The basics of a commercial real estate lease.

For most businesses, large and small, a real estate lease represents a major commitment. It is a commitment that goes beyond the financial outlay: it circumscribes the location of the business, the expansion opportunities, the operating environment, and other matters. Accordingly, the preparation of a real estate lease is not a matter to be entrusted to, and negotiated by, a lawyer. The business manager or owner should make the relevant decisions about the lease. Once those decisions have been made, then a lawyer can serve as a mechanic to put them on paper. Or the competent business man can do it himself and then have the lawyer check it over for the fine details of real estate law. The most important thing about a lease is to make sure that all relevant conditions are spelled out in plain unambiguous language.

Usually the landlord will propose a form of lease that provides the prospective lessee with a starting point. But before entering into the lease, there are a number of matters that should be considered.

The Term of the Lease

This represents a dilemma for both the landlord and the lessee. If the lease is for a short period, the lessee may soon be faced with a decision on the desirability of moving--or that decision may be forced upon him. If the period is inflationary, the lessee will want as long a term as possible without an increase in rent. Vice versa for the lessor. The term desired by the business manager will depend upon a great many factors, including whether and under what circumstances the lease can be renewed or extended. Usually, commercial leases are for terms of three to ten years, but provisions for renewal options may extend for longer periods.

The term of the lease is defined by stating precisely when the lease starts and when it ends. However, the starting time is not always so simple. Suppose the premises under consideration are already occupied and the current tenant is scheduled to vacate before the starting date of the lease. If the tenant refuses to move, what then? The lease should state clearly what happens if the premises are not ready for occupancy by the starting date. This matter can be critical if you are under a deadline to move from your present premises. If premises are to be completed or remodeled prior to the starting date, delays in construction, even those beyond the control of the owner, can cause major difficulties. These contingencies should be considered in advance and the lease worded accordingly. If there is any doubt about the actual starting date of the lease, provide some leeway in your own schedule: it may be difficult to operate your business from a moving van.

The Right to Renew

If a term lease carries no option to renew or extend the lease, the tenant has no rights over any other prospective tenant and will certainly have to pay the going rate for a renewal. Options of renewal are usually at an increased rate. If the renewal price proves to be significantly above the market, negotiations with the landlord are in order.

The lease may provide for the exercise of the option in different ways. For example, the lease may provide that the tenant must give notice six months or a year in advance in order to exercise the option. If the tenant "forgets" to give such notice, the lease expires. Or the lease may be extended automatically in the absence of advance notice by the tenant. This may be the better arrangement if your docketing system is not reliable.

The Rented Space and Its Cost

Commercial leases are most often priced by the square foot of leased space. That may seem like a simple and straightforward procedure: just measure the space and that is it. Not necessarily. There are a number of different ways that leased space is measured, so be sure your lease specifies exactly how the square footage is to be computed. It is usual to measure commercial space on the basis of the outside measurements of the building. This may result in including a number of square feet in the rent computation that in fact will be unavailable to you. Moreover, in multiple-tenant buildings, the "public" areas of the building are usually apportioned among the tenants. The space that is provided for use by all tenants or by customers or clients of the tenants may include lobbies, hallways, elevator shafts, janitor rooms, rooms for heating and air-conditioning equipment, and stairways, etc. Be sure you know just how much space you are getting for your own use. Don't be surprised if 20% to 30% of the space you are being charged for is apportioned as public space.

There are a number of so-cal led "standard" methods of allocating the public space in multi-floor buildings. The "Boston Method" apportions charges for the lobbies and hallways on each floor, but not the bathrooms, elevators shafts, and mechanical rooms. The "New York Multiple Tenancy Floor Method" apportions the space taken by bathrooms and lobbies among the tenants on each floor, but excludes elevator shafts

and stairways. The "BOMA International Method" apportions all of the public areas on multiple-tenant floors to the building as a whole and then apportions the space among the tenants. In order to compare rents among different buildings, it is necessary to know precisely how the square footage is to be computed.

The cost of a commercial lease can be deceptive because of hidden costs and escalation formulas. Before you can compare the relative costs of different premises, it is necessary to understand fully just how the rent is to be calculated. The first step is to determine what charges are to be added to the base rent.

There are a number of widely used kinds of leases. A Gross lease requires only that the tenant pay a fixed charge and the landlord is responsible for building maintenance, taxes, insurance, and operating expenses. Your are unlikely to find commercial space with such a lease. Even under a Gross lease, there may be an add-on charge for electricity and heat depending upon the tenant's usage or requirements.

Net leases require the tenant to pay all or a portion of the real estate taxes. If the building is a single-tenant building, the tenant usually pays all of the real estate taxes. In multi-tenant buildings, the taxes are usually prorated on the basis of square feet.

A Net Net lease includes all of the charges of a Net lease plus a charge for insurance on the building. This cost can vary considerably depending upon the breadth of coverage of the insurance. Before agreeing to such a provision, the particular insurance coverage should be specified.

A Net Net Net lease is most common when an entire building is occupied by a single tenant. Under such a triple-net lease, the tenant pays all of the costs of the building including maintenance, repairs, grounds upkeep, snow removal, and the like. An annual rental of $10 per square foot may cost $10 per square foot--or it may cost $15, ore more, per square foot.

Retail outlets in shopping malls usually pay a base rent plus a percentage of gross revenues. This surcharge takes care of the mall upkeep, parking facilities, security protection, etc.

The Right to Sublease 

The longer the term of the lease, the more important it is to have some right to sublease. The inherent uncertainties of business make it impossible to accurately forecast the needs of a business some years into the future. The right to sublease offers some comfort in the event of an unforeseen turn of even--either good or bad. A right to sublease is usually restricted at least to the extent of requiring the consent of the landlord. This restriction is not objectionable if it includes the caveat that the permission will not be unreasonably withheld. Even then, there can be disputes over what is "reasonable." The subtenant must meet the same standards as the other tenants in the building and must accept all the restrictions included in the original lease. If you occupy high-tech space in a research-oriented building, the landlord would be within his right to object to a sublease to a heavy machinery fabrication company.

If the property is subleased, the original tenant usually remains responsible for the lease payments. If the new tenant defaults, the original tenant will be liable for the rents. The landlord is not likely to negotiate this position away. However, that raises the question of who keeps the gain if the new tenant pays a higher pricethan called for in the original lease.

If your lease contains no right to sublease, you will need to be sure that the corporate entity holding the lease is not changed. For example, what if the tenant corporation merges with another corporation? If the surviving corporation is the tenant, there is not likely to be a problem. But if the other corporation is the survivor, it may have no right to the leased premises.

Dane Shields is a paralegal and freelance writer based in Tarzana.