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The tenant commandments.

There are certain key items, in addition to rent, that a tenant and its advisors should consider as they begin the leasing process. Failure to properly address such items could be disastrous, and it may be too late or expensive to fix the problem once the lease is signed.

If Moses had been a leasing professional, he would have admonished the tenants of his day to make these essential items their own "Tenant Commandments".

I. Thou shalt carefully measure thy premises!

It is common knowledge among leasing specialists that the same-sized premises in different buildings may have different square footages (for example, a tenant may pay rent based on 5000 square feet in one building and 5500 square feet in another for the same-sized space). Since no two premises are identical, it is difficult for tenants to compare premises size and some landlords take advantage. While landlords cannot compete for tenants unless they offer similar rents per square foot for similar space, a landlord can increase its aggregate rent by artificially "growing" its rentable space (including by charging tenants for more than their actual portion of expense increases). Accordingly, as one of the first steps in the leasing process, tenants should carefully measure each prospective premises.

II. Thou shalt receive sufficient services and amenities!

Since a tenant's rent includes a charge for services and amenities, it is essential that they be properly provided. The most important are elevators, bathrooms, HVAC, power and cleaning. It is critical to contact other tenants in the building and hire a consultant to check services and amenities before signing a lease. No matter what lease protections are negotiated, such as detailed specifications or "self-help" rights, there is no substitute for prior investigation.

III. Thou shalt endeavor to obtain free rent!

Premises usually must be "built-out" for occupancy, and rent is typically abated during such build-out and often afterwards. If the landlord carries out the work, rent should begin no earlier than "substantial completion" of the work (the date the tenant is able to begin to utilize the premises). There should also be a deadline for the completion of such work so the tenant can occupy within a reasonable time. If the tenant is to handle the build-out, the landlord will require the tenant to begin paying rent by a date certain, whether or not the work has been completed. Accordingly, the tenant must have sufficient time to complete its work, and such time should be extended by delays beyond its control, including landlord delays. With regard to free rent after the work is completed, the amount and structure will depend on the market. If the market is soft, there will be more free rent, while if the market is firm, the free rent, if any, is likely to be spread out.

IV. Thou shalt make the most of thy allowance!

Leases typically require the landlord to provide a build-out "allowance". In order to get the biggest "bang for its buck", the tenant should make sure the landlord not only provides an adequate allowance, but will permit it to be applied to "soft costs", such as architectural, engineering and moving costs, and will not overcharge for services related to the build-out, such as freight elevator charges, supervision, electricity and security. Further, customary preparatory work should be at the landlord's expense, including HVAC, bathroom and common area upgrades, asbestos abatement, ADA compliance, floor and wall patching, and window repair. If the landlord is handling the build-out, especially if it is using an affiliated contractor, the work must be bid since that is the best way to ensure that costs are at market. In addition, preliminary construction plans should be attached to the lease or the tenant will be at the mercy of the landlord after lease execution when landlord approval of the plans is required.

V. Thou shalt limit the landlord's recourse!

Unlike large public companies, most tenants are typically required to provide security and lease guarantees, and therefore should try to limit the landlord's recourse following a default. Security deposits can be "burned down", meaning reduced over the lease term, and letters of credit can be substituted for the security deposit. If a guaranty is required, the tenant should negotiate for a "good-guy" guaranty, which means that the guarantor is liable only for the time the tenant continues in occupancy after the lease expires or is terminated.

VI. Thou shalt know all sums payable under thy lease!

Leases typically require tenants to pay sums in addition to base rent, including increases in operating expenses and property taxes above a "base year" amount. Tenants should ascertain the approximate amount of such increases before they sign their lease. They should also determine whether base amounts were depressed due to reduced occupancy, tax deferrals or some other factor. If base amounts were artificially low, the tenant could be socked with major increases. Tenants should also negotiate for customary exclusions, such as carve-outs for capital improvement costs, excess management fees and leasing costs. Other sums a tenant should check before signing a lease include charges for electricity and water, overtime HVAC, freight elevator use and cleaning.

VII. Thou shalt maximize thy exit opportunities!

Other than a cancellation option (as described below), the right to assign or sublet may be the best way to reduce tenant risk. If a tenant needs to downsize or relocate, such right allows them to. The main restriction on the right to assign or sublet is the requirement for the landlord's consent. Not only might the landlord reject the proposed transaction, a delay in decisionmaking could cause the deal to crater. Accordingly, the tenant should attempt to negotiate a strict timeframe for the landlord's decision, and any rejection should be reasonably based. In addition, certain assignments and subleases should be exempt from the landlord's consent, such as deals with an affiliate or arising from a merger, reorganization or sale. The "recapture right" (the landlord's right to take back premises proposed to be sublet or assigned) and share of profit from a sublease or assignment must also be negotiated.

VIII. Thou shalt attempt to obtain the right to expand!

Tenants should bargain for expansion rights or options in case they need additional space. At minimum, tenants should negotiate for rights of "first offer". A right of "first offer" requires the landlord to offer the tenant adjacent space before it offers it to others. The tenant then has a specified time to try to come to terms with the landlord, failing which the landlord is permitted to lease the space to others. Most landlords will grant such right since they would first offer vacant space to adjacent tenants anyway. For tenants, such rights are important since they provide at least a first look at available space. Options, on the other hand, are typically granted only to larger tenants because they require the applicable space to be vacant by a specific date, and that impedes the landlord's ability to market the space.

IX. Thou shalt attempt to obtain rights to renew and terminate!

It is disruptive and expensive to move, and therefore it is likely that a tenant will renew its lease. Consequently, tenants should obtain renewal options so their premises are not leased out from under them. Most landlords will grant such options since they would offer the space to the current tenant anyway. Any renewal option should contain an arbitration or similar procedure so the landlord cannot stonewall on the rent, and since there will likely be no free rent or work involved the arbitrators should be required to factor that into setting the renewal rent. Although desirable, cancellation options are usually granted only to larger tenants since landlords typically want to lock in their tenants for as long as possible; they normally require the tenant to pay the unamortized cost of the build-out, free rent and brokerage commissions plus some part of the remaining rent.

X. Thou shall not have thy lease disturbed!

Tenants should determine the financial health of their prospective landlords, including the amount of debt on the property. Failure to do so could result not only in poor services if the landlord goes bust, but in a loss of the lease if the lender forecloses or the ground lease is terminated. Leases are subordinate by law to pre-existing mortgages and ground leases and virtually all leases provide that they will also be subordinate to future mortgages and ground leases. Accordingly, unless the tenant conditions such subordination on obtaining a non-disturbance agreement (i.e., an agreement providing that the lease will not be terminated due to a foreclosure or ground lease termination), it is at risk of losing its lease (including the amounts it sunk into improvements), especially if it is below-market.

Conclusion

The "Tenant Commandments" is a leasing checklist for tenants, and as many of the checklist items as possible should be covered in the lease term sheet (which, although typically non-binding, does carry moral weight). Obviously, the leverage of the respective parties, as determined by the market, will dictate how each of these items is resolved. A failure to sufficiently consider the Tenant Commandments before signing a lease could result in problems that make the "Ten Plagues" pale in comparison.

ROBERT C. EPSTEIN, ESQ., REAL ESTATE LAWYER
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Article Details
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Title Annotation:Commercial Sales & Leasing
Author:Epstein, Robert C.
Publication:Real Estate Weekly
Geographic Code:1USA
Date:Mar 10, 2004
Words:1545
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