Through the years, I have had the opportunity to represent both landlords and tenants in the negotiation of commercial leases. In addition to that, as an investor in commercial real property, I have negotiated, from the position of an owner, the terms and conditions of long-term leases. It is from this experience that I offer the following observations regarding potential challenges and pitfalls involving commercial leases:
- The parties to a commercial lease have typically agreed upon a price and initial lease terms. From there, one of the first sticking points often becomes whether or not the landlord will grant the tenant an option to extend the lease. Personally, as an owner of commercial property, I am opposed in general to granting the tenant an option. From my perspective, an option to extend the lease is solely for the benefit of the tenant and provides no particular benefit to the landlord. Essentially, by granting an option, the landlord is giving the tenant the right, but not the obligation, to stay in the property after the expiration of the first term of the lease. From an owner’s perspective, I have never seen the benefit of this clause. That being said, there are certain situations wherein a strong regional tenant will insist on an option period. Were that to occur, it is certainly appropriate that the parties would negotiate an increase in rent during the option periods. However, the problem that arises is that the tenant has no obligation to stay, so the net effect is that the landlord is obligated to make the property available to the tenant, but the tenant is not obligated to keep renting the space. From an owner’s perspective, I have never found that to be very attractive.
- Use of the premises. I have seen this issue arise in negotiating leases for retail shopping centers. Specifically, if a tenant in a shopping center is in the business of selling furniture, for example, they would typically insist upon a clause that prohibits another tenant from selling furniture. This is true of tenants who are in the food and beverage business, or really any other business. They simply do not want competition within the shopping center, and this is understandable. However, these clauses need to be given careful consideration in regard to the precise wording. An unintended consequence whereby a prospective tenant is precluded from leasing space because of a use prohibition granted for the benefit of an existing tenant can cause some economic hardship to the owner.
- Most commercial leases contain a clause prohibiting assignment or sub-leasing without the consent of the owner. Certainly, this is a clause that owners value. However, from the tenant’s point of view, they should negotiate to retain the benefit of assigning their lease to a third party. In fact, the inability to assign or sub-lease the property diminishes the value of the lease to the tenant and can, in certain circumstances, create economic hardship.
- Triple net leases. Much has been written about the perceived benefit of a Triple Net Lease. The term “Triple Net Lease” is essentially shorthand for a contractual agreement that obligates the Tenant to pay its proportional share of the annual property taxes, property insurance, and common area maintenance. The benefit to the landlord of a Triple Net Lease is that any increase in property taxes, property insurance, or common area maintenance is typically passed along to the tenant.
- Improvements, modifications, and repairs. Typically a lease will reflect that the tenant has to return the property in its original condition upon termination of a lease. Tenants can and do negotiate verbiage that carves out normal wear and tear to the premises or damage not caused by the tenant’s control. A related issue is alterations. This is an issue that is easy to overlook but can have a potentially large impact upon the termination of the lease. It is not uncommon for a tenant to modify or improve the leased space. This may require landlord consent. Certainly, landlords do not want tenants modifying the premises without prior approval. So, in total, modification of the leased premises, repair of the leased premises, and the condition of the leased premises upon termination of the lease must all be considered and negotiated.
- Termination and accelerated rent. A commercial tenant must make certain it understands the procedure for terminating the lease. Of particular importance is the implication of terminating a lease early. In the absence of a clause to the contrary, it is my belief that a landlord is entitled by law in Kentucky to accelerate rent if the tenant breaches the contract before its terms has expired. So, for example, if the rent was $1,000 per month and the tenant walked away from the property with 14 months left on the lease, more likely than not the tenant owes the landlord an additional $14,000. I have seen commercial leases wherein sizeable regional tenants insist on a clause that rent cannot be accelerated. This does not mean that the tenant does not owe the rent for the remainder of the term, but rather the entire amount is not due immediately upon breach. Rather, the tenant still owes the rent each month as it comes due.
- Security deposit. Landlords and tenants need to discuss and make sure it is clear what can and cannot be deducted from the security deposit.
These are just a few of the normal issues to be tackled when negotiating a commercial lease. In the final analysis, depending upon the amount of money involved and the duration of the lease term, lease agreements can be very detailed, resulting in time-consuming negotiations that should not be taken lightly. A real estate attorney can provide invaluable assistance.