April 23rd, 2023
April 23rd, 2023
For most business owners, at some point during the life of their business, they will probably find it necessary to evaluate the terms and conditions of a Commercial Lease while trying to secure a space from which they can operate the business. Commercial leases are much more subject to negotiation and pitfalls than residential leases, which are more tightly regulated in most states. Depending on the terms of the lease, the success or failure of the business may ride on the lease that has been negotiated. Many business owners hire brokers to assist them with lease negotiations and many landlords employ the services of a broker when attempting to rent a commercial space. However, no matter who is responsible for the negotiating, this guide provides an overview of the topics that should arise in discussions when negotiating the terms of a commercial lease.
It is important to understand from the outset that legally and practically speaking, commercial leases are considerably different from residential leases. Though each state has its own rules and regulations on commercial and residential leases, all states make general distinctions between the two types of leases between landlord and business or residential tenant. Here are some of the major distinctions between these two types of leases.
A residential lease agreement is a contract between an individual tenant and the landlord to use a property for a living space. A typical residential lease for housing includes a space in a home, townhouse, duplex, condominium, or apartment. The property is primarily used as a residence and not for a profit. No commercial purposes, such as for the sale of goods, services, or manufacturing products, exist. The rent for the occupation of a residential rental is typically based on a set amount per month, varying from a month-to-month lease to a term of a year or two.
A commercial lease is a contract between a business tenant and a landlord for use of a commercial property to generate a profit through the sale of goods, services, or manufacture of a product. A business space is generally not designed for sleeping and day-to-day living that would be required for a residential tenant. The commercial property is typically a warehouse, strip mall, or office space in an industrial or commercial building. The rent is usually based upon the amount of square footage occupied by the tenant plus, in some instances, a percentage of the gross revenue received by the tenant. The term of the lease is typically for a set number of years whereupon, near the end of the term, the tenant has an option to renew for another set term.
States are quite uniform in holding that there is little to no protection for the commercial tenant in their business arrangement with a landlord. The commercial tenant is presumed to be on equal footing with the landlord in negotiating a commercial contract, unlike the residential tenant who is considered to be a layman who does not have the same level of business acumen and knowledge as the landlord. The assumption is made that the commercial tenant has the training, experience, knowledge, and sophistication to enter into the written commercial lease, along with access to skilled third-party professionals, such as lawyers, brokers, and contractors, to consult during the negotiation process. Furthermore, the commercial lease is usually uniquely designed for the particular commercial tenant's needs unlike the typical standard form of the residential lease with boilerplate that is not tailored to the residential tenant's needs. The commercial lease is also much harder to break prematurely than a residential agreement.
Generally, leases are for either commercial or residential purposes and this is stipulated in the lease agreement itself. Depending on the lease, using a property for commercial purposes when the lease was for a residential space or vice versa could be considered a violation of the lease terms and subject the tenant to eviction based on this violation. The related issue of zoning laws that dictate how spaces are allowed to be used is discussed later on in this guide.
Before signing a commercial lease, a business owner should make sure they understand and agree with the basic terms of the lease. The following are important considerations that should be addressed in negotiations, and in the lease itself, before the business owner makes the major commitment of signing a commercial lease and entering into a landlord/tenant relationship.
One of the most crucial parts of a commercial lease is spelling out the particulars of the space to be rented in exact detail in the lease. The lease should specify what is included within the space to be rented, including common areas such as hallways, restrooms, and elevators. Further, there should be a determination of whether there is a distinction between the space leased and the actual space that is usable. Often, tenants are required to pay rent on a commercial space measured from wall to wall, also known as a "vanilla shell," even though, after the area is built out for commercial purposes, the resulting useable space may be significantly smaller. Further, some leases measure the space including the thickness of the walls.
If the space is in a shopping center or office building and the tenant shares responsibility for common areas with other tenants, the tenant's responsibilities for the common areas should be clearly explained in the lease. Matters such as who will be responsible for cleaning and maintaining the shared spaces; when the common areas will be open or closed to the business owners and/or the public; and when other facilities such as restrooms and storage are available, must be described in detail.
Another important lease term is the cost of the space. A flat monthly rent or one that will change based on the tenant's earnings at the location, as is often the case in shopping centers and office buildings, must be determined and detailed by the lease. In order to evaluate the cost of a lease, a business owner should compare it with other similar spaces in the same locale. They should not be afraid to negotiate for more favorable rent terms. It is also important to consider allowable rent increases, known as escalations, how often they can occur, and how they will be computed. Commonly, rent increases are less frequent for leases that are for longer periods of time due to the additional stability that the landlord has of having a guaranteed tenant for a longer period of time.
Before signing a commercial lease, the business owner should also consider the time period of the lease, known as the "term." If, for example, they are merely renting a booth at a trade show, then they would only be concerned with a short term lease. On the other hand, if they intend to rent for a year or two, it is a good idea to get an option to extend the lease since, when they advertise and promote their business, the location is one of the main things that is advertised. Moving can cause a lot of problems with mail and telephone numbers and can be quite expensive and a logistical hassle to manage.
Extensive remodeling may be necessary for certain spaces to become suitable for business use. If this is the case, then it is important to determine who will be responsible for the costs of remodeling, who will determine the contractors to be used, and who owns the tenant improvements. In addition, it is essential to find out if the tenant will be responsible for restoring the premises to their original, pre-remodeled condition when the lease ends. This can be expensive and, in some cases, impossible depending on the improvements and the premises itself.
If the business will need special hookups, such as water or electrical lines, the business owner should determine whether the landlord will provide them or whether they will have to bear the cost. Even if the leased premises already has the necessary facilities, the landlord should be questioned regarding the cost of these utilities and whether they are included in the rent or to be paid separately.
For example, in some locations, garbage pickup and disposal is not an issue, since it is one of the services provided by the local municipality. On the other hand, it is common for renters to be responsible for their own trash disposal. In commercial spaces, this can be quite expensive and should be addressed in the lease.
Customarily, the landlord will be responsible for the exterior of the building. It will be the landlord's obligation to make sure that it does not leak during rainstorms and that it is properly ventilated. Aside from these basics, it is important to make sure the lease deals with the question of responsibility if, for example, the building is damaged and some of the business' property is damaged or destroyed.
Similarly, the business owner should find out whether or not it will be their obligation to obtain liability insurance for injuries that are caused in portions of the building that are not under their control, such as common hallways and stairwells. For more information about how to allocate responsibility for damages and injuries under a lease, see the guide "In a Lease Agreement, Who Has the Duty to Maintain and Repair."
In addition to the general terms of the lease, the business owner and landlord should consider the impact of federal, state, and local laws on the lease provisions and how they may affect the landlord/tenant relationship. These are a few of the most important laws and legal provisions that should be considered before entering into a commercial lease.
The Americans With Disabilities Act, also known as the ADA, covers, among other things, real estate. The ADA requires that places known as public accommodations be reasonably accessible or provide reasonable accommodations to people with disabilities. The law is broadly interpreted and includes virtually every form of business. The term "reasonable accommodations" is not precise and, so, it is important to determine what must be done in order to fulfill the requirements of this federal law. Typically, approximately 25 percent of the cost of a remodel to any space covered by this law must be allocated to items that aid accessibility. These would include, among other things, levered door openers, larger bathroom stalls, widened doorways, braille signs, wheelchair ramps, approved disability-accessible doors, and elevators. Business owners and landlords should determine whether the cost of complying with the ADA will be imposed on the landlord, the tenant, or shared.
Environmental laws can have the impact of inhibiting the use of a space for certain businesses. It is essential to determine whether any of the materials used in the business will violate federal, state, or local rules with respect to hazardous materials. In addition, there can be hazardous materials cleanup problems resulting from prior uses of the space to be occupied by the new business. For example, space previously occupied by a dry cleaner, chemical company, automotive repair business, or similar may require an expensive cleanup operation prior to any occupation.
Other issues, such as whether the building contains any asbestos, lead-based paint, or the like, may exist. These present specialized problems in the costs of remodeling and occupation. It is essential to spell out who will bear the costs of any environmental compliance in the lease.
If the business owner intends to use the leased space as both a personal dwelling and for business purposes or if the business being conducted is of a nature of selling highly controlled items like guns or alcohol, legal issues can arise with zoning. Zoning is a restriction on the way land in a particular jurisdiction or area may be used. Zoning laws help local governments preserve property values and ensure that communities are both functional and safe places. The local government usually sets the zoning rules and regulations for their particular locality. Typically, jurisdictions are divided into zones classified by particular types of land use. So, one area might be zoned for residential use, another nearby for commercial use, and an area outside of the city for agricultural use to raise livestock. Hybrid zones, such as mixed-use residential and commercial buildings, may exist within these broad categories. Areas around schools or playgrounds often have zoning restrictions that prevent businesses such as gun stores, adult clubs, or bars from operating within a certain distance of that zone. These restrictions should be taken into account when assessing whether a potential leased property is a good fit for the business that the business owner hopes to conduct out of it.
For the business owner who wants to live and work in the same space, local zoning ordinances can be a significant issue. Some city ordinances flatly prohibit using the same space as a business and as a dwelling. In some commercially zoned areas where low-cost spaces are available, it is illegal to maintain a residence in the same space. In residential areas, regulations may require permits and restrict the size and use of the workspace. Before signing a commercial lease for a property that a business owner also hopes to use as a dwelling, it is crucial that they check with the appropriate local government agency to determine specific requirements and whether their intention would be restricted by local zoning laws.
Long-term leases are recordable in some states. Recording, where permitted, is generally accomplished by having the lease filed in the same office where a deed to the property would be filed. Recording a lease protects the tenant's interest in the building and stops any confusion or misunderstanding about who has an interest and stake in the property. Further, having a lease recorded means that the tenant will be entitled to receive notices, legal and otherwise, that are related to the property. Local real estate title companies can explain more of the particulars about what is available in that state.
Negotiating a favorable lease can have a major impact on the success or failure of a business. By staying abreast of the most common commercial lease issues, a business owner can ensure that any commercial lease they sign is well-suited to their purposes and will not stand in the way of their success.
About the Author: Malissa Durham is a Legal Templates Programmer and Attorney at Wonder.Legal and is based in the U.S.A.