The tenant commandments - Commercial Sales & Leasing

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

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.