The tenant commandments - Commercial Sales & Leasing

Real Estate Weekly, March 10, 2004 by Robert C. Epstein

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.