USEFUL TIPS FOR NEGOTIATING COMMERCIAL LEASES:
Signing a commercial lease in California is one of the biggest, if not the biggest, financial commitment your business will make. Commercial leases are easy to commit to, full of traps for the unwary, and very hard to get out of without significant pain and expense. When you consider that a commercial lease is an enormous financial commitment (five year lease at a rental rate of $5,000 per month is a $300,000 liability), it really pays to develop a basic understanding of commercial leases and to learn how to avoid common pitfalls.
Commercial leases are binding: A commercial lease is a specific type of contract. In a commercial lease, the owner (landlord) of a building or land grants your business (tenant) the exclusive right to use some or all of the building or land in exchange for monthly payments of rent. Commercial leases can be oral, though almost always the terms are spelled out in a very long written contract. Many commercial leases use pre-printed forms that are then further modified in the landlord’s favor by the landlord’s lawyer through an addendum attached to the back of the lease. Commercial leases can be enforced in court and the landlord almost always has the advantage in a lawsuit because the contractual language favors him.
Understand the lease and bargain: Your job is to understand the unfavorable terms and then bargain as hard as possible to improve them. Even if you don’t completely succeed in eliminating unfavorable terms, you will know what you are agreeing to and be better prepared to fulfill the responsibilities that you are undertaking.
Consider what may go wrong: Think like a lawyer. This means trying to figure out the different ways in which you and the landlord may end up in a dispute. Then negotiate the potential disputes with the landlord before signing the lease so that the two of you can figure out how to allocate responsibility in the written lease. It is always better to negotiate a resolution of potential problems before signing the lease rather than signing the lease and then fighting in court over unclear or unfavorable provisions.
If it isn’t in writing — it doesn’t exist: When you bargain, never rely on oral promises made to you by the landlord before or after the lease is signed. Most written leases have an entire paragraph devoted to disclaiming (i.e. denying) the existence of any oral agreement outside of the written terms of the lease and stating that any modification to the lease must be made in writing. If the landlord promises you improvements to the building you are thinking about leasing, get the landlord to describe in detailed writing what improvements will be made, when they will be made, and that the landlord will pay for them. You can also attach drawings to the lease that illustrate the improvements to have further clarity. If the landlord objects to putting any promises in writing or waters down the promises once they are written down there is an overwhelming chance that you will not get what the landlord promised orally.
Rent isn’t the only lease obligation: Many business owners bargain hard over the rent and then happily sign any rental agreement given to them by the landlord thinking that they got a great deal. This is understandable. The written lease contract is usually difficult for a business person to digest because it is very lengthy, contains small type, and is commonly packed with legal terms that are hard to decipher. When you are signing the lease, it is hard to image that there will ever be any dispute between you and the landlord. The tenant may be excited about the new premises, the landlord is on his or her best behavior, and all the fine print in the lease seems irrelevant. Many business owners discover that the fine print in the lease obligates them not only to pay monthly rent but to also pay significant property taxes as well as maintenance and utility expenses on top of the rent.
Do your homework: Most landlords will not guarantee that the rented premises are suitable for the type of business you are planning to run. For example, the lease may permit you to run “an auto body repair business” or more broadly a “car repair business” but not other businesses. However, this is not a guarantee that the city or county will permit you to run an auto body or any auto repair business in the rented location. You must check city and county records to determine whether the landlord has received any notices or warnings related to the property and talk to the zoning officials. An auto body repair use that was permitted 20 years ago may no longer be permitted today. Prior body repair shops at the premises may have been granted an exception (been “grandfathered in”) and this exception may not extend to you. The more industrial the use the more likely you are to run into zoning restrictions. Do not assume anything and whenever possible make the lease contingent on your business obtaining a use permit for your specific business.
You may be taking the premises “as is”: Most of the time the owner will give you the rented premises “as is” meaning that they are not making any guarantees or warranting about the condition of the premises. Other leases may provide for a very limited warranty meaning that the landlord will fix certain problems but only if they are reported within 30 or 60 days from the beginning of the lease. Most industrial businesses may not look like palaces but the structural condition of the leased premises does matter. Have a good contractor inspect the premises you want to rent before committing to the lease and either get the landlord to commit in writing to fix items at the landlord’s expense or agree to fix the items yourself but ask for a rent credit. Common problems include cracking foundation, damaged walls, leaking roof, non-functioning HVAC, and lack of compliance with ADA (lack of handicapped access). These issues can be very pricy and difficult to fix because they may trigger further upgrades and remodeling necessitated by new building codes.
You may have to fix everything: Most commercial leases place the burden of fixing the premises mostly or entirely on the tenant. You may be obligated to fix all problems with the premises if the landlord does not provide a warranty or the warranty expires, and the lease makes fixing all problems at the premises your responsibility. Read the commercial lease carefully to determine whether the landlord is taking any responsibility for repairs and whether or not these responsibilities expire shortly after the lease begins. Negotiate so that the landlord agrees to fix any problems with the roof, walls, foundation, and the parking lot throughout the duration of the lease.
Get a shorter lease with options: Try to avoid signing a long term lease unless you are absolutely sure that you can get the same length of lease with a shorter initial term followed by several options. A 10 year lease is not as good as a 5 year lease with an option for another 5 year extension or a 3 year lease with two 3 year extensions. Options give you flexibility because near the end of the term you can choose to either exercise the option or to let the lease expire and move to another location.
Use CPI index for rent increases: A fixed increase is the commonly accepted method to escalate rent in a commercial lease context but it may yield high rent down the line. So if possible don’t tie the annual rental increases to a fixed percentage per year unless the fixed annual rent increase is less than 3% per year. A low initial rent may grow significantly over time if the rental increases each year outpace inflation. It is advisable to tie the rental increases to the local Consumer Price Index that tracks the actual inflation in your area. This means that the rent will track inflation and therefore remain constant in today’s dollars.
Good attorneys are useful: A good attorney, like a good doctor or car mechanic, can be your best friend. It is always advisable to consult an attorney before signing any significant contract and this is especially true for a commercial lease. Anyone who has gone to court over a written contract will confirm the old saying that “An ounce of prevention is worth a pound of cure”.
No matter how hard you negotiate you may still sign a commercial lease that favors the landlord. However, given today’s poor economy and high vacancy rates, you owe it to yourself to get the best deal possible not just on the rent but on the entire lease.
Based in San Francisco and the Bay Area, Attorney Martin Zurada regularly advises and litigates on behalf of California businesses.
Please remember — this web site only provides general legal information but not legal advice. You should consult a lawyer who will provide you with legal advice by applying the specific laws in your state to your specific factual circumstances.