Wednesday, December 21, 2011

First Right to Acquire Adjoining Space

Next segment in our Leasing Series…First Right to Acquire Adjoining Space.

The concept of a Tenant having a ‘First Right’ to lease adjoining space, is often provided for in a standard lease agreement. The benefit to the Tenant is obvious, as it gives them first option on the space should it come available during the term and allows for premises to expand into. Typically the clause can be worded in one of two ways ---
i) the Tenant does not have to act on the space, until a 3rd party offer to lease comes forward – meaning they may be able to buy time during a vacant period.
ii) the Tenant receives notice immediately upon the space becoming vacant.

Landlords normally do not prefer the first option, as they have to engage a 3rd party tenant prospect on the space, serve notice, and wait the period out before knowing which party is taking the space. The 3rd party tenant does not normally care for this delay in learning whether or not they can proceed, given costs incurred in considering the premises (ie. drafting offer proposals, doing due diligence etc.). It can be rationalized as a cost of doing business with the initial Tenant, if at the end of the day it allows them to expand – which is ultimately good for the Landlord.

The second option simplifies the entire requirement, in that the Tenant receives notice immediately upon the space becoming available, or based on a set date at which it will become vacant. This can then allow a Landlord to offer it over to the adjoining tenant immediately upon it becoming available, and prior to having to market it.

As for notice periods, as with everything in commercial leasing, it is subject to negotiation and conditions in your particular market. Typically 1 week to 10 days would be deemed reasonable, with shorter periods favouring Landlords and longer periods favouring Tenants.

Again seek out experienced commercial realtors with strong leasing backgrounds, to assist you in negotiating the appropriate terms on the ‘First Right’ provision within your lease.

Thursday, December 15, 2011

Renewal Options/Holdover Provisions

Next segment in our Leasing Series…Renewal Options/Holdover Provisions.

Generally all lease agreements have renewal options built-in to the initial lease. Both tenant and landlord effectively agree on the basics of a renewal term, with respect to a new term for the space. Beyond the actual duration of the renewal term – other items which may be included would include; the lease rate itself (or some sort of ceiling on a percentage basis) and the notice period for exercising the renewal.

The term and notice period are generally easy to agree on. Where things get more complicated is on the rate itself or a ceiling. Tenants will argue that they do not wish to see a substantial increase in the base rent, as they move into the next term. Landlords will rightfully point out, that they should not be forced to fix base rental amounts, as there is no commitment to remain in the space beyond the initial term. This matter then becomes a very much negotiated term of the deal, and both sides need to determine how forceful a position they need to take.

If the parties cannot agree, depending on the jurisdiction, an Arbitration Process is a practical solution for all concerned. It effectively allows a 3rd party to determine the rate if the parties cannot come to an agreement at the time of renewal. Arbitration can be used for other reasons, but most often it applies when the parties cannot come to an agreement on dollars, with differing views of market rates. There are definite costs to pursue this line of resolution for both sides, so it is best to review them prior to filing for it.

Again, seek out experienced commercial realtors with solid leasing backgrounds in your market to assist you in negotiating the right renewal terms for your purposes.

Tuesday, December 6, 2011

Leaseable vs. Usable (Square Footage)

Next segment in our Leasing Series…Leaseable vs. Usable (Square Footage).

This concept is often times misunderstood by Tenants - that is the idea that LEASABLE SPACE DIFFERS FROM USABLE. Typically this is the case whether we are talking about a freestanding building (for one occupant)or multi-tenanted commercial complex.

In a single user tenancy within a freestanding building, the entire building envelope becomes the leasable amount. For instance, if the building dimensions based on a perimeter measurement are 25’ x 100’, its leasable area is deemed to be 2500’. But if you actually calculate the floor area which you can actually stand on (or use), it is less by the width of the wall sections on all 4 sides. Depending on the building’s construction, this can make for a reduction of 100’-150’.

In the case of a multi-tenant complex, the above determination becomes a bit more complicated. The term ‘common area factor’ comes into play, and it refers to an add-on for shared spaces on a single floor or within a building entirely. These spaces would include lobbies, bathrooms, hallways, and utility closets. It can add as much as 8-12 percent, depending on the extent and size of the common areas within the building. Again, the reality is that the Tenant pays for a percentage of space, above and beyond the actual usable floor area within their actual unit.

In terms of an acceptable measurement standard, one of the most widely used is the BOMA Standard, which is well recognized throughout the commercial real estate world. If used, it becomes the official square footage measuring tool and certifies both the ‘leasable’and ‘usable' square footage for the premises.

Again seek out experienced commercial realtors with strong leasing backgrounds, to assist you in determining ‘leasable vs. usable’ considerations, as well as ‘common area factors’ which may apply in your property search.

Tuesday, November 29, 2011

Restrictive Covenants

Next segment in our Leasing Series…Restrictive Covenants.

Restrictive Covenants (RC) are always an interesting point of negotiation between Landlord and Tenant in working out a commercial lease deal. Rather than pick sides, let me try to give you the differing perspectives for both parties.

If you are a Tenant, you would like to ensure that the Landlord does not put you head-to-head with a similar operation within a commercial complex. For instance, if you are setting up a new hair salon, you would prefer to have ‘exclusivity’ on your use within this location. In your RC, you would cover off the key elements of your operation – ie. hairstyling and aestetics. Practically, these areas should represent the ‘bread and butter’ of your business and they cover a high percentage of your total sales. At the end of the day, you become the one and only ‘Hair Salon’ in this particular development.

If you are the Landlord, you want to ensure you are not allowing RC’s that create problems in bringing in other quality tenants. Going back to the hair salon example, you might want to allow a restrictive on the ‘hairstyling side’, but only for women or not on the aestetics side. This would allow you then to bring in a separate ‘nail salon’ or a ‘traditional barber shop’. The most challenging RC’s for landlords, are generally those that are too broad and cover too many areas, thereby precluding a host of other uses. Although not always easy to do, landlords typically try to respect the tenant’s main business focus, but are not as willing to allow restrictions on their secondary business lines.

As a final note, this will again vary property to property, and generally RC’s get harder to incorporate into a lease, the larger the commercial property gets. In a larger commercial setting, competition is seen as good and this includes in-line competition.

Again seek out experienced commercial realtors with strong leasing backgrounds, to assist you in negotiating ‘restrictive convenants’ that suit your purposes.

Tuesday, November 22, 2011

Additional Rent/Operating Costs

Next segment in our Leasing Series…Additional Rent/Operating Costs.

Additional rent is the other half of the rental amount that applies to commercial premises. Again in industry terminology, this is most often referred to as the ‘operating costs’ of the property. It includes realty taxes, building insurance, maintenance/management costs, janitorial expense, and any other related costs which support the operation of the property. It is applied as a proportionate share of the tenant’s space, relative to the size of the overall property (or building square footage). Simply put, if a tenant occupies 10% of a building, they pay 10% of the total operating expenses, as additional rent.

When considering ‘Additional Rental Costs’ on properties, the amount is represented on a dollar per ft. basis. Additional rent costs, although included on line with most MLS listings, are not as prominent on listing summaries. After doing the net rent comparision - tenants need to make sure they compare the additional rent factors, so as to have a handle on the total monthly cost.

A budget breakdown of additional rent costs, should be available for a tenant’s review, to understand how the cost per ft. is arrived at. It is typically done annually on a projected basis, and then reconciled at year’s end, to the actual expenses incurred on the property. Sounds like a lot of math and accounting - but it should be relatively straightforward and confirms the additional rental costs that apply.

Just a final note, on ensuring additional rent costs do not exceed your expectations during the term of the lease - there is a means of capping increases allowable on additional rent, so that a tenant is not faced with a 10-20% increase from one year to the next. It is acceptable to require a landlord to hold the line on annual increases to a modest % (say 2-3%), in any given year. The only justifiable exceptions would be for property taxes and or utilities, which the landlord has no real control over.

Again seek out experienced commercial realtors with strong leasing backgrounds, to assist you in negotiating the appropriate lease terms for your purposes.

Tuesday, November 15, 2011

Lease Base Rates

Next segment in our Leasing Series…Lease Base Rates.

When considering ‘Base Rates’ on a lease, this figure represents the dollars per ft. being paid for the premises. In industry terminology, this figure is normally considered to be ‘Net Rent’ to the landlord – which excludes all property taxes, operating, and common costs relating to the building. This is generally referred to as ‘Additional Rent’. The Net Rent is the basis of the return being generated on the property from an investment standpoint, and also serves to pay the financing against the property.

From a Tenant’s perspective, although base rates represent a major part of your monthly lease cost, you need to do the math in adding the additional rent portion (if this is confusing, look for our next post on Additional Rent). Typically, leased premises online are quoted at its base rate. As an initial comparison of properties, it is a good starting point.

In evaluating any market, you can typically seek out the base rate range of any district by looking at the active properties available. Getting to the actual base rates paid on recent deals, is a more involved process, but certainly is available if you look in the right places. These places include – MLS (ICX) data, local appraisers, and experienced local commercial leasing brokers.

As final note, what can you expect in terms of base rate fixing for a set lease term? Again things vary market to market and deal to deal – but generally, landlord’s will look for some sort of incremental increase(s) over the term of a lease. It will largely depend on the market you are in - ie. high vacancy vs. low vacancy and your approach in negotiating the deal.

Again seek out experienced commercial realtors with strong leasing backgrounds, to assist you in negotiating the appropriate lease terms for your purposes.

Tuesday, November 8, 2011

Lease Terms

Next segment in our Leasing Series…Lease Terms.

Outside of the actual lease rate itself (meaning the $’s per ft.), defined lease terms are the next most important aspect of the deal for both tenant and landlord. It represents the commitment between the parties, for a set period of time for use of the premises.

Terms will generally vary from market to market, and even from property to property. Newly built developments, be they offices/retail plazas, or industrial buildings, are based on longer term commitments for the most part. Typically 10 years would be the standard, at least for an anchor type tenant - with say 5 year leases being available only to smaller scale tenants. Lease terms are also vital to the financing which landlords arrange on these new builds. Generally landlord’s use the 5 year threshold as the bare minimum.

On existing buildings in most categories, term arrangements can become much more flexible. Start-up businesses often times prefer to stick with shorter commitments, as they are uncertain as to business volumes and growth plans in the early days. Bear in mind though, with 2 and 3 year commitments, landlords have little incentive to assist the tenant in any improvements which the space may require. Shorter term deals for the most part, would be done on an 'as is’ basis from the landlord’s side.

Just a quick note on renewal options (beyond the initial lease term). They are generally provided for on the tenant’s behalf, at a pre-set period in advance of the lease expiration (typically 3-6 months). This then gives the tenant the right to exercise his option to renew the lease, for a pre-determined period. In most instances the rental rate ($’s) , needs to be negotiated at the time of exercising the renewal option.

Again seek out experienced commercial realtors with strong leasing backgrounds, to assist you in negotiating the appropriate lease terms for your purposes.

Tuesday, November 1, 2011

Rent Free Periods

Next segment in our Leasing Series…Rent Free Periods.

Once we begin the process of strategizing proposed terms & conditions on a lease deal, what sort of rent free periods can we expect to obtain? As the saying goes – “as much as you can negotiate“.

But once we consider what might be considered reasonable from the Landlord’s position, you soon realize that there are a certain set of expectations which typically apply. Let’s look at the two scenarios below:

Example 1-
In a case where a tenant is proposing a reasonable term lease and accepting the premises in ‘as is’ condition, generally a landlord will provide a better rent-free
incentive. The rationale is that the tenant, in exchange for a rent-free allowance, will undertake their own tenant improvements at their own expense - thus saving the landlord any tenant improvement cost at the front end of the lease. It will vary deal to deal, but 3 months r/f on a 5 year deal should be reasonable - and assuming the tenant is investing their own funds to complete their improvements.

Example 2-
If the tenant has a requirement for the landlord to invest considerable dollars into tenant improvements on behalf of the tenant, then typically any sort of r/f allowance becomes a token amount. Although it can differ deal to
deal, generally a 30 day r/f might be the best case expectation – often times referred to as a fixturing period. In this scenario, the landlord has a further investment
into the lease and as a result, wants to realize the cash flow from the rent as early as possible after commencement.

Again seek out experienced commercial realtors with strong leasing backgrounds, to assist you in negotiating the rent free terms within your agreement.

Tuesday, October 25, 2011

Lease Documentation

Here is the next segment in our Leasing Series…Documentation.

Once you’ve surveyed and toured the market for commercial premises, and selected a property for your purposes -- how does the transaction get ‘papered’. There are 2 prinicipal documents involved in most cases - the ‘AGREEMENT TO LEASE’ and the ‘LEASE’ itself.

The Agreement to Lease is more or less the preliminary document needed in order to negotiate and secure the premises, and becomes the basis for both the agreement and as the precursor to the final Lease document. All terms of the deal are outlined - including the lease term, rate, additional rental costs, commencement date, landlord’s work, tenant’s work, rent free periods etc. In addition, tenant information is normally provided at this time, so that the Landlord may complete their due diligence with respect to the Tenant and their proposed use.

The final Lease then typically follows - which in addition to including all the terms of the agreement, also includes a comprehensive point by point summary of all the obligations of both parties, among other details. There is no such thing as a typical lease length, as they come in all shapes & sizes – they can be anywhere from 8-80 pages. Involve your lawyer at this stage of the process, to ensure you understand the document front to back, as this is the overriding document as it relates to your use of the space. In most cases, you will and should have signed the final Lease Document prior to taking possession of the premises.

Seek out experienced commercial realtors with strong leasing backgrounds, to assist you on the transactional side of entering into a lease deal. Their experience is invaluable, in helping you to understand the documentation side of it.

Tuesday, October 18, 2011

Inaugural Blog Post - Intro to Leasing

Welcome to our inaugural blog post! We hope to tackle a wide range of subjects encompassing all aspects of commercial real estate, as our blog title clearly indicates. Although we have lots of posts to follow in the weeks and months ahead concerning real estate investing - we felt it was high time someone tackled the area of leasing.

With that said, here is the first entry of ourleasing series...

Leasing commercial premises, be it office,retail or industrial space, requires a level of market expertise which is essential for any prospective tenant. Unlike data which is much more readily available on property sales (either through MLS or Real Track), determining actual lease rates is a very challenging task. Relying on leases reported through MLS or like sources, can be misleading as they do not include improvement allowances, rent free periods, or any other inducements that may apply. These all serve to reduce the 'net effective rent' and obviously the cost to the tenant.

In analyzing any market, that is existing or second generation space, you need to consider the cost per foot on an 'as is' basis - both the rent and operating costs (which we will touch on in a blog post coming soon). That then gives you a common ground for comparison, and then you consider what are the additional requirements needed to make the space work for your business. Do you need an improvement allowance to finish the space to your specs, or can you negotiate a reasonable rent-free period to do some minor renovating on your own? Either way, you need it to be 'turn-key' for your operation when you take possession.

Commercial realtors with strong leasing backgrounds can not only put together the market surveys your require, but can negotiate the other terms which are necessary to make the economics of the deal work to your advantage.

In our upcoming posts on leasing, some of our topics will include: lease documentation, lease terms/base rates and capping mechanisms for operating costs.