We recently did a series on what tenants need to know about signing leases and lease negotiations. You can read part one here and part two here if you haven’t already had the opportunity to check them out. This week, we’re talking about the other half of the lease – what landlords need to know.
If you’re new to the world of owning income-producing properties and are just starting to look over leases, you may find them daunting. They can easily run 40+ pages and include clauses for situations you may have never even considered. Even if you have some experience, there are still some key things you should watch for.
While it’s important to read through the entire lease negotiations (and have your commercial real estate agent and attorney do the same), there are a few basic questions you’ll want to ask yourself as you’re reading through it or writing it up.
1. Who is Your Tenant?
When you sign a lease with a tenant, you’re essentially agreeing to be married to them for three, five or even twenty-five years. You want to make sure that you know who you’re doing business with and that they have the necessary assets to ensure a mutually beneficial long-term relationship.
You also want to ensure that the relationship makes sense for you as a landlord before signing a lease agreement. It’s true that any lease you sign is going to come with a certain opportunity cost, especially if you’re signing with less-established businesses, but the goal is always to keep that cost as low as possible.
Make sure that the entity that is actually signing the lease has the wherewithal to pay the rent.If you’re not leasing to a large corporation or company with a long, credible history, you need to make sure that you’re asking for personal guarantees. The tenant is obviously going to want to mitigate their risk as much as possible, as well, so you’ll likely have to strike a balance here. If Joe Jones has a ton of money, but “Jones Main Street LLC” is signing the lease, you may not have recourse to Joe’s assets when trouble comes!
2. What is the Precise Timeline?
In our 30+ years of negotiating lease agreements, we’ve seen some surprising lease situations. We’ve seen landlords fail to stipulate the exact move-in date or make it contingent upon a tenant getting permits but then never put a deadline on getting those permits.
As a result, the landlords didn’t receive a rent check for months or even years in some cases. Whenever a lease is negotiated, there need to be hard and fast dates included and they need to be in sync with each other. Some of the most important items to stipulate are:
- Lease start date
- Rent start date
- Requirements for the rent beginning
- Drop-dead date if not all requirements are met
Including these dates can get a tenant moving much more quickly on their end and give you some extra security. These dates can be keyed off a specific event (e.g. rent starting 60 days after the Landlord delivers the space), but the key date should be something you can control!
Who Pays for What?
When negotiating a leasing agreement, it’s critical to lay out who is responsible for what payments and how payments will change over time. In almost all cases, both parties will do their best to lay as much risk on the other as possible.
Many will remember the month of February, 2010 — the Baltimore area received 50” of snow, a record. Snow removal costs alone that winter ran us about $0.75 per square foot of the building. How you negotiate your leases will determine to what extent you and your tenants are each responsible for the costs of that snow removal, as well as all of the other operational costs of the building.
For landlords, this may mean some compromises, but ultimately you are looking to shift the risk to the tenant. . For retail space, this usually means a triple-net leasing agreement. This type of structure dictates that the tenant pays its pro rata share of real estate taxes, building insurance, and maintenance fees. It often comes with a lower base rent, though.
Landlords leasing out office spaces may favor a modified gross lease, where the tenant pays only for the increase in operating and property costs above the first year of their lease. The effect is the same; it shifts the risk to the tenant, but the appearance on the face is different, and the tenant knows for certain what their first year’s costs will be.
We’ll be covering a few more lease negotiations and points that landlords should be aware of in part two next week. In the meantime, if you have questions or are looking for help drawing up a leasing agreement, contact Art Putzel today – (443) 921-9326.
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