gives you some flexibility. Typically, you have a certain time period before the end of the initial lease term in which you can notify the landlord in writing that you want to renew the lease at the predetermined amount. There may be an additional fee, also agreed upon in the initial lease for exercising your right to stay. Generally, with the exception of the increase in rent, other terms of the initial lease will carry over into the renewal period.

Another option you might include is the option for additional space. Being able to expand is key for a growing business. A landlord who sees the potential of having an important tenant that may attract other businesses, especially in a mall or similar retail situation, may be more inclined to grant you an option for additional space. You will need to examine and negotiate the terms for renting such extra space and make sure the space is suitable to your business needs.

The option for additional space may state that you will expand at the same per square foot rate that you are currently paying, at a fixed rate of increase or at the fair market rate at the time of the expansion. This will need to be determined when working out the initial option agreement.Such an option can only be included if the landlord can reserve or make such space available. A landlord may counter by offering you a right of first refusal, meaning you have first choice on any empty space at the same rental rate that any other tenant will pay. Again, it is a matter of which one of you is in the stronger position.

Also, becoming more common in commercial leases is the option to terminate the lease early. Landlords may offer such clauses to higher profile businesses to entice them to sign longer-term leases and help draw other established tenants into the facility. The landlord will receive some form of compensation if the tenant exercises the option to leave early. In the case of retail leases, particularly at malls, landlords may guarantee a level of occupancy among surrounding storefronts. If that level, for example 75% occupancy, is not met by a certain date, the tenant then has the option to terminate the lease.

Types of Leases

A wide range of commercial leasing possibilities exist. Typically, an office lease in a major city and a retail lease in a suburban shopping center will be considerably different.

From a broad perspective, there are a few types of leases commonly found. Within these categories, leases may vary considerably.

• Gross Lease: The tenant pays a set amount of rent and the landlord is responsible for payment of taxes, insurance and other costs associated with owning the property.
• Net Lease: The tenant pays the rent plus a portion of the maintenance fees, insurance premiums and other operating expenses.
• Triple-Net Lease: Typically, for a freestanding facility, this type of lease has the tenant paying for all fees and operating expenses associated with the space.
• Shopping Center Leases: The tenant pays a base rate in conjunction with the square footage of the retail facility. Typically, the tenant will also pay some common charges and frequently a certain percentage of the gross sales. The tenant may also be assessed part of the property taxes. A shopping mall lease will often include terms about signage, hours of operations, common areas and deliveries. The landlord may also have the right to relocate the tenant.
• Land or Ground Lease: The tenant leases the grounds and builds on the property. Typically, with a land or ground lease, all improvements on the property, including any building or buildings revert back to the landowner at the end of the lease period.

There are numerous variations on common lease forms. For example a lease may cover both office and warehouse space in one facility with separate rental amounts and separate options.

Additional Costs

Leases typically address who pays for electricity, water and heat.  Some terms you should know include:

• Operating Costs: An overall term for additional building related expenses such as janitorial, electrical and maintenance costs.
• Overages: The increase in the cost to operate the property from one year to the next.  If, for example the cost for electricity was $2 per foot one year and $2.30 per foot the next, the overage of $.30 would be passed on to the tenant.
• Pass Through Costs: All expenses that are passed through from landlord to tenant.

Getting Out of a Lease

Your reason for wanting to get out of the lease will factor into the method you choose.  A tenant generally wants out of a lease because:

• Business is growing and the facility is too small
• Business is bad and the rent payment is too high or you simply want to close up shop
• You are dissatisfied with the service of the landlord or how the terms of the lease are being handled

If you need to move to a larger space or a better location, one option is to sublease the space to someone else. You must first make sure subletting is allowed in the terms of the lease. Most often a sublet is allowed with the approval of the landlord.  You will still be obligated to the landlord if the subtenant defaults on payment.

Another option, if business is going well, is to buy out the remaining portion of the lease with a lump sum payment.  If the landlord will be able to rent the space without much difficulty, your buyout price will be far less than the amount remaining on the lease.  This payment may be worthwhile if you are moving to a bigger space or better location.

If business is going poorly, you can also look to sublet, or find a new tenant with whom the landlord can negotiate a new lease for more money.  Talk to your landlord about the situation.  Landlords usually do not benefit from having a tenant who might be headed toward bankruptcy, so they may allow you to rent out the space, or a portion thereof, while actively looking to find a new tenant.

If you are dissatisfied with the manner in which the landlord is meeting the terms as outlined in the initial lease, re-read your lease carefully and see if any terms have been violated that allow you to break the lease.  Read the section on how all disputes will be handled.  Do you have sufficient grounds to get out of the lease?  If, for example, the lease states that you will have the only jewelry store in the mall, but a department store opens directly across from you, selling jewelry in one of their many departments, does that violate the lease?  Your business is being affected.  If you are paying a percentage of your business to the landlord, then this drop in business is also affecting his or her share of your rent.  Therefore, the landlord may try to work out a compromise solution, which might mean relocating your shop or talking with the department store about moving their jewelry department farther away from your store.

You should first make an effort to work out the situation with your landlord rather than having to resort to legal action.

Legal counsel can advise on situations whereby you are looking to get out of a lease because you are dissatisfied with how the terms are being handled.

Lease Review

Below are some common lease terms that you will want to put on your list of key areas to discuss.

• Lease term
• Manner of payment and when payment is due
• Type of lease
• Escalations and manner of calculation
• Responsibility for repairs and maintenance
• Responsibility for common areas (if any)
• Subleasing or   Assignment of lease
• Security deposit
• Terms for early termination
• Options to renew
• Manner of settling disputes
• Permitted use of space