I started this series on commercial leases one month ago. My goal is to cover all of the major issues in a commercial lease over the course of four posts (or maybe more). If you have any specific questions, please feel free to contact me for more information.
Buildout
Buildout tends to be a big topic for tenants looking to rent space for their business. By buildout, I mean the process of reconfiguring the space to suit the needs of the new tenant. Some buildouts are small, maybe moving a wall or adding a door, but some can be huge like installing a kitchen.
Sometimes landlords will do the buildout for the tenant. Generally, when this happens the landlord adds some cost to the rent every month, meaning that the tenant will pay for the buildout over the length of the lease.
I actually like this system for many new businesses, because it defers the cost of renovation for the tenant and works a bit like financing from a bank. Buildouts can cost quite a bit. Large expenses can swamp a small business early in life. By spreading the expense out, the business can more effectively manage its cash flow.
But landlord buildouts are not always a good deal. I recommend that tenants get an estimate of what the buildout will cost and seriously consider the additional rent they will pay. Sometimes the landlord is gouging the tenant on the cost of the buildout.
For example, I represented a tenant that wanted a fairly small buildout for a commercial office. He wanted some walls moved and some glass doors added. Nothing insane, but it wasn’t cheap, either. The estimate for the work was around $18,000. The landlord wanted to add an additional $600/month for the buildout. On a five-year lease that added $36,000 to the cost of the lease (not including the increase in rent every year, which was a percentage increase). The landlord wanted to charge double for the buildout. We decided it wasn’t worth that price tag and the client went elsewhere.
Options
An option allows the tenant to extend the lease at its termination. Generally, there is a period of time where an option is allowed, something like not less than 90 before the end of the lease but not more than 180 days. During that window, the tenant has the right to inform the landlord of its desire to extend the lease for a predetermined length of time. Sometimes the added time is a new term, and sometimes the added term is shorter.
Normally, the extension comes with an increase in rent, which the tenant should plan for. Otherwise, the same terms that applied to the first lease remain in full force and effect.
I consider these provisions to be a benefit to the tenant. It gives the tenant a lot of flexibility. Landlords shouldn’t mind them, either, since they encourage tenants to stay more than one term. They can easier be a win-win situation.
When possible, I encourage tenants to ask for an option. There is usually very little risk for the landlord to agree to an option up-front, whereas once the tenant has been in the space it’s harder to negotiate extensions on term because the landlord might believe that it can get more rent from another tenant.
Arbitration Clauses
Arbitration clauses are becoming very popular in virtually all agreements I review. These clauses normally call for some version of AAA arbitration. Essentially, each party chooses an arbitrator to hear the case and those arbitrators choose a third arbitrator to break ties. This all sounds great in theory, but arbitration doesn’t work for everyone.
Arbitration can be very slow. The process is somewhat unwieldy and there is no central body, like a court, to moderate disputes in the process. Frequently, parties would be happier having the matter heard by a local judge. Despite most people wanting to avoid litigation, arbitration does not necessarily save time or money.
If you are signing a lease with an arbitration clause, I urge you to read it and understand the timelines and requirements it imposes. These provisions usually contain specific deadlines for demanding arbitration and choosing arbitrators. Don’t assume that the other side is familiar with the requirements, either. I find that these provisions are included by lawyers without much discussion with clients.
Next Time
In my next post I plan to discuss security deposits, common area expenses, taxes, and insurance. I post these articles monthly so if you have a burning question before then, please do not hesitate to contact me.
