by Craig Melby, CCIM Melby Corporate Real Estate
Since most commercial real estate leases are initially presented to a potential tenant in a “boiler plate” format, it is critically important to review each and every clause to make sure that no detail goes unnoticed so as to avoid potential landmines that could financially devastate your bottom line.
Scrutinizing the fine print of a lease under the microscope is the only way to mitigate potential dilemmas. A prospective tenant must question every ambiguous clause and negotiate all unnecessary requirements in the contract to avoid financial nightmares that could haunt a company for the duration of its lease term. The most common landmines are:
- Operating Expenses/Audit Rights. Never agree to pay landlord operating expenses that have no exclusions and no cap on expenses. You must always audit all expenses that the landlord expects to be reimbursed by you. Otherwise, you might end up paying for a country club membership or replacing an old roof when you have a short term-lease that expires soon. Instead, provide a long list of carve-outs—items that cannot be added to operating expenses—and thereby minimize the increase in expenses.
- Staying Beyond the Lease Term. This clause is usually expressed as “Holdover” in the contract and sounds innocuous, but the penalty is often Double Rent. A penalty is understandable because the landlord probably needs the space back for another tenant. The space, however, could remain vacant after your departure. Meanwhile, you pay double rent for no reason. Amend the clause: No new tenant, no increase in rent, or at least pay a modest one.
- Relocation. Landlords frequently want the right to relocate your company to a different space. They like this option so they can accommodate major tenants that need adjacent space or the balance of your office floor. That said, you can eliminate this clause if you ask, or at least balance it.
- Building Damage. The landlord usually demands unlimited time to rebuild the premises after fire or other damage, which can be a major disaster for a tenant. What happens if the building is heavily damaged by fire, earthquake, or hurricane and is uninhabitable? As a tenant, you’d like to set up shop someplace else to avoid customer attrition. But if you relocate, you could be liable for rent and operating expenses on the new space and your former space. You have two options: Limit the time the landlord has to rebuild and negotiate a cancellation of the lease in case of major damage.
- Non-Disturbance Clause. This clause, which addresses what happens in the event the property goes into foreclosure, is only problematic for a tenant if the landlord fails to include the clause in the lease. Without this stipulation, a financial lender and new owner of a property can cancel your lease. Make sure a non-disturbance provision is included in the lease agreement.
- Missed Commencement Date. From time-to-time, a landlord does not have the subject space ready when promised, but you’re ready to get set up, move equipment and furnishings in, and open for business. You’ve been hiring, training, and paying new employees and managers for months. We suggest inserting a missed commencement clause in the lease that requires the landlord to give the tenant free additional rent for every day of delay beyond a certain period. This requirement helps the tenant mitigate the extra expenses it incurs as a result of the delay.
- Late-Payment Penalty. Tardiness in payment is sometimes no fault of the tenant, especially with an unreliable postal system in your area. You should negotiate a late payment clause in the lease that allows a late rental payment once a year without penalty.
- Lease Indemnification. Landlords try to indemnify themselves against any possible loss or damage, but sometimes they go too far. This is where attorneys argue about “negligence” versus “gross negligence” and other subtleties, but basically you really want to be protected from the landlord’s action or inaction and that of their employees. Make sure you’re comfortable with the indemnification provision in the lease.
- Sublease & Assignment Rights. Landlords like to maintain control of their property, which is fair enough; however, sometimes they go too far and retain the right to arbitrarily reject a sublease or assignment. This can adversely impact a company’s plans when it wants to sell or acquire a business and has new space needs. Therefore, take the proper precautions and make sure you can live with the conditions of this clause.
- Renewal Options. This is a problem if it’s not in the lease. Renewal options are customarily only provided upon request. You should demand at least one option right, preferably at a set rate rather than a “market rate.” You should also ask for future refurbishment of the Premises at this time.
These problems and other hidden landmines in typical commercial office leases are best defused by a professional corporate real estate advisor. If you negotiate a lease without one, you risk missing an exploding landmine right on your bottom line.