Commercial real estate can be terribly tricky.
When it's time to expand or shrink your office, finding the right space is just the beginning of the process. Even in today's tough real estate market, it is challenging to negotiate a commercial lease that protects your interests as the tenant as well as the property owner. Our recent experience will highlight some of the potential pitfalls.
We're located in a small town, and we have rented space in a lovely, historic building on terms very similar to what you would see for residential property. We rented a stated amount of square footage in the building for a fixed monthly amount including an annual escalation based upon the cost of living, and a term of several years with options to renew. Other than that, the provisions were pretty basic, the landlord paid for basic utilities and repairs. We paid for everything else.
As our little town has grown, several new office buildings have been constructed by developers from outside the area who are in the commercial leasing business. When we identified the space we thought was most appropriate for our business expansion, we identified the terms we wanted and sent out a request for proposal to two of the landlord/developers. We were somewhat naively expecting to be quoted an annual lease amount, which is considered a "gross lease," where we would pay our monthly rent and the landlord would pay all the expenses.
The Net Lease
The responses to our RFP were both in the form of a "net lease," which is expressed as a base rent per square foot, plus "additional rent" to be calculated as our pro-rata share of the landlord's operating expenses (including utilities, repairs and maintenance, taxes, insurance and so forth) incurred each year. We had several concerns regarding these terms:
* The square footage was based on the "rentable" square feet, including our share of the common area, which was quite a bit greater than our "usable" square feet.
* The landlord wanted a cost of living increase on the base rent each year.
* The building is still under construction, so the operating expenses which will be part of our "additional rent" have only been estimated and not fully identified.
We wanted to enter into a fairly long-term lease, and it appeared to us that this arrangement transferred too much of the risk of the ownership of the building to us and the other tenants. Also, for purposes of calculating the impact on our five-year projections, we could not cap or identify the ongoing cost of this type of lease, since we were unsure about the amount of pass-through of the "additional rent."
Paying for Modifications
Our desired space was unfinished, so it had not yet divided into offices. We were able to work with the developer's architect to design the floor plan to suit our business, which was a huge advantage. Fortunately, this work will be almost fully paid for by our landlord. Many times, a landlord will provide an allowance of a specified amount per square foot for this construction, and anything in excess of that has to be paid by the tenant. We are only responsible for a few decorating upgrades.
Every Commercial Lease Is Negotiable
What we learned very quickly is that there are ways to protect ourselves in negotiating this type of lease. In many markets, there is quite a bit of space available and not enough qualified tenants. That puts tenants in a much more favorable position to dictate terms. Landlords are usually willing to consider concessions with longer-term leases. We set our initial lease term at seven years, with two five-year renewal terms to gain designated parking and additional upgrades.