BY MICHAEL GOLDMAN
Outside of the product or service sold, a business”™ most important decision is its lease, affecting revenues, costs and employees. It is frequently a make-or-break decision. Many business owners decide to lease new space or to renew their leases without sufficient information to make the best choices or to maximize negotiating leverage. This is part one of a two-part guide to commercial leasing.
A business”™ location is its single best asset outside of its ability to deliver goods and services. Too many business owners are impatient, selecting a location with drawbacks bound to result in failure.
Retailers need strong traffic counts, visibility, signage and a location where customers want to go. Offices need buildings conducive to their operations, plus convenient to customers and employees. An experienced commercial broker can be helpful in selecting sites, as can members of trade associations or franchisors.
A tenant who rents on a “gross basis” pays a monthly all-inclusive cost. “Net” rent means the tenant pays a “base rent” that does not include such items as a share of the building”™s taxes, insurance and common area maintenance, or “CAM” ”” hence the term “triple net.” Costs above the base rent are called “additional rent.” Some leases combine the gross and net concepts to provide for gross rent plus “escalations,” in which the lease assigns a baseline year for the building expenses and the tenant pays only the annual increases in taxes, insurance and CAM. Some gross leases also contain an additional charge per square foot for electricity if it is not metered separately for each tenant.
Whether a tenant pays gross, net or a combination, costs should be understood up front. For buildings with additional rent, the landlord should supply current and the past two years”™ costs for analysis before lease terms are negotiated. An experienced attorney should review the way additional rent is computed ”” it is frequently appropriate to cap or exclude certain types of charges. Landlords frequently ask for the moon ”” hoping an attorney does not review the terms.
It is also common for a tenant to receive some free rent at the beginning of the term, as well as an allowance for the build-out.
Virtually all space needs to be customized for the tenant. This is true even if the space previously was used by a similar business. Landlords generally have an estimated budget for what they are willing to spend on renovations, based upon size, expected rent and related costs.
It is essential for a business owner to receive good advice from an architect, contractor or other professional to make sure the build-out will meet all needs. Obvious examples include the needs of dentists, information technology outfits and vibration-prone dance studios.
Generally, the landlord looks at the whole picture and may trade rent for build-out. For example, a tenant who will pay for upfront work will generally pay a lower rent. Larger landlords may insist that their own contractors do the build-out. This may avoid friction between the landlord”™s and tenant”™s contractors or a delay by the tenant”™s contractor requiring full payment before the business opens. Therefore, unless the tenant has extensive construction experience, needs highly specialized construction or is part of a franchise that punches out standardized build-outs efficiently, it is often best for the landlord to do the work, allocating costs accordingly in the lease.
A typical lease term is for five or 10 years, although no term fits all situations. The longer the term, the longer the business is liable to pay under the lease. This, of course, can spell ruination for an owner if the business fails long before the lease runs out.
A shorter lease puts the space “back into play” earlier, and can backfire on a tenant who desperately wants to stay but is subject to a landlord who can overcharge or force eviction in favor of another potential tenant willing to pay more.
There are compromise options.
The typical option gives the tenant the right to extend the lease for an additional time period, generally with predetermined rent increases. The tenant likely has to give the landlord written notice to extend ”” usually six to 12 months in advance of expiration. Some landlords offer an option to renew with the rent on the extension to be negotiated. However, if the landlord and tenant do not reach agreement, the tenant may be stuck with an unaffordable rent or lose the option. Another compromise is for the rent to be decided through an independent appraisal in the months immediately prior to the extension.
These provisions should be reviewed and negotiated by an attorney to make sure they are fair to the business owner.
Restaurants are particularly in need of a sufficiently long lease term with options to renew. The ability to sell a restaurant for a good price generally depends on the remaining lease term. Unlike other businesses, which can move down the road when alternative space becomes available, most restaurants lack such flexibility. Zoning laws limit locations due to parking requirements and liquor permit rules. As well, the cost and time to renovate space for a restaurant can make moving prohibitive.
Michael Goldman is an attorney with Norwalk-based law firm Goldman, Gruder & Woods L.L.C. He can be reached at 203-899-8900 or mgoldman@goldmangruderwoods.com. Part 2 will appear next week.
