Friday, November 2, 2012

Six Factors to Consider Before you Sign That Lease

At our recent statewide staff meeting, we had a presentation from one of my colleagues, Steve Burke, Certified Business Advisor, South Seattle SBDC, on understanding standard leases and tips for negotiating the business elements.  Steve worked for a number of years in the property management business and is one of our 'go-to' guys with complicated lease questions that our clients have.  This jam-packed workshop covered a lot of information that many business owners may not be aware of when they are preparing to lease a property.

There are countless items that business owners should consider before signing a lease and starting a business, (like making sure the revenues and cash flow support it!) but here are six details to be aware of in negotiating a commercial space.

1.  Everything is negotiable.
2.  Read and understand the entire lease.
3.  Be objective.
4.  Two biggest points of conflict.
5.  Sign in the name of business LLC or Corporation.
6.  What is Triple Net?

1.  Everything is negotiable.


There are a number of variables and sections in a commercial lease; some are fairly simple to understand, like what date the lease starts, other sections can be far more complicated, such as 'Late charges and what happens if the tenant pays less than the full payment'.   It is important to understand that all these things can be negotiable (within reason):  rent, base rent, square footage, improvements, lighting, signage, lease terms, options, deposits, possession dates, and more.  Granted you can attempt to negotiate and not all property managers will accept.  You may have more success if you look for a few important items (parking, HVAC repairs, see Number 4), rather than trying to get them to change everything in your favor.

2.  Read and understand the entire lease.  


Important advice before signing anything!  The main point of this comment is to understand what you are signing on for, and if you do not, to ask for clarification.  A lease is a legal document and you should know what you are getting into.

Burke strongly recommends that you do not sign leases longer than five years (look at what happened to those businesses that signed long leases in 2008 before the bottom dropped out).  Also make sure that tenant improvements are defined, as well as square footage and uses (what if you want to sell coffee in your book store, is it allowed?).  Square footage can be calculated by 'usable' square footage, rather than actual.  The Building Owners and Manager's Association (BOMA) Standards are generally acceptable standards for configuring square footage.

For example, most leases include something about tenant improvements - did you know that if a tenant makes any improvements that are professionally installed, such as lighting, walls, plumbing, those items are considered the property of the landlord upon termination of the lease?  This could mean a walk-in freezer, wall sconces or other things that the tenant added later are in fact considered part of the property and remain.

3.  Be objective.


The broker's job is to sell the lease for the landlord.  Says Burke, "They are experts at getting the potential tenant emotionally involved in the desired space.  This typically mutes the rational analysis necessary to help the business succeed."  We see this quite often.  A tenant can be so in love with a space that they fail to see fatal flaws in the location or costly extras.  There will always be another option.  It might not be exactly what you are looking for, but there is always another choice.


4.  Two biggest points of conflict after a lease is signed?  HVAC and parking


Burke advised that typically the biggest source of conflict arises when something happens to the heating or air conditioning (HVAC) system - and who pays for replacing it.  This can be extremely costly for a commercial unit and is likely something that a small business owner has not budgeted for.  Another source of conflict is if the controls are in a separate location for your desired space.  Find out prior to signing who will maintain control and who is responsible for repairs.  Just think if your massage studio is located next to a commercial kitchen that needs the temperature set at 65 and they control the thermostat?  Your massage patients could be freezing and uncomfortable and you may not have any say in the matter if it is not addressed up front.

Parking can be a huge issue as well.  Before you commit to a property, you need to ensure you and your employees have adequate parking.  How many spaces are dedicated to your business if there is a common parking lot?  Does the building charge for parking?


5.  Sign in the name of the business LLC or Corporation.

Burke emphasized that this is one item that is often missed and that many brokers will attempt to have the business owner personally sign, and his or her spouse, rather than putting the name in the lease of the LLC or Partnership.  He states, "It is important to be clear which parties are on the lease.  It should include the LLC or Corporation of which the landlord is a part and include the LLC or Corporation that the tenants are a part.  It should not include individual names as that would make this contract binding between those individuals as a person or an individual and an LLC or Corporation rather than between the two legal business entities."

6.  What is Triple Net?


Triple Net, or the three NNN's are typically:
  • Common area maintenance charges;
  • Property taxes passed through; and
  • Insurance on the overall building and property that is owned by the landlord including common area liability insurance.  
Make sure you ask any questions about NNN if you aren't sure.

SUMMARY

A typical commercial lease may have almost 40 sections, not including any riders or addendums, and it can be difficult to comprehend what the terms and different options mean.  Taking the time to read through and analyze a prospective lease can save you time and money in the long run.  It may also allow you to add in some favorable items that your soon-to-be landlord left out and give you the chance to show him or her that you are a savvy business owner.

Above all...if you have not developed a cash flow, balance sheet and projections, do not sign anything until you are sure that the business revenues can support a lease payment.